CHAPTER 1
Learning Objectives

This chapter focuses on the basics of the Malaysian pension and retirement system, the World Bank’s multi-pillar pension framework and the need for Malaysia to develop the private pension industry.
At the end of this chapter, you should be able to:
(a) describe the current state of the Malaysian pension and retirement landscape and its key players;
(b) describe the World Bank’s five pillars framework for pensions and how it applies to the Malaysian context;
(c) give examples of the Schemes under the different pillars;
(d) recognise the need for higher retirement savings;
(e) explain the need to develop a private pension industry; and
(f) describe the benefits of the PRS.

1.1 THE THE MALAYSIAN PENSION AND RETIREMENT LANDSCAPE
The Malaysian pension and retirement landscape may be categorised along two distinct lines:
(a) public sector versus private sector pension schemes; and
(b) mandatory versus voluntary pension schemes.
Public sector and private sector schemes
Public sector schemes tend to be defined benefit plans in which the beneficiaries do not contribute at all to their retirement.
Two examples of the public sector schemes are the Kumpulan Wang Persaraan (Diperbadankan) (KWAP) and the Lembaga Tabung Angkatan Tentera (LTAT).
The KWAP provides pensions and other benefits for retired civil servants while the LTAT provides the same for retired armed forces personnel.
On the other hand, private sector schemes tend to be defined contribution schemes where there is a direct linkage between the amount contributed, the returns of these contributions and the resultant pension nest egg.
Two examples of private sector schemes are the EPF and the employer-sponsored retirement schemes. The EPF is governed by the Employees Provident Fund Act 1991 (EPF Act) and reflects the contributions of both employee and employers. The employer-sponsored retirement scheme refers to a retirement scheme established by a corporation in order to provide benefits to employees of that corporation or for its related corporation. It comes under the purview of section 150 of the Income Tax Act 1967 (Revised-1971) which provides a tax incentive for employers to contribute towards their employees’ retirement savings.
Mandatory and voluntary pension schemes
Mandatory pension schemes are retirement schemes that are mandated
by law. In Malaysia, all private sector employees have to participate in the EPF scheme by contributing a portion of their salary (currently the contribution is mandated at 11%) towards their retirement savings. The majority of these savings can only be withdrawn at the retirement age and the rest of the contribution can only be withdrawn under specific circumstances.
Voluntary pension schemes, as the name suggests, are retirement schemes that are voluntary and unlike the EPF, the minimum contributions to the voluntary schemes are not mandated by law. Currently, an example is the employer-sponsored retirement scheme. The purchase of annuities qualifies as voluntary schemes. The PRS initiative falls under this category.

(a) The adequacy of individual retirement savings
The average retiree in Malaysia faces the real issue of adequacy of retirement savings and whether these savings will last, given the uncertainty of life expectancy and capital erosion with inflation. The tables below illustrate the amount needed to sustain a suitable life-style post-retirement.

Amount of lump sum needed at the onset of retirement, assuming a life
expectancy of 20 years post retirement and an ability to invest the lump sum at 2% per annum:

RM2,000 per month required in retirement RM392,434.40
RM3,000 per month required in retirement RM588,651.60
RM4,000 per month required in retirement RM784,868.05

The table below shows the amount of savings per year needed to achieve the lump sum above, given the years available to save (until retirement) and assuming the individual can invest and compound the savings at 4% per annum:

So for example, an individual who is 40 years old and wants to retire in
15 years’ time with a retirement income of RM3,000 a month would need
to save RM29,398 a year, assuming he can invest this at 4% per annum over
the next 15 years while saving for retirement. Changing the variables such
as the time to accumulate the savings, the investment interest rates and the required retirement income would of course change the calculation but the crux of the matter is that there is a need for an individual to put aside a substantial amount of savings to achieve a post-retirement life-style that is acceptable.
Hence, there is a necessity to prepare an appropriate retirement savings plans so that the individual will have a sufficient nest egg come retirement. This nest egg should be made up of mandatory savings of the EPF and supplemented with voluntary schemes like the PRS. Both are necessary to ensure sufficient retirement savings. The EPF will provide the minimum savings and the PRS will help maintain a life-style that the retiree desires.
To determine the required income for the retiree, there is a need to understand the “income replacement ratio” which is the percentage of working income that an individual needs to maintain the same standard of living in retirement.
This ratio is usually between 60% and 90% of the working income before
retirement. A retiree who attains this replacement ratio through a combination of EPF withdrawal and current income through investments like the PRS and fixed deposits will be in a comfortable state come retirement.

