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Pension plan is an asset accumulation from one's working years and is compensated during their nonworking years. This is necessary as it provides financial security for the retirees. In Malaysia itself, 3 types of pension plans are set out in line with the 3-pillar pension model by World Bank (Rutkowski, n.d), mostly under 2nd pillar on mandatory occupational or personal pension plans and recently on 3rd pillar, focusing on voluntary pension plan. The three types of plans are as follows:
(i) Defined-benefits pension plans
This scheme is usually publicly managed, which in Malaysia, Retirement Fund Incorporated (KWAP) manages the contributions and investments. Benefits are paid to retirees usually based on the average annual salary (if payable in one lump sum) or on percentage of the last drawn salary (if payable monthly until death). However, in Malaysia, the Government Pension Scheme is paid monthly to public servants once retired.
(ii) Defined-contribution pension plans
This scheme mandates employees and employers to contribute a fixed percentage of the members' salary to serve as savings in the fund. Just like most savings, benefits are uncertain as it depends on the scheme's investment returns. Private sector members contribute to the Employee's Provident Fund as a savings plan (Manulife, 2009).
(iii) Private pensions plans
Under this category, the pension plans are decided entirely on the individual. Contributions are voluntary and this plan serves as complementary and supplementary to the other pension plans. Malaysia's Prime Minister, Dato' Sri Najib Tun Razak said the move to introduce the Private Retirement Scheme was to reform and strengthen the entire pension and retirement landscape, giving more options for employees and self-employed to save for retirement plans (Carvalho & Rahimy, 2012).
2. Major developments in pension fund industry in last 10 years
2.1 Contribution Rate
Contribution rates for employees to the EPF had been floating throughout the past 10 years. Contribution rate stands at 11% in 2003 then decreased to 9%, effective May 2004 onwards. However, the rates increased to 11% again in 2008 but down again to 8% in 2010. In 2011, the rates were adjusted to 11% up to now. Contribution rate for employers on the other hand, has had a slight change of 13% to employees with salary of RM 5,000 and above, effective 1st January 2012 onwards. Those below RM5,000 remained 12% since 1995 (KWSP, 2012). This is to meet the volatile economics needs.
Effective 1st February 2008 onwards, with the launch of "Beyond Savings" by EPF, obligation period for employers and employees to contribute to EPF had been extended from 55 years old to 75 years old. This can further ensure the amount of savings in their account so as to have a better life quality in later years (Swiss Life Network, 2012). Members above 75 years-old will have no dividend paid. Also, if pension savings are not withdrawn till the age of 80, it will be transferred to Registrar of Unclaimed Money. Rates of contribution to the pensions differ before and after the age of 55 years old. Before 55 years old, contribution to pensions from employer is 12% while for employee is 11%. Following April 2007 onwards, the contribution rates for 55 years old and above will be reduced to 50% of pre-55-year-old which become 6% and 5.5% respectively unlike previously, they are not required to contribute and dividends are not given (Malaysia Payroll Services, 2009). After the age of 55, they actually no longer need to work. However to encourage these old-age population to continue work and contribute to the country, they statutorily approve them to further contribute even after the age of 55, achieving goal to encourage savings and assist the elderly prepare for retirement.
2.2 Dividend growth
Dividend in % (Annually)
Table 1: Dividend rate given by EPF
(Source: Annual Report KWSP, 2011)
Chart 1: Graph on fluctuation of dividend payout rate by EPF annually (in %)
(Source: Annual Report KWSP, 2011)
There was a steady increase in the dividend rate from EPF from 2003 to 2006. A significant hike was seen in 2007 mainly due to profit from past investments. It was the 10.01% investment growth in 2006 that caused the dividend hike in 2007. However, there was a significant drop from 2007 to 2008 due to the subprime mortgage financial crisis but market health picked up and dividend payout was record high at 6% in 2011 within the past 10 years.
2.3 Compulsory Retirement Age
In 2001, government has increased the age of compulsory retirement of public servant from 55 to 56 subsequently, increased to 58 years old in 2008 and latest one is 60 years old in 2012. At the same time, minimum retirement age for private sector employees from 55 to 60 implemented in 2012 will only be effective in January next year (JPA, n.d. and Daily Express, 2012). There are two reasons for the government making such change. Firstly, average lifespan of Malaysians has increased (See Table 1). Having longer lifespan, they need more funds to support their later life.
Table 2: Life Expectancy of Malaysian citizen
(Source: World Bank)
Secondly, longer working years will reduce the fiscal burden on the Government to pay gratuity and pensions as government's operating expenditure on pensions and gratuity dramatically increased 2.5 times from RM4.9 billion in 2000 to RM12.29 billion in 2011 (Nor, 2012).
