Post date: Thu, Feb 23, 2023
Category: Economic Policy
By: Fiona Okadia,

Introduction

The Economic Survey 2022, page 413 states that pensions, social security and individual savings are ways through which workers achieve retirement security. Pensions aid in maintaining the standard of living in retirement, which in turn, prevents poverty. In Kenya, the National Social Security Fund (NSSF) is a mandatory pension scheme, while the Public Service Pension Scheme (PSPS) and parliamentary Pension Scheme (PPS) are exclusively available to civil servants and members of parliament, respectively. Additionally, private-sector employers can establish their own occupational pension schemes, which must be registered with the Retirements Benefits Authority (RBA). This article will solely focus on the NSSF.

NSSF was established in 1965 under the National Social Security Fund Act (Cap 258 of the Laws of Kenya). NSSF performs several functions such as registering members, collecting contributions, managing the fund, and paying benefits to members upon retirement, death, or disability. All employers and employees are required to contribute to the fund, while self-employed individuals can also join voluntarily and contribute based on their incomes. The NSSF has undergone several reforms throughout its existence to enhance its effectiveness as a trusted social security provider. These reforms were introduced through amendments to the NSSF Act in 1987, 1997, and 2013, and the creation of the Retirement Benefits Authority (RBA) through the Retirement Benefits Act, No. 3 of 1997.

Over the 48-year existence of the NSSF, statutory contributions have undergone two reviews. The latest rates were introduced through the NSSF Act of 2013 and are scheduled for implementation in 2023 following their validation by the Court of Appeal, which overturned a previous decision by the Employment and Labour Relations Courts, which had deemed the Act unconstitutional. The NSSF Act, No. 45 of 2013, section 20 (1), introduced a crucial modification, requiring both the employee and employer to contribute an equivalent of 6% of the employee’s monthly earnings for savings. The maximum monthly contribution is Ksh 2,160, while the lowest is Ksh. 360 dependent on the employee’s income level.

 

The Three Effects

The implementation of the NSSF No. 45 Act of 2013 will have three significant effects. Firstly, it will increase the amount collected by NSSF annually and lead to a growth in the fund’s size under management compared to the base case. Secondly, it will drive up the cost of employment, and thirdly, it will increase the individual pension savings of employed individuals who do not have a private pension saving scheme.

  Increase in Savings

Table 1 below computes the changes in contributions deposited with the NSSF based on the implementation of the NSSF No. 45 Act of 2013.

The calculations are based on the following assumptions:

1. The composition and number of formal sector employees categorized by income groups remain the same as in the base year of 2020.
2. The final figure does not include old provident, new provident, fines, and penalties as they are insignificant compared to pension contributions. For example, in 2021, the pension contribution, old provident, new provident, fines and penalties comprised of 7% of the gross contribution of the year.
3. Voluntary contributions are not taken into account, which would increase the total collections.
4. Contributions from employers who unilaterally complied with the requirements of the law despite disputes in court in 2013 are not included.
5. No employer seeks exemption for tier 2 contributions.

Table 1: Changes to NSSF Contributions Based on Implementation of the NSSF 2013 Act

The Annual Report of the NSSF 2020/21 reveals annual contributions of Ksh 13.20 billion before the implementation of the NSSF Act 2013, which will increase to Ksh. 70.1 billion with the new contribution rate, representing a 431% increment.

In March 2022, the Retirement Benefits Authority reported the overall assets as of December 2021 were 1,547.43 billion, therefore a Ksh 70.1 billion contribution will represent about 6% annual addition to the total assets relative to the position in 2021. The proposed increment may pose new risks to the NSSF, which could result in regulatory implications, including higher compliance costs. Furthermore, it may attract greater public and regulatory scrutiny, raising questions about the management of the funds.

Pension savings at the individual level will also increase. An employee with an average monthly salary of Ksh 5,000, will now save Ksh. 7,200 annually from Ksh 4,800, representing a 50% increment. On the other hand, an employee earning a minimum monthly wage of Ksh 100,000 will save 440% more than they were contributing from Ksh 4800 to Ksh 25,920 on an annual basis. This increment in savings would hold provided the contributors do not reduce savings elsewhere to accommodate this increment.

