Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
Provident Fund in Malaysia: Sustainability of Retirement
Income Provision
Saidatulakmal Mohd
The Provident Fund in Malaysia is the first provident fund
established in the world in 1951. The aim of the fund is a
scheme to provide non-labour income to the elderly upon
retirement. This fund a defined contribution scheme funded
through the contribution of the employee and the employer.
Given the increasing number of elderly in the world as well as
Malaysia, a scheme lik e the provident fund is necessary as a
mechanism to continue providing income to the elderly to
finance their retirement expenses. This paper assesses the
equity, efficiency and efficacy of the fund in its ab ility to continue
providing non-labour income to the elderly. Areas of
assessment include adequacy of retirement benefits, return on
investments, nature of the scheme and coverage level. The
study concludes that at present the accumulated savings in the
provident fund is inadequate to provide continuous retirement
income to the elderly. This situation is worsened by the low
return on investment of the fund. In addition, the nature of a
provident fund itself does not encourage a stable savings fund
after retirement. Moreover, the fund fails to be extended to the
whole population, in which the informal sector is neglected from
receiving retirement benefits.
Field of Research: Provident fund, Retirement income, Sustainability
1.0 Introduction
There are at least six common areas in which the success of any social security
retirement programmes or pensions schemes can be assessed. The six areas are
1. Equity, efficiency and efficacy of the programmes or schemes;
2. Achieving the goals of poverty alleviation and consumption smoothing;
3. Favourable macroeconomic effects, especially in promoting saving,
investment and output;
4. Favourable external effects, particularly in the financial sector development;
5. Favourable effects on the labour market;
E Rp   Rf
6. Sound financial performance measured by the Sharpe index1: Sp 
 Rp
where E Rp  is portfolio return, Rf  is risk free return and  Ro  is the standard
deviation.
____________
Author‟s affiliation: School of Social Sciences, Universiti Sains Malaysia, 11800 Penang, Malaysia.
Author‟s email address: eieydda@usm.my
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
The provident fund in Malaysia, introduced in 1951 is a scheme that provides
retirement income to the elderly in Malaysia. The provident fund is a defined
contribution scheme funded by the employee and employer. The current contribution
rate is 11 percent and 12 percent for employee and employer respectively. Although
the scheme is generally for the private sector, the civil servants can opt for this
scheme after a compulsory contribution into the fund for three years. Being the
biggest retirement scheme in Malaysia, the provident fund is seen as an important
provision of non labour income for the elderly. Nevertheless, the fund has been
questioned on not being able to provide adequate financial protection to the elderly.
Hence, the issue of sustainability on the retirement income provision to the elderly is
highly debatable. What more, with the changing in the demographic trends of the
elderly in the world, including Malaysia, the issue on sustaining the retirement income
for the elderly should be given a number one priority in government policy agenda.
This paper assesses the equity, efficiency and efficacy of the provident fund in
providing retirement income to the elderly. The assessment covers the aspect of
adequacy of retirement benefits, return to investment and coverage. In assessing the
programmes, considerations and suggestions for reforms are discussed to further
improve the current system. The paper begins by providing a brief background of the
changes in the demographic trends of the elderly.
2.0 Demographic Trends of the Elderly
There have been many discussions, debates and conferences on the issue of
retirement financing in the world. The main concerns are ageing, longevity and
inadequacy of retirement income to the aged. Greater concern relates to the
developing countries particularly because of their much increase life span. A report
released by the United Nations (2002) on demographic trends includes the following:
1. In 2000, about 0.6 billion people, 10 percent of the world‟s population were
over 60 years of age.
2. By 2025, people over 60 years of age will double to 1.18 billion (approximately
15 percent of the world‟s population)
3. By 2050, people over 60 years of age will be 1.96 billion (approximately 21.1
percent of world population)
4. In 2000, the life expectancy at 60 years of age, for the total population was
18.8 years in which by 2025, these numbers will be 21 years.
5. Many developing countries (especially India and China) will have an „old‟
demographic profile, at a much lower level of per capita income than the
industrial countries.
