Voluntary Pension

System
Its Development, Structure &
Prospects

Nasim Beg
11th August 2005

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Pensions in Pakistan
The Background

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Dependant on the next
generation to provide for us
 Like most countries of the world, Pakistan has weak provisioning
for pensions.
 We primarily depend on the next generation to provide for us
during our retirement.
 Most governmental jobs are covered by unfunded pensions –
current employees will be paid pensions by taxing the next
generation.
 Some private sector employees and the organised sector labour
are covered by funded pensions. Funds are primarily invested in
government bonds, which will be repaid by the next generation.
 A very large section of the population has no pension
provisioning – totally dependant on the joint family support
system.

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Pensions that exist
are mostly inadequate
 Most government jobs entitle one to a pension
linked to one’s last drawn salary but the salary does
not necessarily reflect one’s true earnings – mostly
salaries are low and are supplemented by benefits,
which can include plots of land that help make up on
the low salary. Thus the pension is a fraction of the
true wage.
 Private sector pensions are better but applicable to
a very few.
 Most employers require a minimum years of service
to get pension rights. Only EOBI allows for
portability of pension rights.

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Employers worldwide want to get
away from defined benefit plans
 Defined benefit pensions systems require employers to ensure
availability of funds to meet the obligation.
 Many plans set up in Pakistan under a high real interest rate
environment are now creating an additional burden on the
employers.
 High market volatility makes the investment of pension funds
even more burdensome.
 Employers would rather have defined contributions and let the
employee carry the burden of the final benefit.
 In turn, the employee would get portability through the defined
contributions system.

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Tax Breaks
 Most pension regimes give varying degrees
of tax breaks.
 Most pension savings and incomes in
Pakistan are tax free.
 Some long-term savings which can be used
towards retirement by individuals are entitled
to tax deferral.
 Some savings towards annuity plans give tax
rebates.
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Pension Reforms in Pakistan
 Reforms have been considered on several fronts –
funding of government pensions, allowing for
portability, compulsory provisioning by all
employers, proper regulatory authority, etc.
 There has been some discussion on a national
pension scheme but many difficult issues have
forced the government to initially concentrate on the
Voluntary Pension System.

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Development of the
Voluntary Pension
System

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Initiated by the Finance
Ministry
 The current Prime Minister (then Finance Minister)
initiated the process soon after taking charge of the
Finance Ministry.
 The SECP was given the assignment to develop a
pension system.
 Several models were studied. The first proposal of
2002 recommended a mandatory system. This was
not accepted by the Finance Ministry.
 The SECP then commenced work on a second
proposal for a voluntary scheme.

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Evolution of the
Voluntary Pension System
 The SECP set up a committee in June 2003 consisting of persons from
Industry, the Ministry of Finance and the SECP itself.
 The committee had several meetings and developed a broad proposal
recommending a voluntary scheme, with a tax deferral structure.
 This was presented by the SECP to the then Finance Minister.
 Some additional research was conducted, including study of models in
some emerging economies.
 The final draft was circulated and posted on SECP’s website and
several meetings were held by the SECP with representatives of various
financial institutions and members of the actuarial profession.
 The Voluntary Pension System Rules, 2005 were finally issued in
January 2005.
 The SECP had continuous interaction with the CBR throughout.
 The Finance Bill 2005 has introduced several changes in the Income-
tax law incorporating all the necessary features for an EET structure.

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The Structure of the
VPS

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Main Features
 A self contributory pensions savings scheme open to all adult Pakistanis
registered with the tax authorities, if not covered by other occupational
pension schemes. Employers can also contribute.
 Certain limits on the maximum annual contributions with some catch-up
provisioning for persons above 41 years age.
 Contributions to be invested in specially set up mutual funds, with
flexibility of individualised asset allocation through individual accounts.
 Stringent requirements for licensing of pension fund managers under
SECP regulation. Fee structure much lower that normal mutual funds.
 The individual can diversify savings (contributions) amongst more than
one fund manager and can transfer the account to other fund
managers.
 EET structure, i.e., tax rebated on contributions, investment income and
gains accumulate tax-free, tax is paid at the stage pension is drawn.

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The Legal Structure
 VPS Rules set up under the framework of the NBFC
Rules, which in turn are issued under the
Companies Ordinance, 1984.
 The VPS Rules allow for asset management
companies and life insurance companies to be
licensed by the SECP as Pension Fund Managers.
 Pension Fund itself is authorised by the SECP as a
unit trust scheme and structured under the Trust
Act.
 The Income Tax Act provides the tax breaks.

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Structure of the Pension Fund
 Three sub-funds - equity, debt and money-market. Additional
asset classes later.
 SECP mandated investment policy governing each asset class.
 Mandatory for each Fund Manager to offer a minimum of four
pre-set asset allocation plans. Very Conservative plan with
maximum 20% equity and Aggressive plan with maximum of
80% equity. Two additional plans (like life-cycle) may be offered
by Fund Manager during first 5 years.
 Each sub-fund to announce NAV based prices daily.
 Management fee not to exceed 1.5% p.a. and Front Load 3% but
no load on transfers.
 Funds will not distribute dividends but are totally exempt from
tax.

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Investment Limits &
Restrictions
 Equity – Limits: 5% per company, 20% per sector.
1% per green-field, 5% total green-field. None in
unlisted or PFM’s associated companies.
 Debt – Limits: at least 50% in government
securities. Other debt range between 5% in any AA
rated and 2.5% in BBB. Average duration of fund
within 10 years.
 Money-market – Limits: GoP securities no limit;
Others upto 20% (Minimum rating A-); Bank
deposits no limit but 25% per bank. Average
duration of fund not to exceed one year.

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Participant’s Rights
 Tax rebate on contributions of upto 20% of income or Rs.
500,000 per year.
 Eligible persons investing under VPS (Participants) have right to
save with one or more PFM.
 Right to transfer the account to some other manager/s once a
year. No restriction if PFM is de-authorised.
 Select plan of choice within the offerings of each PFM.
 Select retirement age between 60 and 70 years.
 Cash out any time before retirement by paying tax.
 Draw 25% of fund at retirement tax-free (grey area).
 Opt for an annuity plan or income draw down plan at retirement.
At age 75 funds left over must be invested in annuity plan.
 Receive account statements and financial statements.

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Regulation
 SECP to license PFMs and authorise
schemes.
 SECP shall measure performance against
benchmarks. SECP may take corrective
action. SECP will publish comparative
performance each year.
 SECP can order Special audit.
 SECP can carry out inquiry/inspection.
 SECP can de-authorise manager and fund.
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Prospects
 Wonderful opportunity for self-employed to build their own pension funds.
 Opportunity for employees not covered by occupational pensions to build their
portable pension funds.
 Opportunity for corporate sector to supplement or replace provident funds with
matching contributions to VPS for their employees.
 Opportunity for NRPs to build pension funds in Pakistan.
 Opportunity for individuals to build professionally managed portfolios, with
optimal asset allocation.
 Example of asset allocation benefits: Rs. 1,000 invested each month and
increased over time in line with salary growth (average 15% p.a.) over 30 years;
Equities give Rs. 34 million; DSCs Rs. 24 million. Please note that DSCs no
longer giving old level of real returns and are now taxable.
 Opportunity for corporate sector and local governments to benefit from inflows
into the market.
 Regular inflows will help market stability.
 Over time should overtake investment in NSS and replace the traditional
retirement savings and long-service plans of the corporate sector.

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 Thank you
Questions welcome

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