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The Risk and Rewards of Investing in Pension Funds
Money Management

The Risk and Rewards of Investing in Pension Funds

One of the top financial goals you must have set for yourself by now is having a dependable source of income when you retire. And if you have embarked on that path, you must have realised it requires a lot of saving and investing, and for it to work out, you need to start early. 

But saving and investing is not a walk in the park, especially if you're risk averse, have a low-risk capacity, or generally have a low-risk tolerance. If you are one of those individuals, you've probably heard of pension funds. 

You can invest in a pension scheme through the National Social Security Fund (NSSF), the premier pension fund in Kenya, or through other retirement benefits schemes regulated by the RBA

But are pension funds a worthy investment? This article will explore the risks and rewards of investing in this vehicle, but first, how do they work?

Read Also: 6 Clever Ways to Overcome Your Fears and Take More Risks in your 30s

How Pension Funds Work 

Pension funds are professionally managed funds that pool together money from employees and employers, invest it on their behalf and provide income to them when they retire. They can also offer compensation in case of permanent disability and assistance to your dependents after your untimely demise. 

Investing in pension schemes can be mandatory or optional; formally employed individuals are required by law to contribute to NSSF, and the contributions are often deducted from their payslips depending on their tax bracket. Individuals can also voluntarily contribute to the national scheme starting with as low as Ksh200 per month.

Pension schemes act in the best interest of their clients (i.e., contributors) and invest their contributions in low-risk investments that will prevent loss exposure. For example, over 75% of NSSF portfolio allocation is spread across government securities, real estate, and deposits. 

Read Also: 10 Things to Do When Taking a Risk Backfires

The Rewards of Investing in Pension Scheme

What benefits do you stand to gain by investing in a pension scheme, and are they worth the potential risks that came with them? Here are some rewards that this retirement planning investment provides.

Generate Income in Retirement 

The biggest reward of investing in any pension scheme is that you are guaranteed income upon retirement. This is, after all, the point of investing in a pension scheme. 

The amount you contribute to the fund over your working years is invested in different vehicles, and the returns will be distributed to members. The higher your contributions, the more you will receive upon retirement. 

Pension schemes support flexible payment options that can be increased or decreased depending on your income. You also have the option to decide how often you want to contribute– monthly, quarterly, or annually. You can also make a lump sum contribution once.

Depending on the contract you sign with your pension provider, there are two ways you can claim your money when you reach retirement age. You can receive it as a one-time lump sum or a series of payments over specified years or for the rest of your life. You can use this money to pay your bills and be self-dependent in your golden years.

Tax Deductions 

The Kenya Revenue Authority (KRA) provides various tax incentives to encourage people receiving income to register for retirement benefit schemes. These incentives include:

  1. Tax-deductible contributions - You can receive a tax relief of up to Ksh20,000 or Ksh240,000 per annum if you contribute to a registered pension scheme. For example, if you earn Ksh85,000 per month but save 15% of your salary in a pension scheme, your taxable income is Ksh72,250.
  2. You pay no tax when transferring your savings from one pension scheme to another.
  3. The first Ksh600,000 is tax exempt for lump sum withdrawals 
  4. The monthly pension you will receive is tax-free unless it's more than Ksh25,000 per month or Ksh300,000 per year.

Benefits from Long-term Investing

Pension schemes are designed to be long-term recurring investments. One of the benefits that come with this is compound interest. The return that your contributions generate is added to your principal and reinvested. This loop continues until your retirement, which is decades away. 

The income that pension schemes generate is also tax-exempt; this allows the members to earn the maximum returns possible.

Since the investments can take decades before they mature, you don’t have to worry about short-term market volatility. While returns might be low when the market is down, you can wait for it to recover without worrying about making a panic exit.

Read Also: The Life-changing Magic of Compound Interest

Professionals Funds Management

Pension schemes are managed with the primary intent of ensuring members receive benefits when they retire. To reduce risks and live up to this promise, pension funds employ qualified financial planners who help allocate their portfolio, advise on how to invest, and create a framework to assess and mitigate risks.