(b) The World Bank’s Pension Conceptual Framework

(I) The five pillars framework
The World Bank’s policy framework applies a five pillar model when
evaluating a country’s pension and social security reform efforts. The
World Bank is of the view that a multi-pillar approach provides for
more flexibility and is therefore better able to address the needs of
the target segments of the population as well as provide a better safe
guard against any economic, political and demographic risks faced by a
specific pension system.
(ii) The five pillars in the Malaysian context
The following section conceptualises the World Bank multi-pillar
framework within the Malaysian context.
A non-contributory “pillar zero”
The World Bank sees this as a general social assistance financed and
provided by the local or national government to ensure people with low
lifetime income are basically cared for in their old age.
In Malaysia, the Social Welfare Department provides financial aid to
low-income citizens and this includes old age financial aid on a means
test basis.
A mandatory “first pillar”
This pillar aims to link contribution to varying degrees of earnings
with the objective of replacing some portion of lifetime pre-retirement
income. These defined benefit plans are usually financed on a pay-as-
you-go basis and subjected to demographic and political risk.

This pillar of the pension framework is not available in Malaysia but an
example of this “first pillar” would be in Japan where employees pay a
portion of their income to the national pension system which aims to
provide a “basic pension” to all residents in Japan. The basic pension
for the elderly is payable to a pensioner at the age of 65 if the person
has paid premiums for 25 years or longer.
This pillar is said to be subjected to demographic risks because, as our
example in Japan shows, the rapidly greying population puts enormous
strain on the funding. With fewer and fewer younger employees
to support the growing number of pensioners, there is a shortfall in
contributions to meet pension disbursements and there is considerable
pressure on the government to help fund the pension system.

A mandatory “second pillar”
This is typically an individual’s savings plan i.e. a defined contribution
plan where there are wide options in investment vehicles, investment
managers and withdrawal phase selections. Defined contribution
plans provide the individual with a clear link between contributions,
investment performance of the savings and end benefits.
In Malaysia, this pillar includes the EPF, the KWAP and the LTAT.
A voluntary “third pillar”
This pillar can take many forms (defined benefit or contribution plans,
individual savings plans) but it is essentially discretionary and flexible.
This third pillar’s flexibility compensates for the rigidity of the other
pillars and allows the individual to complement whatever is perceived
to be lacking in the individual’s retirement planning.
For Malaysia, this is where the PRS will feature. Other schemes under
this pillar include the private investment/saving schemes for individuals
(unit trusts, fixed deposits and insurance products), employer-sponsored
retirement scheme approved under section 150 of the Income Tax Act
1967 (Revised-1971), additional contributions to the EPF, annuities and
unfunded occupational gratuity scheme.
The PRS is being introduced to supplement EPF savings (for employed
persons) and other second pillar schemes. Although the EPF can be
considered an unqualified success with comprehensive coverage for
the employed sector and with healthy returns over the years in spite
of the global financial crisis, it is not mandatory for the self-employed.
Amongst the aims of PRS is to encourage this segment of the population
to start saving earnestly for their retirement.
Furthermore, studies have shown that most retirees exhaust their EPF
lump sum within three to five years of their retirement. This over-reliance on the EPF savings for their retirement needs is further exacerbated with leakages from their EPF savings with pre-retirement withdrawals for housing, healthcare and education. The PRS would encourage the pensioner to save more in an alternate source of scheme to provide diversity of income streams.
The PRS will also alleviate the concentration risk of the retirees who
have relied on one primary source for their retirement savings. The PRS
will provide an alternate source of fund management expertise and
one where members of the Scheme are ab[e to freely choose between
competing service providers.
A non-financial “fourth pillar”
The World Bank defines this as access to informal support such as
family financial support by the younger generation, other initiatives or
programmes such as universal healthcare, subsidised elderly housing/
retirement homes, home ownerships and availability of reverse
mortgages.
For Malaysia, this pillar relies mainly on traditional Asian values where
the young are expected to care for parents and elders.

