The Difference Between A Pension Plan And A Provident Fund

Unveiling the Nuances of Provident and Pension Funds in Kenya

Saving for retirement is a crucial financial undertaking, and in Kenya, civil servants, including teachers, now participate in a compulsory contributory scheme known as the Provident Fund.

As we explore the differences between pension and provident funds, it’s essential to understand the distinctive features of these schemes and their implications for retirees.

Provident Fund: Compulsory Contributory Scheme for Civil Servants

The Provident Fund, a mandatory contributory scheme for civil servants in Kenya, guarantees the payment of lump sums and other similar benefits to employees upon leaving employment.

This includes the provision of benefits to the dependents of employees in the unfortunate event of their demise during service.

Unlike pension funds, provident funds offer members the entirety of their accumulated balance as a lump sum at the point of retirement.

Pension Fund: Monthly Pension and Commuted Lump Sum

In contrast, pension funds follow a structure where a portion of the retirement fund is commuted as a lump sum at the time of retirement.

The remaining balance is then disbursed as periodical payments, providing retirees with a steady monthly income stream.

The commuted amount from the pension fund is subject to specific regulations, allowing no more than one quarter of the retirement benefits in schemes without member contributions and not exceeding one third in schemes with member contributions.

Understanding Defined Contribution (DC) and Defined Benefit (DB) Schemes

Within the pension and provident fund landscape, two prominent structures emerge: Defined Contribution (DC) and Defined Benefit (DB) schemes.

These structures significantly impact how retirement benefits are determined and disbursed.

Defined Contribution (DC) Schemes

In a DC scheme, both employees and employers contribute fixed amounts, either as a percentage of pensionable earnings or a specified monetary value.

The retirement benefits are directly tied to the cumulative contributions, net of expenses and premiums paid for insurance.

The final retirement income is contingent on factors such as the level of contributions, deducted charges, and investment returns during the accumulation phase.

DC schemes present a degree of uncertainty regarding the ultimate retirement benefit, as it is not predefined.

The variability is influenced by the performance of investments, deductions for expenses, and the overall financial health of the fund.

Defined Benefit (DB) Schemes

On the other hand, DB schemes guarantee predetermined benefits based on the scheme rules, often linked to the employee’s final salary and years of service.

The fixed nature of benefits in DB schemes provides employees with a clear understanding of the retirement income they can expect.

The table below illustrates the key distinctions between DB and DC schemes:

Aspect	Defined Benefit Schemes	Defined Contribution Schemes
Employer Contribution	Assumed by the Employer	Fixed by the Employer
Employee Contribution	May or may not be required	Fixed by the Employee
Risk of Investment Performance	Certainty of Benefits	No Risk of Investment
Potential Increase in Cost	Issue of Sustainability	No Potential Increase

Hybrid Schemes: Blending DB and DC Features

Hybrid schemes seek to combine elements of both DB and DC schemes, offering a unique approach to retirement savings.

Despite potential variations, hybrid schemes are categorized as DB due to the promises made to members.

In navigating the intricate landscape of retirement savings in Kenya, individuals must comprehend the nuances of provident and pension funds.

The choice between these funds, along with the structure of DB and DC schemes, depends on personal preferences, risk tolerance, and financial goals.

As the Provident Fund becomes a mandatory contributory scheme for civil servants, including teachers, it is imperative for individuals to make informed decisions based on their unique circumstances, ensuring a secure and comfortable retirement.

FAQs on Pension Vs Provident Fund

1. What is the difference between a pension plan and a provident fund?

A pension plan provides a steady monthly income stream to retirees, with a portion of the retirement fund commuted as a lump sum at retirement.

In contrast, a provident fund offers the entirety of the accumulated balance as a lump sum at retirement.

2. How does the Provident Fund benefit civil servants in Kenya?

The Provident Fund guarantees the payment of lump sums and other benefits to employees upon leaving employment, including benefits to dependents in the event of an employee’s demise during service.

3. What is the structure of a pension fund?

In a pension fund, a portion of the retirement fund is commuted as a lump sum at retirement, with the remaining balance disbursed as periodical payments, providing retirees with a steady monthly income.

4. What are Defined Contribution (DC) and Defined Benefit (DB) schemes?

DC schemes involve fixed contributions from both employees and employers, with retirement benefits directly tied to the cumulative contributions.

In contrast, DB schemes guarantee predetermined benefits based on scheme rules, often linked to the employee’s final salary and years of service.

5. How do hybrid schemes combine features of DB and DC schemes?

Hybrid schemes blend elements of both DB and DC schemes, offering a unique approach to retirement savings.

Despite potential variations, hybrid schemes are categorized as DB due to the promises made to members.

6. How should individuals choose between pension and provident funds?

The choice between pension and provident funds, along with the structure of DB and DC schemes, depends on personal preferences, risk tolerance, and financial goals.

It is essential for individuals to make informed decisions based on their unique circumstances to ensure a secure and comfortable retirement.