Staying afloat through retirement means making financial preparations during your working life. However, UAE employers’ ambivalence towards addressing the need for retirement savings means employees must fend for themselves, assisted to some extent by the end of service gratuity.
For the majority of expats in the UAE, the occupational retirement plans found in western countries do not exist. Instead, employers are obliged to make a lump sum payment known as the end of service gratuity.
The gratuity value
The amount of the gratuity payment depends on the employee’s salary at the time they leave service and how long they have been with their employer – it is, therefore, a “defined benefit” (DB) payment.
The rate at which this benefit accrues during their working life is 21 days’ salary for each year of service in the first five years and 30 days’ salary for each year of service after that.
The maximum a UAE employee could potentially receive through this benefit is two times their basic annual salary – or to put it another way 730 days’ salary.
To accrue this amount, the employee would have to work for the same employer for just under 26 years. If they left and joined another employer, the lower accrual rate (during the first five years) would come into play again. This means an employee working for three employers during their working life would take about 30 years to earn the maximum entitlement.
However, this doesn’t factor in an employee leaving during the first five years of employment; then the gratuity entitlement would be reduced by a third or two-thirds. For our purposes here, we’ll assume that our hypothetical employee stays with each of their three employers for at least five years.
So if an employee retired today on a final basic salary of $20,000, having worked for three employers during their 30-year working life, they would be entitled to a $40,000 lump sum.
In perspective
In other developed economies, a company-sponsored retirement savings plan is part of employment.
A fairly average DB plan in the UK for example may be an 80ths plan. This means that the employee would accrue 1/80th of final salary as a pension for each year of service completed.
So an employee with 30 years’ service would have built an entitlement to 30/80ths of final salary at retirement. If the final salary is $20,000, (as above) then this would equate to a pension of $7,500 a year for life.
We now need to calculate a “cash equivalent” amount to enable direct comparison to the lump sum payable under the gratuity model.
Considering the “average” DB plan would include a spouse’s pension on the death of the retiree and there would be some indexation to the pension in payment, the accepted multiple to use is 25 times. This means the “cash equivalent” of the annual pension is $187,500.
Remember, though, pensionable pay would include other elements of remuneration that are not taken into account in the gratuity calculation.
Therefore, the “average” DB plan in the UK is about five times more generous than the gratuity benefit.
But with many defined benefit plans now closing, let’s make a defined contribution (DC) comparison.
To build up a benefit of $40,000 today over a 30-year period would require a 4 per cent contribution rate, assuming 3 per cent annual salary inflation and annual investment returns of 6 per cent, on a final salary of $20,000. How does that compare with other DC plans?
A survey by Towers Watson in May 2013 found that FTSE 100 companies with DC plans were prepared to pay an average of 10 per cent of pensionable salary.
In many developed economies, employees would also be accruing an entitlement to a state pension.
The crux of the matter
The gratuity entitlement is simply not enough to fund retirement. A recent Zurich survey showed the vast majority of UAE employees (83 per cent) believe the gratuity is an inadequate method of retirement saving.
Isn’t it time responsible employers accepted that for their employees to cruise comfortably through retirement, they’re going to need a bigger boat?
Companies that provide a retirement savings solution will find they become an employer of choice with significantly improved recruitment and retention results.
Peter Cox is the head of international pension plan sales for the Middle East and Asia Pacific at Zurich International Life.
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