The RBA also requires that pension schemes appoint a licenced auditor who will only work upon approval from the regulatory body. The auditor will ascertain that the annual reports released by the scheme are complete and correct in every respect.

Additionally, pension schemes are required to have a loss protection policy. This can be in insurance or guarantees the RBA sees fit that ensure risks are minimised.

Bundled With Life and Income Protection Insurance 

Some pension schemes can provide additional benefits that protect you if you lose your income due to a permanent disability or terminal illness that keeps you from generating income. You can file an early claim when faced with any of this and will start receiving payments soon before you reach retirement age.

Retirement schemes can also come with life insurance– in the event of your untimely demise. Your dependents are paid an annuity which can be a large sum or series of payments that will ensure their lifestyle is maintained in your absence. This payment can go a long way in ensuring your children receive education and other basic needs.

Read Also: 7 Biggest Mistakes Couples Make in Retirement Planning

The Risks of Pension Funds

Pensions, as highlighted above, can provide a safe way to invest your money and grow your nest egg. But as with every investment, they carry their fair share of risks you ought to keep in mind as you pay your contributions.

Inflation Risks

Most pension plans invest in low-risk vehicles to avoid losing clients' money, which translates to low returns that might not keep up with rising inflation. While you might receive more money than you contributed over your working years, the high cost of living and weakening of the purchasing power of the shilling means the payments you receive might not be enough to sustain you. 

To avoid this, you should factor in inflation when making your contributions and increase it over time. You can also look for pension funds that invest in more risky instruments. But often, these schemes are not RBA members, so you might miss out on the tax incentives and the oversight that keeps your money safe.

Taxation on the Annuity

You are not entirely free from the taxman. While KRA gives juicy tax breaks, exceeding them means you won’t you might lose some money. First, the high cost of living means you will probably need to withdraw more than Ksh300,000 per annum, especially if you don’t have another source of income. The extra amount will be taxed as income.

If you withdraw your plan early or as a lump sum upon retirement as an annuity, only the first Ksh600,000 is tax-exempt. The remaining amount can attract a tax of up to 30%.

You should also note that contributions to unregistered retirement schemes don’t attract tax relief. You will be taxed at the point of contribution and at the point of investment but not on withdrawal.

You have no Control Over your Money.

When you invest in a pension scheme, you give up control over how your money will be invested and what return you will receive. While the fund's manager will work to ensure you get the maximum return possible, rules and regulations prevent them from investing in instruments with risk levels above their threshold.

This loss of control also means you will likely miss out on opportunities that could guarantee higher returns. You will also be unable to withdraw the funds earlier unless you prove you lost your income or have retired.

Additionally, you can only borrow against 60% of your accumulated benefits when you need to take a loan. Even with this, you are still not exempt from the charges and taxes you incur when taking loans, including interest.

Read Also: 10 Assumptions That Are Exposing You to Financial Risks


If you are still in your 30s and formally employed, retirement is decades away, and you probably have the mandatory NSSF pension plan, which can be your backup plan. Before you make this your primary retirement planning investment, you should explore other investments that can guarantee more income in retirement. When investing and allocating assets for retirement, it's crucial that you factor in inflation and other risks that might cause you to outlive your money.

If you have limited financial knowledge or fear taking risks, pension schemes might work for you. However, you should talk to a financial advisor who can help you overcome your fear or help you draw up an investment plan that will expose you to fewer risks. 

Finally, weigh the risks against the rewards you get when investing in pension schemes and make the decisions that make the most sense to you financially. 

Read Also: How to Plan for Retirement While in Your 30s

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Farah Nurow is an experienced Content Writer who enjoys writing creative and educative articles meant to provoke readers' thoughts. He loves sunny weather and thick books. You can connect with him on LinkedIn.

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