Malaysia is not excluded from this trend, in which the population is ageing and the
elderly dependency ratio is increasing. As a whole, the proportion of population
above 60 years old will increase to about 14.5 percent in 2030; a rise of 8.8 percent
from 1990 (Heller, 1997). One of the reasons for this is the longer life expectancy.
The Department of Statistics (1998) classify the elderly into two groups, namely the
young-old (60-74 years) and the old-old (75 years and above). Table 1 below shows
the demographic trends of the elderly in Malaysia.
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
Table 1 indicates that the number of elderly is increasing. In 1980, the young-old and
the old-old populations were 813 thousands and 219 thousands, respectively. This
number had increased to 1.15 million and 267 thousands for the young-old and oldold population after another 2 decades. It is projected that the figures will continue to
rise to 2.63 million for the young-old population and 574 thousands for the old-old
population in the year 2020. It is apparent from the figures that the young-old
population is expanding at an accelerating rate compared to that of the old-old
population. This suggests that the trend will exhibit an upward turn once the cohort of
young-old advances in age (Sim, 2001). While the number of the elderly is
increasing, the growth in the average annual rate of the labour force is projected to
decrease. Heller (1997) predicted that the average annual rate of labour force growth
would decrease from 2.6 percent between 1990-2000 to 1.6 percent between 20002030 and 0.5 percent between 2030-2050. This indicates that the Malaysian
population is ageing and the issue of retirement financing should be a top priority for
the nation‟s policy makers.
Table 1 Demographic Trends of the Elderly
Numbers („000)
Percentage
Growth Rate
YoungOld-Old Young- Old-Old
Young- Old-Old
Old
Old
Old
1980
745.2
604.5
140.7
81.1
18.9
1991
1,032.3
813.1
219.2
78.8
21.1
2.7
4.0
2000
1,418.2
1,150.8
267.4
81.1
18.9
3.9
2.2
2010
2,076.1
1,688.4
387.7
81.3
18.7
3.8
3.7
2020
3,209.8
2,635.0
574.8
82.1
17.9
4.5
3.9
Source: Senior Citizens and Population Ageing in Malaysia, Department of Statistics
Year
Total
(„000)
Will the elderly be able to support themselves with the retirement income available to
them or will they have to depend on their children to finance their old-age
consumption? Hence, it is important to analyse on how the current provident fund
could provide a sustainable non-labour income to the elderly to finance their
retirement expense. This paper discusses the issues based on the provident fund
that exist in Malaysia. The provident fund, a defined contribution scheme, as stated
by Kpessa (2011) requires strong and effective government with the capacity to
enforce the payment of contributions and to regulate the management of privately
managed social security funds. In this regard, the Malaysian government made it
compulsory for all employees (at least in the formal sector) to contribute to the
provident fund with shared contribution from their employers. The sustainability of
this fund in providing sustainability retirement income to its contributors is assessed
via several issues that are adequacy of retirement benefits, investment policies and
performance, nature of the schemes and coverage.
3.0 Adequacy of Retirement Benefits
A survey conducted by the provident fund on the pattern of expenditure on the basic
needs of contributors who had withdrawn all their savings since taking retirement in
order to cover expenditure on basic needs excluding medical care for catastrophic
illnesses, is between RM 510 to RM 1,000 per month2 (Ibrahim, 2004). The survey
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
also indicates that a member will need today at least RM 85,000 at retirement age to
finance his/her basic needs for the next 20 years to at least reaching 75 years of age
(of approximately RM 4,250 per year).
The issue of adequacy of retirement benefits will be evaluated based on the social
security retirement wealth per capita calculated following the work of Mohd (2006).
Mohd (2006) found out that an individual who started contributing to the provident
fund at the age of 33 in 1990, will only have an actuarial discounted value of
accumulated saving of approximately RM 10,893 at retirement, while a person
contributing to the provident fund at the age of 34 in 2001 will have approximately
RM 41,844 at retirement.
The result provides an early indication on the failure of the provident fund in providing
adequate retirement benefits to the elderly. Moreover, the provident fund itself has
not denied its failure (Ibrahim, 2004).