Also, the employer incurs additional costs in order to comply with the new law.  As illustrated in Table 2 below, an employee earning a monthly wage of Ksh 50,000 has a net pay of Ksh. 41,457. With an increment in her contribution to the NSSF, her net income will be Ksh. 40,841 showing a reduction in her disposable income by Ksh 616.

  Table 2: Changes in Net Pay Due to additional NSSF Contributions for an Employee with a Monthly Wage of Ksh 50,000.

The employer incurs an additional cost of Ksh 880 for the employee’s NSSF contributions. Thus, the cost of the amended regulations is shared between the employer and employee, with the employee foregoing part of their disposable income. However, despite this loss, the average employee still has a net saving of Ksh 1,044 per month.

In 2021, a World Bank publication reported Kenya’s gross savings to be 16% of GDP, which is lower than Sub-Saharan Africa’s average of 25%. Increasing savings contributions could improve this ratio, and if incentives fail, some governments may use compulsion. There is a positive correlation between GDP and savings because savings provide funds for investment in productive activities. “This link is not significantly determined by the level of economic development”. Efficient domestic savings are important for economic growth, and national economic policy should aim to encourage people to save therefore policies to raise savings are conventionally desirable.

High savings can fortify a country’s citizens against shocks. However, it is important to ensure that politicians do not misuse the fund or invest in projects with little economic multiplier effects.

Pursuant to the provisions of Regulation 21 and the Fourth Schedule of the National Social Security Fund Act No.45 of 2013, employers who wish to remit Tier 2 contributions into a contracted-out scheme as provided may apply to do so to the RBA. Employers will be required to submit a duly completed Form C1 together with the requisite attachments referred to in the form for consideration by the Retirement Benefits Authority. For a scheme to qualify to receive Tier II contributions as a “contracted out scheme,” it is required to meet the Reference Scheme Test. The Authority shall issue a Reference Scheme Certificate to Schemes that have met the said qualifications.

This duration of opting out by employers should be shortened. The reason is that the application for the issue of a contracting out certificate shall be submitted to RBA at least 60 days prior to the intended date of contracting out. Also, within 30 days of receiving the application, RBA will determine whether the employer is to be issued the contracting out certificate. This raises the question of does the employer continue to remit tier 2 contributions while awaiting confirmation and if the application is granted, will the contributions previously made be refundable? To ensure that employers can opt out before new contributions take effect, a 60-day grace period should be in place unless there is a reimbursement caveat.

Challenges Associated with the Implementation of the NSSF Act

 

1. The Complexity of the Policy

The tier 1 and 2 contributions can be complex for laypeople, yet policies should be easy to understand. Employees can simplify the process by calculating 6% of gross salary, not exceeding Ksh 1080, and deducting Ksh 360 (tier 1) from the result. For instance, an employee earning Ksh 15,000 will contribute Ksh 900, and their tier 2 contribution will be Ksh 540 (Ksh 900 – Ksh 360)

2. NSSF’s Poor Investment Performance

In spite of its size and guaranteed collection, declared returns by the NSSF have been consistently lower than that of most private provident funds and pension schemes. Legislation ought to be passed to allow Kenyans to choose their preferred pension schemes, thereby fostering choice and competition without perpetually preserving the monopoly status of an underperforming public pension manager. It seems that is what is partially achieved by having employers opt out of tier-two contributions, but this should have been extended to the entire contribution. Mandatory savings may be justified but there is absolutely no reason that contributors should be compelled to save with NSSF if they know they can get a better deal elsewhere while diversifying their risks too. This means that employers and employees who have an existing pension fund should be allowed to opt out entirely of NSSF if they can produce evidence that they are already saving at the required rates.

Table 3 below shows what the members of the NSSF have received as returns for the last 8 years with the highest interest being 12.5% in 2013/14. It is immediately evident that with the exception of 2013, 2016 and 2020 the returns for the other years were all below the inflation rate meaning that this fund is not even achieving the basic requirement of maintaining the economic value of the contributions.

