The third pillar: Private pension funds offer more options for saving for retirement

Malaysia has long lacked a formal third pillar to its pension system. While the Employee Provident Fund (EPF) is well established and has operated successfully even under the most trying of circumstances, it is seen as inadequate in terms of providing replacement income for the country’s ageing population, and for a population that is living longer.

At the core of the initiative to move away from state-funded pension schemes and a traditional reliance by the elderly on family support is the Private Retirement Schemes (PRS) initiative, a range of voluntary and privately managed funds intended to offer Malaysians several options for building up a private pension as a supplement to a state pension and the existing mandatory private pension scheme administered by the EPF. The PRS will, as the third pillar, provide Malaysian retirees with additional income beyond their second-pillar payout.

Malaysia has no formal first pillar to its pension system, according to Allianz International Pensions. The Social Security Organisation is designed for people earning less than RM3000 ($936) per month and provides a wide range of benefits. But the payouts are low: about RM3000 ($936) per year for a survivor’s pension. The Older Pensions’ Aid benefit is also available but pays a modest RM300 per month ($94). The Civil Servant Pension Scheme has historically been quite a bit more generous. It is a defined benefit plan that has provided between 20% and 60% of final salary. But because of costs and because of concerns that it may not have enough to cover obligations, it is being transitioned to a defined contribution system under the Government Transformation Programme.

The Provident Fund

The mainstay of the Malaysian pension system is the EPF. Founded in 1951, it is considered the oldest provident fund in the world. It covers all private sector employees and public sector employees without civil servant pensions. The self-employed, foreigner workers and civil servants with pensions can make voluntary contributions to the EPF. The rates for the mandatory contributions are 11% for employees, with no maximum, and 12% for employees, with no maximum (though the 0.5% which goes toward social insurance stops being collected for earnings above RM2000, $624, per month). Around 52% of the labour force is covered which, according Allianz, is high for Asia; only Singapore has a higher rate in the region. Payments to the EPF are tax deductible up to RM6000 ($1873) per month. Returns generated by the fund and pension income are tax-free. The system pays a guaranteed 2.5% a year but the actual rate has historically been higher. The withdrawal policy is complicated, but essentially EPF members have been able to access their funds at the age of 55. In general, the system is seen as robust, flexible and relatively comprehensive.

Private Schemes

The PRS is designed to be a true third pillar that will bridge the gap between the EPF payout and required replacement income. The establishment of private retirement schemes is part of the Economic Transformation Programme (ETP). In 2012 the Securities Commission approved eight PRS providers, all major fund management companies or insurers. The system requires that 70% of the funds be in a sub-account not available until retirement. The rest can be in sub-account B, which can be tapped early, upon payment of an 8% penalty fee.

There are now eight PRS providers, providing 44 PRS funds among them, with take-up of the scheme starting to gain momentum. As of end-December 2013, PRS providers have some RM280m ($86.87m) worth of assets under management, a figure that is expected to double by the end of this year. According to the Private Pension Administrator (PPA), the central administrator of the PRS industry, the contributor base will grow from 65,000 members as of the end of 2013 to between 140,000 and 150,000 by the end of 2014.

Tax relief is available up to RM3000 per year ($936), though there is no maximum limit to contributions. Employers can also contribute and receive certain limited tax relief for their payments made to the fund of an employee. Income generated is also tax-free. One of the main benefits of the programme is that all funds in the accounts can be invested freely by the individual, allowing for a level of control not available under the EPF. Under the ETP, the goal is to cover 2.7m people under private pension plans by 2021.

Planning For Future

State agencies and the private sector are combining to promote private pension schemes, as a measure to strengthen provisions for Malaysians in retirement and to boost liquidity in the nation’s capital markets. However, longer-term success will depend on convincing the younger segments of society of the need to prepare for life after work.

The need for Malaysia to increase retirement coverage for its population is becoming more pressing. While the population base is still young, that situation is changing, with more than 11% of citizens expected to be 60 years of age or older by 2020. According to estimates from the World Bank, some two-thirds of Malaysians are currently not adequately prepared for retirement, meaning that the state will have to carry an increasing burden in the coming decades unless there is a far greater take-up of private pension schemes. According to Steve Ong, chief executive officer of PPA, more Malaysians need to ensure their financial security in the post-employment years. “Currently, the income replacement ratio of an average Malaysian is at 30%, which falls short of the two-thirds, or around 66%, recommended by the World Bank. The two-thirds replacement ratio is to provide the financial means to continue with the same living standards and lifestyle one has become accustomed to when retired,” Ong told OBG. “With the PRS, PPA envisages that over time the Malaysian public will have two retirement funds, namely the EPF and PRS, to support their retirement years,” he said.

Younger Customers Targeted

To deepen the savings pool and to spread out the demands on state-funded pension schemes, the government raised the minimum retirement age from 55 to 60 in 2013. This move allows workers to make a further five years of EPF contributions and also gives older workers the chance to buy into PRS funds.

The government and fund managers have been looking at the younger segments of society, those under the age of 30, as being the priority target for the PRS market. As of the end of 2013 only 6% of contributors to private pension schemes were below the age of 30, according to PPA. The agency hopes this will rise to 20% by the end of 2014 as promotional initiatives, including a scheme launched in the 2014 budget offering a one-off incentive of RM500 ($156) from the state to new subscribers, boost interest.

Capital Markets Boost

If, as expected, younger Malaysians start to buy into PRS, this will provide a sharp influx of funds under management, which in turn will serve to add long-term liquidity to the country’s capital markets, with pension investors not looking for a payout for 30 years or more.

In March 2014 the chairman of the Securities Commission, Ranjit Ajit Singh, said that the collective investments segment, which will increasingly be driven by pension funds, has a strong potential for growth. The market regulator will take steps to further expand PRS distribution channels and promote the use of employer-sponsored schemes as part of broader measures to encourage a more sustainable retirements savings culture, he said while launching the commission’s 2013 annual report.

If PRS providers are able to maintain the rate of growth foreseen by PPA through to 2020, they will have a massive asset base at their disposal. PPA anticipates funds under management by PRS providers reaching RM30.9bn ($9.6bn), even with the rising level of payouts expected, by the end of the decade. This will make the funds managed by PRS providers a significant factor in Malaysia’s capital markets, and this should lead to greater demand for long-term bonds and other longer-term asset classes, adding more depth to the market and strengthening its appeal.