Micro-pensions Demystified

A micro pension is a financial security scheme for investors or individuals with a low income. It combines both the elements of a usual pension scheme and specific features of microfinance. As this pension product is not provided by the government or employer but requested by the investors themselves, micro pensions can be classified as a third pillar pension scheme. However, there are several differences from the setting of the regular pension, as familiar to the citizens of all developed countries. One of these differences is that self-employed people, or those belonging to the informal sector, do not have any official fixed salary. This makes it impossible to use the mechanism of collecting money as taxation of the income, as in most second pillar pension schemes. The income of self-employed people is often irregular and more vulnerable to the risks like natural disasters, uncertainties in the economy, health emergency or theft than that of people working in the formal sector. This makes the collected amount and consequently, the future stream of cash flows more uncertain. This even leaves aside the simple fact that it is often not possible to have a personal bank account for the money accumulation.

There is no strict definition for the micro pension as such. The reason among others is that at the moment all over the world there are almost no examples of sustainable pension schemes designed specifically for investors with a low income. Still, as in the case of a classic pension scheme, the ultimate goal of micro pension is to provide financial security to the elderly, when they cannot continue to work due to physical reasons. Therefore, the pension contributions they have been accumulating should ensure long-term financial security or even health provision in retirement.

The two stages of participating in the scheme for every individual member include the accumulation phase and the payment phase. In the first stage, a future retiree makes regular contributions to the pension fund and the fund collects and invests accumulated money according to predefined investment scheme rules & regulations. The retirement date is the beginning of the second stage when the retiree starts to receive and consume the accumulated wealth. At the retirement date, a few options may appear: the investor can withdraw the accumulated funds as a phased withdrawal (obtaining a share of the accumulated funds on regular basis), a lump sum or an annuity. The phased withdrawal is an option that ensures a stream of income for the retiree for life.

What makes micro pensions different from the classical setting, is the scale of initial investments and the risks involved. People with a very low income are much more vulnerable to any kind of instability in their life, such as health problems or natural disasters, which has a direct impact on their ability to pay regular contributions. In the case of a purely defined contribution scheme, the pension fund plays a simple role of the inter-agent between the investor and pension provision, collecting and investing the money and delivering back a final payoff. In the case of micro pensions, it is a questionable strategy, as poor people cannot take the risks similar to those that regular investors can afford. This means that there might be a need in downside protection, which is an element of a defined benefit pension scheme. Octagon micro pension mitigates this downside in investment by providing an investment with some of the assets in guaranteed /secure assets. The guaranteed return is 4%.

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