2.4 Computation of Pension Payment
Traditional pension scheme was for government servants which provide life-time annuity of usually a half of last basic salary upon retirement. In 2009, the government has decided computation of pension based on formula that takes into account a period of up to a maximum of 30 years of service which will provide additional 20% benefit compared to the previous computation. This new policy is not applicable to officers whose reckonable service is less than 300 months (JPA, n.d.).
For example: A public servant who has 380 months of reckonable service with last drawn salary of RM 3,000.
Upon 31.12.2008 (Older computation)
Retire on 1.12.2009 (New computation)
300 months/600 x RM3,000.00
= RM1,500.00 per months
360 months /600 x RM3,000.00
= RM1,800.00 per months
Table 3: Computation of annuity for a maximum of up to 30 years of service
Throughout these years, the amount of pensions had also been adjusted to meet basic expense required monthly by the pensioners. At the date of 1st January 2009, minimum monthly pension payment to officer (25 or above reckonable service years) had been adjusted from RM280 to RM720, last changed since 2001. This could be a result of rising inflation rates, making it impossible to live with only RM280 monthly. Pension fund aimed to provide some fund for Malaysian to maintain their golden-age life, as mentioned by Ex-Deputy Finance Minister, Datuk Dr Ng Yen Yen (Rajah & Shari,2003). In order to provide a better life for pensioners, their pensions further improved from RM 720 to RM 820 at the year of 2012. According to Prime Minister Datuk Seri Najib Razak, these increases were to act as token of appreciation for pensioners that spent 25 years or more, serving people (Sulaiman, 2012).
2.5 Maximum Leave Accumulated for Cash Award
In 2003, maximum leave accumulated for cash award (GCR) increased from 90 days to 120 days and subsequently to 150 days in 2009. It means that in the employee's retirement year, public servants are allowed to obtain the cash reward of up to 150 days leave accumulated for cash award (JPA, 2012). This shows that the development of the pension scheme provides more employee benefits. As opposed to KWAP, EPF has no statutory cash-in policy for annual leaves were set. It varies from companies to companies as stated by manager of Robert Walters Malaysia, Sally Raj (Leong, 2011). Not all company offers cash-in options for annual leave unlike KWAP with a maximum of 150 days accumulated cash award annual leave policy.
2.6 Account 1 and Account 2
EPF savings are divided into 2 accounts that vary by their withdrawal flexibilities and share of savings that was effective at 2007. Account 1 store 70% of members' monthly contributions and account 2 store 30%. Account 1 allows withdrawals when a member, reaches 55 years old, is an immigrant, is incapacitated, or passes away. Whilst withdrawal of savings from account 2 is allowed to settle down payment or remaining balance of housing loan for first house, provide finance to further education or medical expenses for applier or his/her children's (Daily Express, 2012). This improvement of EPF aids EPF holders during financing distress.
But at January of 2008, EPF holders with savings greater than RM 55,000 in their Account I were permitted to invest part of their saving through external fund managers. Consequently, this changed as of February 1, 2008 (Daily Express, 2012). Only 20% of the balance in the basic savings amount could be invested in products of approved investment institutions. This gives the opportunity to EPF members to get higher profit investment.
2.7 Derivative Pensions
Table 4: Timeline for improvements in derivative pension
(Source: JPA, 2012)
According to Bahagian Pasca Perkhidmatan (2012), government announced that starting from 1 January 2002, derivative pension is given to widow or widower who remarries in order to support the younger children from previous marriage. In year 2004, it was further improved where derivative pension was given to the parents of deceased personnel without a widow / widower or children who are eligible for the derivative pension. It provides financial support to their parents especially for employees who are the only child. Besides, Bahagian Pasca Perkhidmatan also announced derivative pension to be paid to dependants have increased to 100% starting from 1st of Jan 2009. In year 2008, Ex-Prime Minister Datuk Seri Abdullah Ahmad Badawi announced that due to financial burden for families with young children, Government decided to abolish the 70% depreciation on the derivative pension (The Star Online, 2008). Previously, the depreciation of derivative pension to be received by next of kin is 70% of pension after a lapse of 12½ years.