(c) Key Players and Components
(i) Employees Provident Fund (FPF)
The EPF dominates the pension landscape in Malaysia. As at 31
December 2011, the EPF had a total of 13.15 million registered
members of which 6.26 million are active contributors and 487,664
active employers. (www.kwsp.gov.my)
The EPF is intended to help employees primarily save for retirement by
procuring a percentage of each member’s monthly salary and storing it
in a savings account. Employers also contribute a specific percentage
to the fund to meet their legal and moral obligation to safeguard and
enhance the members’ retirement savings.

Legally, the EPF is only obligated to provide a yearly dividend of
2.5% on the savings left in the member’s account but has historically
provided a higher dividend to the members although the dividends
have been declining on a trend basis because of the generally low
global interest rate environment. Unlike the net asset value (NAV)
for the PRS that will change every business day to reflect the latest
changes in the underlying fund assets, the amount of savings in the
EPF do not accrue any dividends until the dividends are declared by the
EPF. Most of the EPF savings are invested in Malaysian Government
Securities and other fixed income instruments (including private loans)
but investments in equities is allowed. Up to 20% of the EPF assets
can be invested overseas. The EPF members do have a choice of
some diversification if they participate in the EPF Members Investment
Scheme which allows the EPF members to invest 20% of the amount
in excess of the required basic savings in Account 1 with a unit trust
management company appointed by the Ministry of Finance.
The EPF is an occupational scheme and is tagged to employment
under the EPF. Thus persons who are self-employed would not
contribute to the EPF and would not benefit from mandatory savings
for retirement. With the current 11% employee and 12% employer
contributions to the EPF, an employed person saves at least 23% of
their salary each month with this scheme. Effective 1 January 2012,
the employer’s share contribution for monthly wages of RM5,000
and below increased 1% from 12% to 13%. Further, those who are
comfortable with the returns offered by the EPF (stable and higher than
fixed deposits) can opt to increase their contribution per month over
the mandatory rate of 11% by filling out a form with the EPF. This
“extra” contribution may not be tax exempt if the total contribution
amount is already above the tax relief limit.
Over time, in the absence of a viable alternative to EPF, individuals who
do not fall under the EPF would experience a significant difference
in their retirement savings. The PRS is introduced to encourage all
target groups including the self-employed to save more so as not to
be disadvantaged compared to those under the EPF although current EPF members are also encouraged to enrol in the PRS to supplement
their EPF savings if these savings in the EPF are insufficient to provide
for retirement. One thing to note is that the PRS and EPF contributions
are not inter-changeable. Once contributed, the amounts stay with the
respective Schemes and its Scheme rules. The PRS is also suitable for
any employer that wants to use it. The PRS is complementary to existing
mandatory provisions. Employers can use the PRS as an opportunity
to improve their recruitment appeal or employee value proposition to
attract employees.
The 1Malaysia Retirement Savings Scheme is akin to the PRS in that it
encourages those who are self-employed to contribute to a retirement
plan but through the EPF. Once the contribution goes into the EPF,
the self-employed will not have a say about the investments of their
contributions as per the other EPF members.
The EPF manages the fund both internally and externally through fund
managers. Unlike the PRS, the EPF members cannot select the asset
class, fund manager or the mix of funds for their contribution. There is
also no daily NAV calculation posted on the KWSP website because all
the contributions are commingled and a dividend is declared at the end
of the fiscal year. It is only then that the EPF member can assess the
performance of the fund and manager.
(ii) Kurnpulan Wang Persaraan (Diperbadankan) (KWAP)
The pension scheme for civil servants was established under the
Government Pension Ordinance of 1951 and applies to government
personnel that were eligible as of 12 April 1991. The pension scheme
is intended to provide financial security for retired civil servants by
paying them a monthly pension that reflects a percentage of their last
qualifying salary. The monthly pension benefit is no longer offered to
any civil servants after the date but the pension liability remains for
those who joined the civil service before the above date and needs to
be funded. The Pensions Trust Fund was established with the aim of
funding the pension liability in 1991 with a launching grant of RM500
million from the Government.
The KWAP was established on 1 March 2007 to replace the old
Pensions Trust Fund and receives a minimum of 17.5% of each civil
servant’s salary each month as contribution from the Government