Table 3: Trend Showing Declared Interest by the NSSF

Financial Year	Declared Interest	Annual Average Inflation-December
2013/14	12.5	5.72
2014/15	3.0	6.88
2015/16	6.0	6.58
2016/17	7.0	6.30
2017/18	7.0	7.98
2018/19	3.0	4.69
2019/20	3.0	5.2
2020/21	10.0	5.41
Source: NSSF Annual Report 2020/21-page 48, Central Bank of Kenya.

3. Investment Portfolio

The NSSF portfolio heavily invests in government securities, accounting for 58.86% of total assets in 2021, followed by quoted equities and immovable property at 22.98% and 15.23%, respectively, in the same year. With a large portfolio size and a young demographically advantageous membership, citizens should expect better returns for their pension savings. Increased savings could support the development of Kenya’s capital markets and diversify the investment portfolio, reducing reliance on government securities. Relying solely on government securities can limit diversification and expose the pension fund to various risks. Compared to other options such as corporate bonds, returns from government securities are lower, if safer.

4. Administrative Costs

There should be stricter regulations governing the administration costs of the NSSF. The key performance ratios as shown in Table 4 below illustrate that the percentage of total operating costs takes up to 44% of the contributions. The NSSF 2013 Act, section 50(1) provides that there shall be paid out of the fund expenses not exceeding two per cent of the total fund assets for the administration of the fund. Further, section 50(2) states that the percentage provided in subsection (1) shall apply in the first year from the commencement date and the Board shall thereafter take necessary measures to ensure that the percentage reduces and is capped at one and a half per cent in the sixth year following the commencement date. Upon commencement, these administrative costs should not exceed 2%. Such measures ensure that the members achieve the best value for the money that they have put in freeing up more money for pay-outs and investments.

Table 4: Summary of Key Performance Ratios in Percentages-NSSF

Source: NSSF Annual Report 2020/21-Page 34.

5. Taxes Upon Maturity

Section 5 (d) of the Third Schedule of the Income Tax Act, states that the savings for retirees above the age of 50 years or those who have contributed to the pension scheme for more than 15 years are taxed using a graduated scale when they make lump sum withdrawals. This means that the first Ksh 400,000 is taxed at a 10% rate, the next Ksh 400,000 at a 15% rate, the third Ksh 400,000 at a 20% rate, the fourth Ksh 400,000 at a 25% rate, and any amount exceeding that is subjected to a 30% tax rate. The tax rate is higher for those who withdraw their pensions before the age of 50 years.

However, this tax policy can have negative consequences, as it serves as a disincentive for retirees above 60 years, who rush to withdraw their money immediately after they turn 50 years, as the tax rate remains the same regardless of their age henceforth. This goes against the objective of ensuring financial security for workers upon retirement. Moreover, the same money received has been devalued by inflation, and low-interest rates make it insufficient to provide adequate social protection in old age.

The Kenyan government as part of its policy objectives of promoting a savings culture can adopt a flat tax rate incentive for all individuals regardless of the scheme when accessing their pensions at the age of 60 or above by adjusting the pension tax structures. These citizens can incur a flat tax rate of 10% on their pension earnings which could encourage them to save more.

 

Conclusion

The NSSF Act 2013 is expected to have different effects on pension savers of all income levels, but its most significant effect will be in the increment in the size of contributions managed by the NSSF. These could in turn lead to increased retirement benefits and investments that create economic growth. Nevertheless, the implementation of the NSSF Act 2013 will present challenges, such as a modest rise in employment costs for employers, and the added risk of manipulation of the fund to direct investments to favoured political projects, whose results would be invariably disastrous.  The reality of these risks creates the imperative for extensive institutional and administrative reforms at the NSSF in terms of administration, investment choices and board appointments. Oher internal reforms should include managing the funds, diversifying investments, minimizing administrative expenses, and enhancing returns on savings.

---

More Blogs

---

---

---

---

---

---

< < < More Blogs