2.8 1Malaysia Retirement Saving Scheme
In the past, EPF does not reach to the self-employed but in 2009, the Prime Minister had announced in Budget 2010 that a unique plan was set up to care for the welfare of all self-employed, that is the 1Malaysia Retirement Saving Scheme. It is to accommodate non-involvement of self-employed in formal retirement plans for financial security, especially those without fixed monthly income for instance; hawkers, real estate agents, actors etc. The scheme is flexible in terms of contribution amount and interval because it depends mainly on how much the individuals can afford, ranging from RM50 to RM5000 (Star Online, 2009). Therefore, this plan was seen as to target a wider range of individuals in the workforce, aiming to overcome income inadequacy during retirement age. It seem almost similar to private pension plans due to the voluntary characteristic but we could say that it serve as a preparation stage before an effective and formal private pension scheme is formed.
2.9 Private Retirement Scheme (PRS)
In July 2012, Malaysia Prime Minister also the Finance minister Dato Sri Najib Abdul Razak launched a new private pension fund, called Private Retirement Scheme (PRS) (Carvalho and Rahim, 2012). This scheme allows people to voluntarily contribute into an investment for constructing future retirement income (Hann, 2012). Launch of PRS also established the Private Pension Administrator (PPA) (Malaysia Chronicle, 2012). The PPA eases and improves the efficiency to members and provides inclusive administration on an effective PRS (Private Pension Administrator Malaysia, 2012). The launch offers employees and the self-employed with an additional way to save for their retirement.
PRS only officially started in September, and is open for all Malaysia and foreigners who age 18 and above. Under the PRS, 24 funds will be managed by 8 providers. Those providers, schemes and funds are as follows:
CIMB-Principal Asset Management BHD.
CIMB-Principal Private Retirement Saving Scheme
-CIMB-Principal Conservative Retirement Fund
-CIMB-Principal Moderate Retirement Fund
-CIMB-Principal Growth Retirement Fund
CIMB-Principal Private Retirement Saving Scheme
-CIMB Islamic Conservative Retirement Fund
-CIMB Islamic Moderate Retirement Fund
-CIMB Islamic Growth Retirement Fund
Hwang Investment Management Berhad
Hwang Private Retirement Scheme
-Hwang PRS Conservative Fund
-Hwang PRS Moderate Fund
-Hwang PRS Growth Fund
ING Funds Bhd
Manulife Unit Trust Bhd
Manulife PRS NESTEGG Series
-Manulife PRS-Conservative Fund
-Manulife PRS- Moderate Fund
-Manulife PRS Growth
Public Mutual Bhd
Public Mutual PRS-Conventional Series
-Public Mutual PRS Conservative Fund
-Public Mutual PRS Moderate Fund
-Public Mutual PRS Growth Fund
Public Mutual PRS-Shariah-based Series
-Public Mutual PRS Islamic Conservative Fund
-Public Mutual PRS Islamic Moderate Fund
-Public Mutual PRS Islamic Growth Fund
RHB Investment Management SDN BHD
RHB Retirement Series
-RHB Retirement Series-Conservative Fund
-RHB Retirement Series-Moderate Fund
-RHB Retirement Series-Growth Fund
Table 5: PRS providers and the schemes and funds offered
(Source: Private Pension Administrator Malaysia, 2012)
This private sector fund providers are licensed and approved by the Securities Commission. (Securities Commission, 2012) According to Carvalho M. and Rahim (2012), employees and employers can contribute to this fund without any fixed amount or interval. The contribution of employer to employees is based on which type of the funds the employees choose, offered by the relevant PRS provider. If the employees choose not to choose any of the funds, the employers need to follow the default option of the chosen PRS provider. Besides, if the member withdraws the pre-retirement withdrawals or the amount in sub-account B from each provider once a year after making the first contribution, they need to pay an 8% tax penalty on the withdrawal amount.
3. PRS Complementing existing pension system
3.1 Management of own retirement income plans
Unlike EPF, PRS allows its contributors to choose between funds based on their financial needs, goals and risk tolerance (Shearn Delamore & Co., 2011). EPF invests the contributions based on their own decision but it may not be of favor of some contributors as some may not prefer the risk consideration by EPF. In 2011, EPF had invested about 64% in fixed income securities (such as Malaysian Government Securities, loans and bonds, money market instruments and properties) (iFAST Content Team, 2012). (See Chart 2)
Chart 2: EPF Asset Allocation as of 31 December 2011.
(Source: iFAST Content Team, 2012)
Based on Chart 2, EPF is considered as a risk-free investment as majority of the investment guarantees return. Therefore, this may not be in favor for risk takers who takes "High risk, high return" as principle. PRS on the other hand takes into consideration of such issue; contributors are free to choose whichever investment suitable for their risk tolerance and even diversify their contributions to multiple funds or providers (Securities Commission, 2012). Doing so, it is a move for the individuals to take control of their own retirement savings planning.
Private Pension Administrator (PPA) illustrates the choice of diversification individuals could take as follows:
Diagram 1: Channeling of contributions to several funds under PRS offered by different providers.
