Improvements required in Voluntary Pension System Regulatory Regime

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Improvements required in Voluntary Pension
System Regulatory Regime

• Nauman A. Cheema
• Actuary

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INTRODUCTION

• 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.

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IS VOLUNTARY PENSION SCHEME NEEDED?

• Certainly
• Few people covered by retirement benefits in
  Pakistan
• For covered people, amounts are grossly
  inadequate.

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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 Pakistans
  existing Pension System (apart from EOBI).

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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

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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 PFs

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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

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VPS SCHEME INDIVIDUAL, CORPORATE SPONSORED OR
BOTH

• Basically for individuals
• Corporate involvement appears to be an after
  thought (changes are required).

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IMPROVEMENT AREAS IN EXISTING VPS REGULATORY
REGIME

• In view of above essentials for success,
  following areas (in my opinion) need to be
  amended
• Unfavourable tax treatment on retirement (E,E,T)
• Installments fully taxable
• Commutation gray area
• Changes required in IT laws
• 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
• .

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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

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• F. Eligibility Criteria
• Extremely important to review eligibility
  criteria in VPS Rules and IT Ordinance and
  understand differences
• VPS Rules
• Eligible Persons are
• Pakistani Nationals
• Over 18 years of age
• Have valid NTN
• 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.

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Eligibility Criteria Contd..

• IT Ordinance
• Eligible Person is
• i. an individual Pakistani
• ii. has NTN
• not entitled to benefits under any other
  approved employment or annuity scheme

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Eligibility Criteria Contd..

• Areas of difference are
• 18 years condition waived in IT laws
• 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?

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Eligibility Criteria Contd..

• Areas of difference need to be removed
• Little rationale for excluding individuals
  covered in occupational/employment pension
  schemes due to
• general low and variable levels of occupational
  pensions
• 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

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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 (?!)

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ISSUES TO BE ADDRESSED Contd.

• Employer contribution can be currently many times
  employees 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 (!)

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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 employers 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

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RISK OF MISSELLING

• Key area of concern
• Risk 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

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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

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SUMMARY

• First important step taken by SECP supported by
  CBR
• Further changes and refinements needed to make
  system more effective in view of
• Prevalent individual related investment
  environment
• Existing corporate environment
• Short-term culture

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SUMMARY Contd

• Greater co-ordination between SECP and CBR
  required for Schemes 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 EBFs

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• Thank you