towards financing its pension liability. There is no contribution at all
from the individual civil servant as it is a defined benefit plan. The
objective of the KWAP is to manage the fund towards achieving
optimum returns on its investments and shall be applied towards
assisting the Government in financing its pension liability.
(iii) Lembaga Tabung Angkatan Tentera (LTAT)
The LTAT was established in August 1972 by an Act of Parliament. The
main aim of the LTAT is to provide retirement and other benefits to
members of the armed forces (who are compulsory contributors) and
to enable officers and mobilised members of the volunteer forces in the
service to participate in a savings scheme. The secondary objective is
to promote socio-economic development and to provide welfare and
other benefits to retiring and retired personnel of the armed forces of
Malaysia.
Under the superannuation scheme, serving members of the armed
forces are required to contribute 10% of the monthly salary to the LTAT
and the Government being the employer will contribute 15%.
(iv) Employer-sponsored retirement schemes
As part of a broader corporate social responsibility as well as to
encourage employee loyalty, some employers have opted to provide
their employees with a pension that is usually funded by employer
contributions above the required EPF percentage. These plans need
to be approved and fall under section 150 of the Income Tax Act 1967
(Revised-1971). These contributions by the employers (usually tax
exempt up to a certain percentage — currently up to a maximum of
19%) vest immediately but can only be enjoyed at retirement in line
with the EPF savings. These schemes are usually managed in-house,
have a board of trustees with specific investment and withdrawal
rules and its funding is at the complete discretion of the employers.
These schemes are only open to the employees of the company or
group of companies. As mentioned earlier in the chapter, it is a
defined benefit plan for the benefit of the employees and not a
defined contribution plan like the PRS.
This employer-sponsored retirement scheme must be established
through a trust deed and rules of the fund, both of which must be
clearly expressed and both must also meet the strict requirements,
some of which are stipulated below:
(a) there must be alienation of contribution to the fund i.e. the
contributions made must be alienated from the contributors
and be held by a third party which is the board of trustees;
(b) payment of the retirement benefits can only be made when the
employee reaches the retirement age of 55, retires early due to
illness, dies or leaves Malaysia permanently; and
(c) the scheme is required to follow the investment policy laid
down by the IRB.
The possible losses suffered by these schemes during the recent
economic crisis and the high costs of administrating such schemes have
resulted in many employers opting to migrate their scheme to the EPF.
(v) Annuities
In an effort to encourage more retirement income, the public can take
advantage of the tax incentives under the tax law to buy annuities
offered by insurance companies. These annuities are contracts
whereby the annuitant (the person who buys the annuity) receives
a series of fixed payments at regular intervals (usually monthly) from
the insurers until the death of the annuitant. Each annuity payment
represents the repayment of a portion of the purchase price plus interest
earned.
The purchase price may be done at one go (a lump sum payment)
or more likely in the context of saving for retirement, paid monthly/
annually over the working tenure of a person. Contributions must
continue until the price of the annuity is paid or the annuity may not
provide the annuitant with the desired payment (after all, the annuity
functions on the total contributions and stopped contribution disrupts
the workings) at retirement. If an annuity is cancelled the annuitant
may get back the contribution less administrative and other charges
and the person will have to start all over again later if he wants to buy
another annuity.
(vi) Conclusion
The current retirement landscape in Malaysia cannot fully address the
needs of retiring Malaysians. Although the second pillar mandatory
savings has provided the basis for retirement planning, solely relying
on it would not be adequate to maintain a comfortable lifestyle post
retirement. The traditional fourth pillar which relies on the young to
care for the elderly would only work in a society where there are many
to support the few. In an increasingly greying/ageing population like
Malaysia, the number of elderly will increase exponentially with time
and the burden on the fewer young people will be enormous. There is
an impetus to find a self-sufficient solution.
Hence, there is the need to develop the third pillar of voluntary
savings. The government’s initiative to promote the PRS through
tax incentives highlights the urgency and the importance to get the
populace to think about their own retirement needs. With a national
focus on more voluntary savings, the PRS is the platform to kick-start
this initiative by providing a universal, flexible and tailored solution to the individual.