(Source: Private Pension Administrator Malaysia, 2012)
3.2 Withdrawal flexibility
Member of EPF and KWAP is prohibited to withdraw their savings before their retirement age (except for Account 2 in EPF for specific reasons). However, PRS consists of 2 accounts dubbed as sub-account A (70% of total savings) and sub-account B (30% of total savings) is allowed to withdraw whole amount of money in sub-account B after 1 year without any reasons needed but subject to 8% tax penalty for withdrawing whole amount of their savings in both accounts (Security Commission, 2012). Despite the penalty, PRS clearly provides the flexibility in controlling their finance for the PRS members who needed money immediately unlike restrictions from EPF and KWAP.
3.3 Contribution flexibility
As the contribution of private sector's employees to the EPF is mandatory, this action might oversee financial affordability of the employees (Security Commission, 2012). For example, minimum wages implemented this year is RM 900 in Peninsular Malaysia (Gooch, 2012) and take if an employee earns this much of money after contributed to EPF; they will have not much left for daily use. Therefore, they will not have extra fund for investment, having stuck in poverty or middle-income trap for a long time. However, with PRS, they can save more if they can afford and is an investment by itself as contributors can choose their choice of fund, having no minimum contribution or interval for contributions.
3.4 Administrative efficiency
According to Mahalingam (2012), Ernst & Young Australia adviser and global pension practice member Nick Sherry said the recently launched Private Retirement Scheme (PRS) have 8 providers (an optimum number) to manage a pension plan, will result in better administrative efficiency. Ernst & Young also mentioned that if several providers need to link multiple funds and accounts, challenges will occur, however, Malaysia does not have that problem because so far, the main providers are only EPF or KWAP. However, having just one to monitor all investments will lead to too much a workload. Therefore, PRS having 8 providers can not only diversify workload but also provide administrative efficiency.
3.5 Additional Saving Scheme
The newly launched private retirement scheme (PRS), effective in September 2012 acts as a tool to improve the existing pension funds industry in Malaysia. According to Hamid (2012), millions of Malaysians are currently not under the government pension scheme or employees provider fund (EPF) scheme. They normally consist of the self-employed such as night market traders, salesperson etc. Though there is already 1Malaysia Retirement Scheme which accommodates retirement plans for the self-employed, PRS act as a complement or additional tool for them to save. Not only for self-employed, PRS also acts as an additional fund scheme for employees who is already under either the government pension scheme or EPF scheme, to voluntarily contribute towards the retirement saving. PRS participants are entitled to enjoy up to RM3,000 of tax relief, encouraging individuals to save their money under PRS and indirectly contribute more funds to the pension fund industry. (Private Pension Administrator Malaysia, 2012)
3.6 Limitations to PRS
Unlike the EPF where statutory requirement requires dividend payment of at least 2.5% per annum, PRS dividend payments depend entirely on the investment returns (Moneysaver, 2012). Therefore, these contributors must at least have anticipated investment with no return (Risk tolerable).
4. Potential growth of pension fund industry for the next ten years
4.1 Alternative Income
Although statutory requirement for EPF dividends was set to be at least 2.5%, there are chances that inflation rates to be higher than the dividend rate. In average, between years 2007-2011, dividends annually and inflation rate was 5.55% and 2.59% respectively. However, the dividend rate may not always be higher than inflation rate, meaning savings cannot cover the inflation cost. For instance in 2008, dividend was 4.5% and inflation at 5.39% (iFAST Content Team, 2012). (See Chart 3)
Chart 3: EPF Dividend Rate and Malaysia Annual Inflation Rate
(Source: iFAST Content Team, 2012)
As a precautionary measure, EPF officials have constantly highlighted the need for contributors to supplement their retirement with other sources of income. The income can therefore be from other investments, savings or even under the new private retirement scheme. The introduction of the new private retirement scheme will thus aid in accumulation of dividends earned from both EPF and PRS to combat inflation. Take the case in 2008, EPF rate was 4.5% but if added with probably PRS rate of 2%, it will be higher than the inflation rate. Knowing that, public will tend to contribute to PRS to save as retirement plan and in return help grow the pension fund industry.
4.2 Competition enhance efficiency
According to Siau (2012), having more choices of pension fund for members will lead to the competition amongst the funds in both service and performance. Besides, based on the Money Compass (n.d.), in an interview with PRS providers, Datin Maznah Mahbob, CEO of AmInvestment Bank Bhd said that the competition between the providers will grow the PRS industry. Therefore, the competition between PRS providers will not only boost efficiency in service and performance but also help in growing the pension fund industry in a whole.
