“Improvements required in Voluntary Pension System Regulatory Regime”

1. “Improvements required in Voluntary Pension System Regulatory Regime” Nauman A. Cheema Actuary

2. 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.

3. IS VOLUNTARY PENSION SCHEME NEEDED? • Certainly • Few people covered by retirement benefits in Pakistan • For covered people, amounts are grossly inadequate.

4. 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).

5. 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

6. 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

7. 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

8. VPS SCHEME – INDIVIDUAL, CORPORATE SPONSORED OR BOTH • Basically for individuals • Corporate involvement appears to be an after thought (changes are required).

9. 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 ….

10. 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

11. 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.

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

13. Eligibility CriteriaContd…….. 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?

14. Eligibility CriteriaContd…….. Areas of difference need to be removed • Little rationale for excluding individuals covered inoccupational/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

15. 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 (?!)

16. ISSUES TO BE ADDRESSEDContd…. • 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 (!)

17. ISSUES TO BE ADDRESSEDContd…. • 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

18. 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

19. 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

20. 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

21. 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

22. Thank you