1.2 THE OBJECTIVES AND BENEFITS OF THE PRS
(a) The need for retirement protection
Like the rest of the world, Malaysia will also be, in the coming years, experiencing a rapidly ageing population.

The longevity risk has posed a great challenge to the adequacy of savings for retirement. This is further compounded by premature exhaustion of retirement savings in the early period of retirement, in view of the prevailing practice of lump sum withdrawal of the EPF contributions at the age of 55 and greater demands for a lifestyle post retirement that mirrors that currently existing. This naturally necessitates an overall higher amount of savings to address this situation of funding one’s lifestyle in the retirement phase. Furthermore, there is statistical evidence to suggest that the current amount of savings under the EPF and other schemes under the mandatory “second pillar” is insuffident to last a retiree long into their retirement (with some studies showing that most run out of money within 10 years of their retirement). This is more so when the saver is wholly reliant on the EPF savings as the sole basis f retirement income and there is no alternate source of savings to supplement that income.

To address this problem, four solution are possible

Firstly, Malaysia is exploring whether to raise the mandatory retirement age which will allow a longer period for the employed to accumulate savings. Furthermore, with medical advances people are healthier and can work productively up to an older age.
Secondly, it can increase the mandatory contribution rate under the “second pillar”. This is not ideal as it puts an unnecessary strain on employers and increases the cost of doing business and can make Malaysia uncompetitive in the effort to attract and retain talent. Furthermore, this solution is not universal as only employees who are covered under the EPF or other “second pillar” schemes would benefit.
Thirdly, it can consider raising the minimum wage over time if productivity allows so that the workers can benefit from a higher level of wages and hence savings both through the mandatory EPF and other voluntary schemes.
Lastly, it can develop a voluntary retirement scheme under the “third pillar” in order to expand the range of retirement schemes, expand coverage on a voluntary basis to all segments of the population and improve the adequacy of retirement savings overall. Having a robust multi-pillar pension system would cater to the Malaysian society’s varied retirement needs and would absorb the economic, demographic and political risks faced by the pension systems. The implementation of the PRS comes under this solution.
(b) The benefits of the PRS framework
The PRS addresses the coverage issue as it helps those who do not save now under the EPF, like the self-employed. The adequacy of retirement savings is also tackled by the additional savings through the PRS Scheme. Additional or voluntary employer contributions add to the adequacy solution. Lastly, the PRS is sustainable as in terms of monthly deductions, a person need only save an additional RM250 per month to enjoy the full tax relief where a person earns a basic salary of above RM4,500.
(i) PRS is a transparent investment vehicle
The Scheme is generally a transparent investment vehicle where the
following information is disclosed upfront:
(a) all fees and charges (direct and indirect);
(b) investment mandate including investment objectives and
strategy, investment limits and asset allocation;
(c) fund performance; and
(d) publication of annual reports as well as choice of PRS Providers
and PRS funds within each scheme.
Any changes to the investment objectives or fees require the approval
of the PRS members while some other less material changes require
a supplementary disclosure document to be lodged. The portability
feature of the PRS supports transparency as members need information
PRS Providers.
(ii) Provide a pool of funds to fund retirees during retirement phase
This universal and inclusive effort would encourage Malaysians to
save more for their retirement by becoming a self-funding retiree.
Furthermore, the PRS framework will allow individuals the flexibility to