4.3 Trend Analysis
Chart 4: Graph of potential growth of net assets of EPF
Throughout these years of development and contribution from the labour force of Malaysia, pension industry in Malaysia had a steady increase in terms of net assets under EPF. (See Chart 4). EPF is the main contributor for the whole pension industry as it covered pension fund for all private employer and employee, therefore EPF is said to be the backbone of the pension system. Through the prediction of growth on EPF, the overall picture of growth of the industry could be reasonably foreseen. From the chart above, the trend line have R-square value of 0.9709, R-value of 0.9853 which means, as years increase, net assets increase in value proportionately. The straight-line equation shows that y= 30,000,000x + 100,000,000, which means with every year past, the net assets will increase by around RM 30,000,000, going uptrend. With that, the pension fund industry is foreseeable to grow alongside.
4.4 Higher life expectancy leading higher contribution
According to Yip (2012), Malaysia is currently having an ageing population, with increasing number of citizens entering age group of Generation X and Baby Boomers. Thus, this generation are actively looking for financial security net such as long-term care insurance or private pension schemes to support their retired life. However, due to limited social security benefit for the older people while life expectancy has increased up to 80 years for Malaysians (Park and Estrada, 2012), citizens especially the baby boomers and generation X are facing challenges building adequate savings for retirement. With that issue, they have to form better retirement plans for instance saving or extend their working life. By extending their working life, they are able to contribute more in the EPF scheme, which allows contribution up to 75 years old. At the same time, if they were to voluntarily contribute in PRS, it would secure more funds to support their retired life. With that, it would not only help them in having adequate savings for retirement but also add to the asset in the pension industry, escalating the growth of the industry.
4.5 Wider Distribution Channel
Malaysia currently, as compared to developed country like United States, Germany and Japan, has relatively low coverage of pension system among labour force and working-age population. Developed country, typically, have coverage of 90% on labor force while 60-75% on working-age population.
Chart 5: Percentage of pension system coverage in Asian countries
(Source: ADBI Institute, 2012)
Chart 5 shows the coverage of pension system in Asian countries. As marked, Malaysia pension system covers 50% on labor force while only around 33% on working-age population. As suggested by Schwarz M., defined-contribution pension plan that are calculated based on wages had a problem of low coverage which unable to cover workers who are not part of the formal sector such as farmer from rural population. They need to get themselves registered under EPF in order to gain from the system. Therefore, there is a potential for pension system to expand to rural area for higher growth and involvement into the industry in Malaysia. Through the launching of PRS, PRS provider's agent will cover the rural and urban areas, spreading awareness on the importance of pension fund through various channels hence increasing the coverage of pension system (Yip, 2012).
4.6 Limitation to the growth of pension fund industry
A new pension plan, PRS was introduced in Malaysia recently but do not guarantee the appliers in terms of return compared to EPF, having a minimum of 2.5% dividend return. Although PRS provides 3 different funds with different risk levels (high, moderate and low), catering for contributors with different risk appetite, the scheme is still new. It is not convincing enough to draw contributors in as it may seem as if it is just another savings plan which they could do with the banks what more with no return guaranteed. People will prefer other investment opportunities such as stock, derivatives, bonds etc. All in all, this might hinder the growth of pension funds.
Throughout the years of development, Malaysia's pension system had been developing well, with EPF ranking 5th worldwide (Towers Watson, 2011). From the past, with partial derivative pensions to today's full amount of derivative pensions to deceased's dependents, these developments aimed to provide a better pension system covering participants' and their heirs' welfare. Although current pension scheme had been improving, there is still room for improvement, which was further complemented by the newly introduced Pension Retirement Scheme (PRS) to complete the whole industry. With the introduction of PRS, employees under government pension scheme or EPF now have voluntary additional savings to plan for their future support. As coverage of pension system in Malaysia is considerably low, there are still large potential for the system to grow through various ways.
Hence, a few suggestions that could be done for further improvement was listed:
Establish groups of agency or institution to guarantee the transparency and accountability of pension organizations.
These groups should publish reports constantly to the public regarding the investment and fund management on what they invest in.
Statutory requirement for involvement of all working individuals in pension fund industry.
Since pension fund has no harm and could positively shape people's saving behavior, government can opt to make involvement of all working individual in official pension scheme, a must.
Rural area coverage.
Appoint agents from pension organizations to visit rural areas along with old-age support seminar to educate and encourage rural population to involve themselves in pension funds as retirement plan.
Statutory minimum return
Since PRS is a voluntary private pension scheme, it should be more convincing to attract contributors hence; the contributors should at least be guaranteed a minimum rate of return.