www.sciedu.ca/ijba International Journal of Business Administration Vol. 3, No. 6; 2012 Published by Sciedu Press 45 ISSN 1923-4007 E-ISSN 1923-4015 An Actuarial Analysis of the Payout Options in Nigeria’s Contributory Pension Scheme Ade Ibiwoye Department of Actuarial Science & Insurance, Faculty of Business Administration University of Lagos, Nigeria Tel: 234-80-3307-8121 E-mail: adeibiwoye@yahoo.com Lukman Ajijola (Corresponding author) Department of Actuarial Science & Insurance, Faculty of Business Administration University of Lagos, Nigeria Tel: 234-80-5581-4056 E-mail: ajiluqman@yahoo.com; lajijola@unilag.edu.ng Received: July 18, 2012 Accepted: September 14, 2012 Online Published: October 26, 2012 doi:10.5430/ijba.v3n6p45 URL: http://dx.doi.org/10.5430/ijba.v3n6p45 Abstract Several years after the reform of the pension scheme in Nigeria, there is still trepidation about the success of the scheme. A particularly knotty issue is the mode of collecting benefits after retirement. It would seem that many retirees prefer programmed withdrawal to annuities without considering their individual circumstances. This portends a dangerous trend for the pension scheme. In this paper we attempt to bring in the individual characteristics into the decision making process by comparing the replacement rates of a potential retiree under the programmed withdrawal with that of life annuity. Our study reveals that life annuity may be the future direction if the scheme is not to face the same fate as the previous defined benefit scheme. Keywords: Defined contribution plan, Payout option, Replacement rate, Programmed withdrawal, Life annuity 1. Introduction Nigeria replaced its erstwhile unfunded defined benefit scheme in the public sector with a defined contribution scheme in 2004.The sheer size of the public sector workforce in Nigeria had made it difficult for the government to pay its workers their salary, let alone adequately meet its pension commitments (Lakemfa, 2004). The crisis generated by this development had necessitated the reform undertaken by government. The new scheme applies to both the public and private sectors. It is aimed, among other objectives, at ensuring that every retiree receives his benefits as and when due, unlike what was experienced by retirees under the old scheme. The new scheme differs from the defined benefit scheme both at the accumulation phase and the decumulation, or pay-out, stage. In the new dispensation both employers and employees are required to contribute to the fund. At the decumulation stage Section 4(1) of the Pension Reform Act (PRA), 2004 clearly spelt out the method for disbursing benefits. It provides that a holder of a retirement savings account upon retirement shall have a choice between programmed withdrawal, calculated on the basis of an expected life span, or an annuity for life purchased from a life insurance company licensed by the National Insurance Commission. Neither of the stipulated methods is risk-free. With programmed withdrawal if the retiree lives longer than what had been projected, the capital may be completely exhausted while the retiree is still alive (Antolin, Pugh and Stewart, 2008), old-age poverty could set in and that might defeat the essence of the pension scheme that targets making retirees get regular income till death. In the case of the annuity alternative the risk that the annuitant may die shortly after he has collected a few income payments makes this option rather unattractive. In particular, the annuity market is still relatively new in Nigeria (PenCom, 2010). It would appear, then, that in the absence of any basis for making an informed choice, many retirees have, irrespective of their individual circumstances, opted for either programmed withdrawal when, indeed, they should have chosen life annuity or vice versa. A first quarter report by the National Pension Commission (PenCom, 2011)