VOLUNTARY PENSION SCHEME: VIABLE
ALTERNATIVE TO PROVIDENT FUND
After studying the Chilean model, the Securities and Exchange Commission of Pakistan (SECP) last year took the first step towards pension reform by granting licenses to four private sector asset management companies to act as pension fund managers under the recently promulgated Voluntary Pension System Rules. Pension reforms are essential to ensure that the macroeconomic gains of the last few years are passed on to the masses. While there has been an exponential rise in consumer spending, the saving rate has remained alarmingly low. Moreover, due to inflationary pressures, the real value of money is continuously reducing. ...view middle of the document...
Whether the contribution comes from the investor or the employer, the benefit of the investment goes to the individual investor. The benefit is not dependent on the length of service or any other condition of employment. In addition, VPS is portable. In other words, the individual’s account will stay with the investor even if he or she changes jobs. Contribution can be resumed at any time either through the new employer or based on personal contribution. The investor can also transfer the account to and from another Pension Fund Manager without bearing any cost.
An important feature of VPS is the up front tax advantage offered to the investors.
Retirees shall be taxed on the benefits they receive (in this case 25 per cent of the savings shall be received tax free and the remaining 75 per cent shall be taxed). Investors can contribute any amount; however they can only claim a tax credit for their contributions of an amount equal to 20 per cent of their taxable income, subject to a maximum credit of Rs. 500,000 per year. Investors over the age of 40 can claim an additional 2 per cent per annum for each year exceeding 40 years of age, subject to a maximum contribution of 50 per cent of the taxable income. Employers making contributions on behalf of their employees are also exempt from tax on the contribution amount. Premature withdrawal before retirement age and benefits received after retirement are taxable.
Most licensed pension fund managers are also providing free insurance cover in the event of accidental death and disability.
Assuming at retirement, the investor chooses to receive a lump sum payment of up to 25 per cent of the accumulated balance, with the remaining portion of seventy-five per cent of the accumulated balance, the investor can enter the Income Payment Plan managed by the pension provider. The Income Payment Plan also comprises of the three sub-funds (equity, debt and money market) but will give investors an income on a monthly basis.
VPS is a more sophisticated and superior scheme vis-a-vis the existing Provident Fund. Provident Funds are inherently flawed for the following reasons: Tax credit is not available on employees’ contribution to Provident Fund. The employer contribution to Provident Fund is not added to the income of the employees. Withdrawals from the provident fund, either temporary or permanent are not subject to income tax. Provident Funds do not offer insurance coverage. There is no separate asset allocation for an employee in Provident Fund. The Provident Fund account of an employee is terminated at the time of job switching and the individual has to make a fresh start in terms of savings. In real terms employees hardly achieve a rate of return which matches, let alone beats inflation.
One of the biggest benefits of VPS will be felt in the area of fiscal deficit. Government of Pakistan has high pension expenditure and this is likely to increase in the future with increasing expenses due to salary...