The EPF is not sufficient - laws in Lanka should allow more pension options for individuals

Roshan Perera

INVESTMENT DECISION: Making provisions for your retirement should be one of the biggest investment decisions you will ever make in your life. After all, given that the normal age of retirement in Sri Lanka is 55, your retired life could last in excess of 30 years. In Sri Lanka, if you are in employment, there are broadly three ways in which you can provide for your retirement.

1. The government Employee Provident Fund (here on referred to as the EPF),

2. A company scheme where your employer pays contributions into a privately managed fund, and finally.

3.Your individual savings, either with a bank or through a savings product offered by an insurance company.

If you are working, by law, you and your employer should be making contributions to the EPF. This government run initiative has been set up for you and is the main form of retirement provision in Sri Lanka. Payments are made throughout your employed life and released to you with accumulated interest when you reach retirement.

If you are lucky, your employer may have set up an additional fund for your retirement, however it is not commonplace, and it is more than likely that you as an individual are making provisions to augment the finances available to you in retirement by paying into a separate investment vehicle or investing in land/property etc.

Return at retirement

Assuming a starting basic salary of Rs. 10,000 per month, a salary increase rate of 5% per annum throughout the term of his employment and an EPF return rate of 8% per annum, an employee can, very approximately, expect Rs. 9 million (which, if we assume an inflation rate of 10% per annum, is equivalent to Rs. 760,000 in today’s terms).

If we convert this amount into an annuity (ignoring expenses) you could expect about Rs. 5,000 per month for life in real terms.

Is this enough? This will depend on your standard of living and what you do with your EPF when you retire. As mentioned above, if you are prudent, you are likely to invest this money in an annuity (regular payments in return for a single premium or lump-sum) or in some other form of investment that will give you regular returns throughout your retired life.

However, given that Sri Lanka is facing an ageing population (put simply; people are living longer) coupled with the low age of retirement; it is likely that your EPF is not going to be enough to support you throughout your retirement.

Economic status

The Singaporean Central Provident Fund (CPF) was set-up in 1955 under the British colonial rule with the intent to providing a simple savings-withdrawal scheme for retirement. As with the EPF, the basic principle of the CPF was that an individual’s total benefits are equal to his total contributions plus interest credited to his account.

Initial contributions to the CPF were set at 5% for employee and employer. Contribution levels did not change until, 1968 when they began to rise significantly and were also linked to the economic status of the country; heavier contributions in economically prosperous times and lighter contributions in tougher times.

The fund was solely invested in government bonds and thus the CPF provide the Singaporean Government with a cheap source of credit for social and economic development.

A turning point in the history of the CPF was the introduction of the “Homeownership Scheme” which was designed to encourage the level of homeownership for Singaporeans by allowing them to use a portion of the fund for a down-payment on a housing loan.

However, the outcome was to change the focus of the CPF from a savings-withdrawal scheme into a vehicle for massive state intervention into the housing and capital markets.

The scheme started to withhold large portions of an individual’s personal wealth and link it directly to the housing market were large capital gains and losses were made. (Comparisons can be drawn to the latest Sri Lankan Government initiative where EPF members are allowed to secure housing loans against the capital in their EPF. During this period the member does not earn any interest on their EPF and the loan repayment rate is set at 4% pa).

Little personal choice

The sequence of liberalisation measures contradicted the original aims of the CPF as a compulsory savings scheme and the unpopularity of the scheme where members had little personal choice in the investments was revealed.

The large sums of money that were held within the CPF were set aside for government decision making policies and there were little or no guarantee for the members that the existing government (or new governments) would make honourable decisions with their money.

As highlighted above, a critical issue with the EPF is the purchasing power of the fund. In real terms the rate of return achieved is not likely to be spectacular.

The Sri Lankan government has voiced opinions that members should have more say in the way they can invest their EPF.

This is commendable, however we have to be careful to not lose sight of the original objectives of this type of scheme, which is to provide a tax-free savings benefit for the individual and whilst freedom in investment choices should be welcomed, restrictions on pre-retirement withdrawals should be imposed.

It may be argued that allowing members complete freedom in investment decisions may be a recipe for disaster.

