Peter Cox - Head of International Pension Plan Sales

Why end of service gratuities are simply not enough

For your employees, doing more than simply staying afloat through retirement means making financial preparations during their working life. However, for the majority of expatriate workers in the UAE, occupational retirement plans found in western countries do not exist. Peter Cox, Head of International Pension Plan Sales at Zurich Middle East reviews gratuity entitlements in the UAE and explains why it is simply not enough.

You’re going to need a bigger boat

UAE employers’ ambivalence towards addressing employee savings needs means they have to fend for themselves, assisted to some extent by the end-of-service gratuity.

But what is the value of this gratuity payment in the context of adequate retirement provision? Let’s start by looking at some figures.

  • The amount of the gratuity payment depends on the employee’s salary at the time they leave and how long they have been with their employer. It is a ‘defined benefit’ (DB) entitlement.
  • 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 an employee could potentially receive through this benefit, within the UAE, is two times their basic annual salary.
  • To accrue this amount, the employee would have to work for the same employer for just short of 26 years. If an employee left during the first five years of employment, the gratuity entitlement would be reduced by 2/3 (<3 years) or 1/3 (<5 years).
  • This means an employee working for three employers during their working life would take about 30 years to earn the maximum entitlement.

To keep it simple, let’s assume that our hypothetical employee stays with each of their three employers for at least five years.

If an employee retired today on a final basic salary of USD 20,000, having worked for three employers during their 30-year working life, they would be entitled to a USD 40,000 lump sum. (Incidentally, I’m aware that in practice an entitlement would have been paid by each employer on leaving, but please bear with me – the important thing is the USD 40,000 total.

Now let’s put this benefit into perspective

In other developed economies, a company-sponsored retirement savings plan comes as an accepted part of an employment package. For a fairly average DB plan in the UK, 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 and a final salary of USD 20,000 would be entitled to a pension of USD 7,500 a year for life. The ‘cash equivalent’ amount is not an exact science, but bearing in mind the benefit 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 x25 - USD 187,500. Also as pensionable pay includes other elements of remuneration, it is safe to say that the ‘average’ DB plan in the UK is about five times more generous than the gratuity benefit.

“But”, you might say, “many DB plans are closing or have been closed”. And you would be making a fair point.

So, let’s make a defined contribution (DC) comparison

To build up a benefit of USD 40,000 in the UAE today on a $20,000 salary over a 30-year period requires a 4% contribution rate, assuming 3% annual salary inflation and annual investment returns of 6%.

By comparison, a survey by Willis Towers Watson (March 2017) found that FTSE 100 companies with DC plans commit an average of 10% of pensionable salary – and don’t forget, pensionable salary is likely to be higher than ‘basic’ salary! Many employers also match employee contributions producing a more generous overall contribution rate (average of 16.5% according to the same survey).

In many developed economies, employees would also be accruing entitlement to a State Pension. The DC plan benefit would be in addition to this foundation level.

Whichever way you look at it, the gratuity entitlement is simply not enough in terms of delivering the desired sum to fund retirement and is a very poor substitute for a properly structured workplace savings plan. A recent survey by Zurich showed that the vast majority of employees in the UAE (83%) believe that the gratuity is an inadequate method of saving for their retirement years.

Therefore, isn’t it about time that responsible employers faced up to the fact that in order for their employees to cruise comfortably through retirement, they’re going to need a bigger boat? Either that or they risk falling into the jaws of an unfulfilled retirement life!

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