“Improvements required in Voluntary Pension System

Regulatory Regime”

Nauman A. CheemaActuary

Co-ordinated attempt by SECP and CBR made to introduce Voluntary Pension pillar in Pakistan

Previous attempts did not meet desired success (RAS)

RAS did not fit into overall environment VPS is a step-forward but to what extent? In my opinion, improvements needed to make the

Scheme effectively workable.

INTRODUCTION

IS VOLUNTARY PENSION SCHEME NEEDED?

Certainly Few people covered by retirement

benefits in Pakistan For covered people, amounts are

grossly inadequate.

EXISTING RETIREMENT SCHEMES

Individually purchased Schemes practically non-existent

Employer sponsored Schemes, in some percentage of formal sector, in the shape of Provident Funds Gratuity Schemes Superannuation Funds

Important to view all 3 as part of Pakistan’s existing “Pension System” (apart from EOBI).

MAJOR REASONS FOR NON-EXISTENT INDIVIDUAL

ANUITY/PENSION SCHEMES Short-term “lump-sum” thinking generally prevalent

in the country, accentuated by Government policies Capital gains non-taxable and that too regardless of

holding period (stocks, mutual funds, real estate etc.) Extremely unattractive and irrational tax regime for

annuities, even as compared to insurance Lump-sum withdrawals from life insurance policies

at any age considered tax exempt Labour laws mandate lump-sum schemes Non-tying up with Corporate Pension System

environment

CORPORATE PENSION ENVIRONMENT

Employer paid benefits enjoy extremely tax favoured environment

E, E & E all the way Heavily geared towards tax free lump-sums (PF

receipts are tax exempt on leaving service regardless of age)

Employee money has less favoured T,E,E treatment

Employee money is relatively small in employer schemes – mainly PF’s

ESSENTIALS FOR VPS TO SUCCEED

Needs to enjoy tax treatment at least as favourable as corporate schemes (E,E,E)

Needs to incorporate short term tax incentives

Needs to incentivize lump-sum withdrawals (within limits)

Needs to be able to attract corporate money

VPS SCHEME – INDIVIDUAL, CORPORATE SPONSORED

OR BOTH

Basically for individualsCorporate involvement appears to be an

after thought (changes are required).

IMPROVEMENT AREAS IN EXISTING VPS REGULATORY REGIME

In view of above “essentials” for success, following areas (in my opinion) need to be amended

A. Unfavourable tax treatment on retirement (E,E,T) Installments fully taxable Commutation gray area

Changes required in IT laws

B. Unfavourable tax treatment on death Withdrawals taxable Annuity fully taxable

Changes required in IT laws

C. Unfavourable tax treatment on disability VPS Rules envisaged disability as regular retirement IT laws do not incorporate VPS thinking Disability restrictively defined in VPS Rules

Amendments required in VPS Rules & IT laws ….

IMPROVEMENT AREAS Contd……..

D. No tax relief in case of emergencies OR needs above certain age essential to introduce tax exempt limited withdrawals for

above

Amendments required in VPS Rules & IT laws

E. Tax relief on 25% commutation apparently allowed (gray area) compared to 50% in occupational scheme accumulated tax free withdrawals (including commutation)

upto retirement should be 50%

Changes required in VPS Rules & IT laws

F. Eligibility Criteria

Extremely important to review eligibility criteria in VPS Rules and IT Ordinance and understand differences

VPS RulesEligible Persons are i. Pakistani Nationalsii. Over 18 years of ageiii. Have valid NTNiv. Not employed in any position entitled entitling them to

benefits under any “approved occupational scheme”. Provided contributions can be made if occupational scheme does not entitle to benefits in current year of service.

Eligibility Criteria Contd……..

IT Ordinance

Eligible Person is :

i. an individual Pakistani

ii. has NTN

iii. not entitled to benefits under any other approved employment or

annuity scheme

Eligibility Criteria Contd……..

Areas of difference are :i. 18 years condition waived in IT lawsii. Eligibility criteria made more restrictive by

a. Excluding persons currently or prospectively entitled to benefits under pension scheme of another employer

b. Excluding persons, under all conditions, employed in positions covered by approved pension or annuity schemes

iii. Terminology of “approved occupational scheme” is used in VPS whereas “approved employment pension or gratuity scheme” in IT Ordinance. Is there a difference? Government or Army Schemes?

Eligibility Criteria Contd……..

Areas of difference need to be removed Little rationale for excluding individuals covered in

occupational/employment pension schemes due to :

i. general low and variable levels of occupational pensions

ii. “pensions” provided by other schemes such as Gratuity and PF

NTN condition needs to be removed for corporate money

Amendments required in VPS Rules and IT Laws

ISSUES TO BE ADDRESSED AND CHANGES TO BE MADE FOR

EFFECTIVELY ALLOWING VPS TO ACT AS EMPLOYEE BENEFIT

SCHEME

Some areas that need to be addressed : Total employer contributions to all EBF Limit of Rs.500,000/- employer

contribution on behalf of all employees (?!)

ISSUES TO BE ADDRESSED Contd….

Employer contribution can be currently many times employee’s salary(?!)

How is tax credit determined if employer and employee both contribute to VPS

Taxability of employer contribution to employee above a certain limit

NTN condition will exclude low paid employees (!)

ISSUES TO BE ADDRESSED Contd….

IT eligibility criteria will exclude employees in VPS entitled to benefits under another pension scheme(!)

Retirement age in VPS needs to be made more flexible to conform to employer’s retirement age

Areas of difference between VPS and “Superannuation Fund” need to be analyzed and co-ordinated. Some examples are : Commutation limit Taxability of various benefits Benefits such as early retirement pension cannot be offered

under VPS

Changes required in VPS Rules & IT Ordinance

RISK OF MISSELLINGKey area of concernRisk of misselling increased due to

Only scheme having upfront employee contribution tax credit

General lack of understanding of whole system

Short-term thinking of saver/investor

RISK OF MISSELLING Contd…

As examples, may seem attractive for high-paid individual investor, but is it really in

current largely (capital gains driven) tax free environment?

for PF but is it so after considering full regime of tax, free benefit at all ages, loans etc.?

Huge international scandals, more risk for Pakistan SECP will need to

educate monitor and effectively regulate this risk

SUMMARY First important step taken by SECP

supported by CBR Further changes and refinements

needed to make system more effective in view of i. Prevalent individual related investment

environment

ii. Existing corporate environment

iii. Short-term culture

SUMMARY Contd…

Greater co-ordination between SECP and CBR required for Scheme’s success and increased rationalization

Potential risks need to be monitored and regulated by SECP

VPS needs to move in tandem with investment environments related to individuals and EBF’s

Thank you