Transcript Voluntary Pension System

Voluntary Pension
System
Its Development, Structure &
Prospects
Nasim Beg
11th August 2005
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Pensions in Pakistan
The Background
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Dependant on the next
generation to provide for us
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Like most countries of the world, Pakistan has weak provisioning
for pensions.
We primarily depend on the next generation to provide for us
during our retirement.
Most governmental jobs are covered by unfunded pensions –
current employees will be paid pensions by taxing the next
generation.
Some private sector employees and the organised sector labour
are covered by funded pensions. Funds are primarily invested in
government bonds, which will be repaid by the next generation.
A very large section of the population has no pension
provisioning – totally dependant on the joint family support
system.
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Pensions that exist
are mostly inadequate
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Most government jobs entitle one to a pension
linked to one’s last drawn salary but the salary does
not necessarily reflect one’s true earnings – mostly
salaries are low and are supplemented by benefits,
which can include plots of land that help make up on
the low salary. Thus the pension is a fraction of the
true wage.
Private sector pensions are better but applicable to
a very few.
Most employers require a minimum years of service
to get pension rights. Only EOBI allows for
portability of pension rights.
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Employers worldwide want to get
away from defined benefit plans
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Defined benefit pensions systems require employers to ensure
availability of funds to meet the obligation.
Many plans set up in Pakistan under a high real interest rate
environment are now creating an additional burden on the
employers.
High market volatility makes the investment of pension funds
even more burdensome.
Employers would rather have defined contributions and let the
employee carry the burden of the final benefit.
In turn, the employee would get portability through the defined
contributions system.
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Tax Breaks
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Most pension regimes give varying degrees
of tax breaks.
Most pension savings and incomes in
Pakistan are tax free.
Some long-term savings which can be used
towards retirement by individuals are entitled
to tax deferral.
Some savings towards annuity plans give tax
rebates.
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Pension Reforms in Pakistan
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Reforms have been considered on several fronts –
funding of government pensions, allowing for
portability, compulsory provisioning by all employers,
proper regulatory authority, etc.
There has been some discussion on a national
pension scheme but many difficult issues have
forced the government to initially concentrate on the
Voluntary Pension System.
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Development of the
Voluntary Pension
System
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Initiated by the Finance
Ministry
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The current Prime Minister (then Finance Minister)
initiated the process soon after taking charge of the
Finance Ministry.
The SECP was given the assignment to develop a
pension system.
Several models were studied. The first proposal of
2002 recommended a mandatory system. This was
not accepted by the Finance Ministry.
The SECP then commenced work on a second
proposal for a voluntary scheme.
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Evolution of the
Voluntary Pension System
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The SECP set up a committee in June 2003 consisting of persons from
Industry, the Ministry of Finance and the SECP itself.
The committee had several meetings and developed a broad proposal
recommending a voluntary scheme, with a tax deferral structure.
This was presented by the SECP to the then Finance Minister.
Some additional research was conducted, including study of models in
some emerging economies.
The final draft was circulated and posted on SECP’s website and
several meetings were held by the SECP with representatives of
various financial institutions and members of the actuarial profession.
The Voluntary Pension System Rules, 2005 were finally issued in
January 2005.
The SECP had continuous interaction with the CBR throughout.
The Finance Bill 2005 has introduced several changes in the Incometax law incorporating all the necessary features for an EET structure.
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The Structure of the
VPS
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Main Features
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A self contributory pensions savings scheme open to all adult
Pakistanis registered with the tax authorities, if not covered by other
occupational pension schemes. Employers can also contribute.
Certain limits on the maximum annual contributions with some catch-up
provisioning for persons above 41 years age.
Contributions to be invested in specially set up mutual funds, with
flexibility of individualised asset allocation through individual accounts.
Stringent requirements for licensing of pension fund managers under
SECP regulation. Fee structure much lower that normal mutual funds.
The individual can diversify savings (contributions) amongst more than
one fund manager and can transfer the account to other fund
managers.
EET structure, i.e., tax rebated on contributions, investment income and
gains accumulate tax-free, tax is paid at the stage pension is drawn.
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The Legal Structure
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VPS Rules set up under the framework of the NBFC
Rules, which in turn are issued under the
Companies Ordinance, 1984.
The VPS Rules allow for asset management
companies and life insurance companies to be
licensed by the SECP as Pension Fund Managers.
Pension Fund itself is authorised by the SECP as a
unit trust scheme and structured under the Trust Act.
The Income Tax Act provides the tax breaks.
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Structure of the Pension Fund
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Three sub-funds - equity, debt and money-market. Additional
asset classes later.
SECP mandated investment policy governing each asset class.
Mandatory for each Fund Manager to offer a minimum of four
pre-set asset allocation plans. Very Conservative plan with
maximum 20% equity and Aggressive plan with maximum of 80%
equity. Two additional plans (like life-cycle) may be offered by
Fund Manager during first 5 years.
Each sub-fund to announce NAV based prices daily.
Management fee not to exceed 1.5% p.a. and Front Load 3% but
no load on transfers.
Funds will not distribute dividends but are totally exempt from
tax.
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Investment Limits &
Restrictions
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Equity – Limits: 5% per company, 20% per sector.
1% per green-field, 5% total green-field. None in
unlisted or PFM’s associated companies.
Debt – Limits: at least 50% in government securities.
Other debt range between 5% in any AA rated and
2.5% in BBB. Average duration of fund within 10
years.
Money-market – Limits: GoP securities no limit;
Others upto 20% (Minimum rating A-); Bank
deposits no limit but 25% per bank. Average
duration of fund not to exceed one year.
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Participant’s Rights
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Tax rebate on contributions of upto 20% of income or Rs.
500,000 per year.
Eligible persons investing under VPS (Participants) have right to
save with one or more PFM.
Right to transfer the account to some other manager/s once a
year. No restriction if PFM is de-authorised.
Select plan of choice within the offerings of each PFM.
Select retirement age between 60 and 70 years.
Cash out any time before retirement by paying tax.
Draw 25% of fund at retirement tax-free (grey area).
Opt for an annuity plan or income draw down plan at retirement.
At age 75 funds left over must be invested in annuity plan.
Receive account statements and financial statements.
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Regulation
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SECP to license PFMs and authorise
schemes.
SECP shall measure performance against
benchmarks. SECP may take corrective
action. SECP will publish comparative
performance each year.
SECP can order Special audit.
SECP can carry out inquiry/inspection.
SECP can de-authorise manager and fund.
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Prospects
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Wonderful opportunity for self-employed to build their own pension funds.
Opportunity for employees not covered by occupational pensions to build their
portable pension funds.
Opportunity for corporate sector to supplement or replace provident funds with
matching contributions to VPS for their employees.
Opportunity for NRPs to build pension funds in Pakistan.
Opportunity for individuals to build professionally managed portfolios, with
optimal asset allocation.
Example of asset allocation benefits: Rs. 1,000 invested each month and
increased over time in line with salary growth (average 15% p.a.) over 30 years;
Equities give Rs. 34 million; DSCs Rs. 24 million. Please note that DSCs no
longer giving old level of real returns and are now taxable.
Opportunity for corporate sector and local governments to benefit from inflows
into the market.
Regular inflows will help market stability.
Over time should overtake investment in NSS and replace the traditional
retirement savings and long-service plans of the corporate sector.
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Thank you
Questions welcome
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