However, it should be possible with sensible restrictions (for example setting limits on the extent of how much an individual can invest in a particular type of instrument - 20% in government securities, 15% in quoted shares etc.) to hold a well diversified portfolio that is likely to outstrip inflation and provide the member with a real rate of return.

Another fundamental point that is of importance is what the members do with their EPF fund at maturity. Based on several interviews with retired people, it is apparent that the EPF money released at retirement is in most cases not spent on the provision of retirement income for the long-term, but rather as a one-off expenditure such as repayment of a loan.

It is worth pointing out that in many cases individuals in this country depend on their children to support them in retirement, however, given the changing social climate and value system, it is unlikely that this type of dependency will be common in the future.

As there are no real opportunities to protect against longevity in Sri Lanka, individuals should be encouraged at retirement to make prudent decisions on how to spend the EPF. One solution would be to impose the requirement for the fund to be invested in a pension at maturity. A proposal would be to set up a Defined Contribution type arrangement.

The Defined Contribution arrangement (also known as Money Purchase) is common in the UK; typically it is an arrangement where employers and employees contribute to a privately managed fund where contributions are tax deductible.

The fund automatically purchases a whole life annuity at retirement for the member and, depending on the complexity of the scheme, other benefits such as spouse’s pension; death benefits (death in retirement, death in service, etc.) are granted.

It may be possible to introduce a similar arrangement in Sri Lanka as a simple extension to the existing EPF arrangement. Of course there are issues of costing and administration that would need to be taken into account, but the final result would have significant social and economic impact.

One could argue that the UK may not be a great model for us to look at, given the problems the British have experienced with Pensions over the last 15 years, however, it must be said that they have acknowledged the issues, such as their ageing population (the UK has recently increased the statutory retirement age from 65 to 68) and the potential deficit people are likely to face in retirement without suitable provisions.

Growth transparent

An optional provision available to individuals is the ability to invest in a “personal pension plan” (PPP) which is a private pension offered through an Insurance company.

The advantages of a private pension are mainly; portability (i.e. - not linked to a specific employer) and contribution levels and investment decisions are largely left to the individual. Many of these schemes are unit-linked so the adminstration and level of fund growth is very transparent to the consumer.

Therefore, in the UK, it is common for an employee to have a Basic State Pension (BSP), a State “Second Pension” (S2P) and either an occupational pension scheme (OPS) or personal pension plan (PPP).

All contributions to these arrangements are tax exempt, thus reducing the employer and employee’s tax burden. Given these considerable provisions for retirement benefits, it is no surprise that pension funds account for almost 40% of investment on the UK Stock Market.

The first thing to do in this situation is to recognise that most Sri Lankans face a major problem with regard to income in retirement and that measures should be taken to protect against these potential shortfalls. We should be able to learn from other countries such as Singapore and the UK by not making the same mistakes.

As we can see from the Singaporean model of the CPF, individuals seek greater liberalisation when it comes to their personal wealth. We should therefore welcome the proposed reforms for greater control in the EPF and ask that withdrawals from the fund are prohibited so as to maintain the objective of the fund.

The government reforms should also “shape” the EPF to allow for a diversified portfolio that protects the individual from adverse market movements and also gives a greater risk-return rate.

This may go some way in mitigating the problem of negative real rate of return in times of high inflation. The government should strongly consider providing pension benefits as an extension to the EPF or impose the statutory requirement of purchasing an annuity at retirement.

This can be done with the value of the whole EPF at maturity or with a proportion of the fund (say 75%) allowing the remainder (25%) as a cash-free lump-sum for those members who require a substantial cash release at retirement.

Importance of recognition

Under the current regulatory, budget and tax legislations, it is difficult for insurance companies to contribute effectively in this retirement market. insurance Companies in this country are at a tax disadvantage given that they are taxed at 32.5% on an I-E basis (Investment Income minus Expenses) where as banks are taxed at 10% on investment income. This is a prohibitively high rate for insurance companies to enter the pensions savings market.

The government should recognise the important socio/economic role insurance companies can play and relax the tax constraints placed on insurers thus allowing them to provide a greater choice of annuity products to the general public at retirement.

Measures should be taken by the government to educate the population on the importance of saving for retirement, the EPF should be restructured to provide greater freedom in investments and insurance companies should be encouraged to provide far more retirement related products, all of which will contribute significantly to the welfare and security of Sri Lankans in old-age.