Pension System in Malaysia

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Pension System

The Employee Provident Fund is the fundamental support of the Malaysian pension system. It provides extensive social security functions and, in this regard, is similar to the Singapore system. Recent reforms have mainly aimed to enhance financial security in retirement through incentives that encourage longer contribution and the more prudent de-cumulation of accumulated assets. Like many Asian and Western countries, Malaysia is also faced with adverse demographic developments and must restructure its system to cope with future challenges. Occupational pensions are not widespread in Malaysia and are mostly limited to large employers.

Public Pensions
The Employee Provident Fund (EPF), the national compulsory saving scheme for individuals employed in the Malaysian private sector, is based on the Employees Provident Fund Act 1991. The retirement scheme is fully funded and provides defined contribution type benefits to members.

The EPF is publicly managed and financed through contributions amounting to 23% of the employees' payroll. Of this, the employee contributes 11% and the employer 12%. Employers are obliged to contribute at least 12%, but can voluntarily pay a higher rate.

In order to enhance the financial security of EPF members several changes, known as the "Beyond Savings" initiative, were introduced effective as of February 1, 2008. The reasons for reform are similar to those existing in most other Asian Pacific countries: rising life expectancy, a general weakening of families ties and increasing medical costs, among others.

The first key change is that contribution rates alter when the employee reaches 55 years of age. The employee is still liable for EPF contributions (and this continues to the age of 75), but the employer's share is reduced to 6% and the employee's to 5.5% of total wages. Both are free to contribute a higher percentage above those minimum rates.

Second, the Basic Savings amount was introduced. This stipulates that plan members should have a minimum amount of savings in the account correlating to their age. By the age of 55, plan members are expected to have accumulated at least MYR 120,000 (EUR 24,600).

Third, withdrawal options have changed effective as of November 1, 2007. Instead of having the choice between monthly payments and a one-time lump sum withdrawal, participants now have greater flexibility. They can opt to withdraw part of their savings at any time. This should discourage members from withdrawing lump sums, which have proved to be impractical when it comes to providing long-term financial security. Studies have shown that most lump sum withdrawals were usually spent within ten years given a life expectancy of 75, which means that accumulated savings were spent too rapidly and early. EPF balances not withdrawn by the age of 80 will be transferred to the Registrar of Unclaimed Monies.
The EPF not only functions as a retirement fund, it is also a multi-purpose savings fund that allows withdrawals to be made to finance housing, education and medical expenses. Since January 2007, contributions to the fund are split between two accounts, which were created for different types of withdrawals.

Account I
Seventy percent of monthly contributions are allocated to this account, which is intended for financing retirement. The account balance can only be withdrawn when the account holder reaches the age of 55, becomes incapacitated or leaves the country. In these cases, the whole account balance can be withdrawn. Withdrawals can be postponed by continuing contributions or by annually withdrawing the dividend on the savings.
Until January 31, 2008, EPF members with savings of more than MYR 55,000 in their Account I were able to invest part of the excess saving through external fund managers, although this needed to be approved by the Ministry of Finance. This changed as of February 1, 2008. Only 20% of the balance in excess of the basic savings amount could be invested in products of approved investment institutions.
Currently there are 43 fund management companies approved to provide services for EPF members wishing to enhance their savings. The guaranteed minimum return on EPF savings does not apply to savings transferred to external funds managers. The EPF provides no compensate for any losses resulting from such investments.

Account II
The remaining 30% of monthly contributions are allocated to the second account. Assets accumulated in Account II can be used for:
-Medical expenses 
-Housing loans
-Settling the balance of a housing loan
-Financing education
-Or, after the members attain the age of 50, any other purpose
The withdrawal of Account II savings is subject to certain eligibility requirements, such as stipulating that the member be a minimum of 50 years of age, as well as restrictions as to the amount that can be withdrawn. The frequency of withdrawals depends on the intended purpose. Savings to finance education can be retrieved every semester or academic year, savings to reduce housing loans can be made once a year, but withdrawals to finance a home purchase can only be made for the first house.

Tax treatment of contribution and benefits
The employees' share of contributions to the EPF is tax deductible up to MYR 5,000 (EUR 1,025). Withdrawals from the different accounts are also exempt from income tax.

Fund size and investment policy
In September 2007, the EPF had accumulated assets of MYR 290 billion (EUR 59.5 billion). The fund has been showing continuous growth for decades with the bulk of assets invested in low-risk fixed income products such as government securities, loans and money market instruments.

Quantitative regulations apply to the investment of EPF assets. At least 70% must be invested in low-risk fixed income instruments with the portion invested in domestic equity not exceeding 25%. Overseas investments need to be approved by the Ministry of Finance. In order to meet the growing size of the fund and to improve its risk-return profile, the Employee Provident Fund aims to further diversify asset allocation. For that purpose, it is looking for new investment opportunities through its overseas investment programme.

Currently MYR 7.0 billion (EUR 1.4 billion), representing 2.5% of the total assets, are invested in global equities or are allocated for investment in overseas equities. The decision concerning a global bond mandate is still pending. EPF assets are managed in-house as well as by approved external portfolio managers. Two additional foreign fund manager licences are expected to be awarded in the near future. These fund managers will be mandated to invest the remaining balance allocated to equities. In addition, the EPF is planning to outsource MYR 2 billion (EUR 410 million) to external portfolio managers with MYR 1 billion allocated to equity and bonds managers respectively.

Although the EPF dominates the pension landscape, special pension schemes provide retirement benefits for civil servants and armed forces. The Pension Trust Fund and the Armed Forces Fund are the major pension funds providing retirement provision for public sector employees. Public sector employees appointed after April 1991 are given the choice to participate in the pension scheme for civil servants or, alternatively, to join the EPF.

Occupational Pensions
Supplementary pension provision is not widespread in Malaysia and is predominantly limited to large employers. To provide complementary retirement benefits, employers may either top-up their EPF contributions or set up a self-administered trust fund. The former is the most popular option, particularly for defined contribution plans.

In general, private pension provision is uncommon in Malaysia as the EPF provides a significant source of income. While high, compulsory contribution rates exist for the basic pension, few tax incentives support the development of a comprehensive second pillar.

The domination of the EPF means the private pension market remains underdeveloped. This situation benefits the EPF as most employers providing supplementary pension coverage top-up EPF contributions instead of establishing a self-administered retirement plan.

The general preference to top up EPF contributions instead of establishing occupational pension plans refers partly to the Asian Financial Crisis of 1997, which had a hard impact on many private pension plans. No reforms are currently proposed to further strengthen the development of the complementary pension system. As a result, opportunities for financial institutions in the Malaysian market are expected to continue to be limited.

The opportunity for internal and external asset management companies lies in managing assets outsourced by the EPF. In order to meet the growing size of the fund and to improve its risk-return profile, the Employee Provident Fund aims to further diversify its asset allocation.

Compiled by Allianz Global Investors