choose from various providers and funds offered. The PRS is portable
whereby contributions made and accrued to the PRS members can be transferred to another provider. The portability feature (which we will
discuss under Chapter 4 Features of the PRS) also encourages good
performance that will benefit the PRS participant. Over the long term,
this should result in better long-term returns and a higher amount
of savings available at retirement, provided investments in the fund
performs as expected.
If the retiree managed to build up sufficient savings (both through
contribution and investment performance) in the PRS during the
employment/savings phase of the retiree, then the yearly returns of the
PRS during the retirement phase will enable the retiree to supplement
a portion of the living expenses during retirement. Coupled with a ,
drawdown in accumulated wealth (the EPF savings) and other incomes
(e.g. allowance from children, interest from savings), the retiree will be
able to live a comfortable lifestyle.
(iii) Additional source of long-term capital for economic growth
While maintaining the primary aim of increasing retirement savings
for individuals so as to fund their retirement needs during old age,
the PRS has ancillary benefits of unlocking savings as Malaysians have
a high savings rate by international standards. This unlocked savings
could be channelled to create new and sustainable fund flow to spur
economic growth and growth in the capital markets in particular. This
helps the member directly as robust growth in the capital-markets may
attract talented fund managers who will manage the PRS effectively
to help the member achieve his long-term return goals. The strong
growth in the financial sector will also not be isolated and will spill over to other sectors thereby increasing wage levels and quality of life. When the members help the capital markets, they actually help themselves in a virtuous cycle.
(iv) Benefits to the Malaysian capital market
These sustained fund flows from the PRS will increase vibrancy in the
capital markets and yield benefits, including:
(a) increased product innovation and competition;
(b) increased activities and skill sets of the intermediaries;
(c) building scale in the fund management industry; and
(d) attracting more institutional investors which in turn improve
market performance and foster good corporate governance.

(v) Reduce the burden on Government finances
A vibrant PRS and other “third pillar” schemes guided by the World
Bank’s multi-pillar approach would reduce the need for the Government
to provide a social safety net for the population in retirement phase.

(c) “Third pillar” experiences in other countries
The PRS is an example of the “third pillar” under the World Bank’s framework. This third pillar scheme helps the members to voluntarily save more for their own retirement needs. The implemention of “third pillar” schemes is varied but generally the issues of an ageing population and sustainable retirement, need to be addressed promptly and many governments around the world are doing just that.

Some of the examples of implemented schemes are:

KiwiSaver in New Zealand
This scheme started out as ,a voluntary long-term savings scheme and came about in July 2007. It is aimed at improving the low average rate of saving. Employee participants can chose to contribute 2%, 4% or 8% of their gross pay with a lot of flexibility to change contribution rates or scheme providers. The self-employed can choose how much they want to contribute. There are some tax benefits to the scheme to encourage participation. There were 1.6 million Kiwi Savers as at June 2011 with total contribution of NZ$1.6 billion.

Supplementary retirement scheme in Singapore
The supplementary retirement scheme (SRS) is part of the Singapore
government’s multi-prong strategy to address the financial needs of a greying population. Contributions to the SRS are voluntary and are eligible for tax relief. Investment returns are accumulated tax-free and only 50% of the withdrawals from the SRS are taxable at retirement. The annual SRS contribution cap (currently at S$12,750 for Singaporeans and permanent residents and S$29,750 for foreigners) is subject to review. As at 31 December 2010, the total SRS contributions amounted to S$2.49 billion.

Assessment Questions
Question 1
In the context of the World Bank Pension Conceptual Framework, the Private
Retirement Scheme would fall under the _______________.
(A) “first pillar”
(B) “second pillar”
(C) “third pillar”
(D) “fourth pillar”
[Answer: C]

Question 2
What are some of the cited benefits from the Private Retirement Scheme?
I. Reduce the need for Malaysians to invest in unit trusts
II. Additional source of long term capital for economic growth
III. Improve the living standards of Malaysians at their retirement
IV. Increase the fiscal burden of the Government to provide a social safety net

(A) I and IV only
(B) I and III only
(C) II and III only
(D) II, III and IV only
[Answer: C]

Question 2
Which of the following statements are TRUE in relation to the Private Retirement Scheme?
I. It is mandated by law
II. It is a voluntary pension scheme
III. It is a defined benefit plan
IV. It is a defined contribution plan

(A) I and III only
(B) I and (IV only
(C) II and III only
(D) II and IV only
[Answer: (D]