Adequacy of retirement income in defined contribution pension plans : case of teachers service commission and Jomo Kenyatta foundation
Ogot, Calleb Odhiambo
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The study is a comparative analysis of adequacy of income in Defined benefits Pension plans and defined contribution pension plans. The main objective of the study is to establish whether retirees will have adequate income at retirement under defined contribution pension plan and its differential effects on income distribution among different categories of retirees. Problem with Defined Contribution Pension plan is that the benefits to retirees are not certain because the benefits depend on the contribution rates and investment returns. Because of undeveloped capital markets in most developing countries, it is unclear whether retirees can achieve adequate replacement ratio in defined contribution pension design. The two-thirds retirement model of Macdonald and Cairn (2006) was used to test adequacy of retirement income. If the DC yields a replacement ratio of forty percent, the retirement income will be considered adequate for this study. According to the World Bank and International Labor Organization, 40% replacement ration is considered adequate for developing economies. To determine the inequality of income among retirees in the two pensions plans a gini coefficient was used. Using a sample of 118 employees of the Teachers Service Commission and 40 staff of the Jomo Kenyatta Foundation, the study established that employees with DB plans are likely to be more secure in terms of retirement income than retirees under the defined contribution pension plan. The results also show that there is greater disparity of retirement income under the Defined Contribution Pension design than under the Defined Benefit plan. The key findings are that DC plans tend to have lower retirement income and higher income disparity among workers compared to DB designs. Whereas basic earnings contribute about 80% of retirement benefits under the defined benefits plans, contribution rates and investment returns contribute about 60% of retirement benefits in Defined Contribution pension plan.