While the calculation of Mohd (2006) has been adjusted to take into account the
inflation rate, in reality the accumulated saving in the provident fund is not indexed for
inflation. This means that initial accumulated saving from the provident fund to be
received at retirement could be misleadingly high, and employees might think they
can afford to retire, discovering later that with inflation, their pension turns out to be
inadequate.
One solution would be to index the retirement benefits 1 and the pension payment to
the consumer price index (CPI). But that would mean that the relative value of a
pension as a proportion of average earnings will fall. This, however, only happens in
specific condition where the average CPI is linked with inflation and the timing of the
indexation that is after events i.e. end of year or on-going. Beattie (1998) found out
that if a pension is indexed to the CPI, for Asian economies, a pensioner‟s relative
value of pension would be less than half of his initial level after twenty years in
retirement, and under a third after thirty years in retirement. Another solution would
be to index the retirement benefits to earnings. In this instance, pensioners will
benefit from an increase in income during periods of economic growth but at the
same time suffer from a decrease in income during recession time.
4.0 INVESTMENT POLICIES AND PERFORMANCE
One of the reasons for the inadequacy of retirement benefits is the low return on
contributions from the provident fund. At the end of each calendar year, the provident
would announce a rate of return on the accumulated saving in terms of a dividend.
As stipulated by the Employee Provident Fund Act, the dividend should be a
minimum of 2.5 percent. As emphasised by Asher, Oum and Parulian (2010) the rate
of return on savings in the provident fund is highly dependent on the investment
strategy which is constrained by regulations.
1
Retirement benefits from EPF, however, could only be indexed to inflation if the benefits are taken
out as periodic payment instead of a lump sum payment at retirement.
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
On average, the real rate of return has been 3.45 percent and has almost always
been positive, with the exception of the oil crisis years of 1973 and 1974 and for
1981. The provident fund has demonstrated a good performance compared to the
notion that provident funds provide interest rates level below that of the rate of
inflation (Williamson and Pampel, 1998) Although the real rate of return indeed
exceeds the minimum rate of 2.5%, the dividends are thought to be low compared to
comparable alternative domestic assets with market-determined rates (Fry, 1992 as
cited in Bateman and Piggot, 1997) and the returns that could be achieved on
domestic bank deposit rates (Iglesias and Palacios, 1999 as cited in Clark, 2002).
For the case of Malaysia, the interest rates announced, adjusted for inflation, have
always been higher (for most of the years) than the bank saving deposit rates.
This so-called low return is associated with the low risk investments that EPF has
been adopting for the past years in order to protect members‟ capital. Since provident
funds are funded, the government controls how funds are invested, i.e. meeting
government‟s need for low interest loans to finance development projects, has often
led to poor returns (Williamson and Pampel, 1998). The Employee Provident Fund
Act emphasises that up to seventy percent should be in Malaysian Government
Securities (MGS). Asher (2000) emphasises that a provident fund, which is 100
percent invested in government bonds, is akin to a pay-as-you-go (PAYGO) system.
This means that future generations of taxpayers will have to redeem the bonds with
their tax payments. Hence, during this period, it could be concluded that the
provident fund is similar to the PAYGO system instead of a fully-funded defined
contributions scheme.
The 1991 revisions to the Employee Provident Fund Act, however, allow for more
diversification of fund investment when investment in the MGS was decreased to fifty
percent. This revision was parallel with the government‟s embarking on privatisation
projects and since 1991 the share of MGS has been reducing, whereas, investments
in the money market, including bonds, loans and equities have been increasing. The
return to investment, calculated as the total investment income per total investments
also shows a decreasing trend from the years 1979 to 2000. The planned to invest
abroad was granted permission to do so prior to the 1997 financial crisis. The
“investment abroad strategy” of approximately RM 1 billion was postponed due to the
capital control regulation on exit levy on portfolio investments. The decision to
diversify investment is intended to provide better returns to the members.
However, what members do not realise, is that it is the investments in the MGS that
have helped the fund to produce good dividends to members. The shift away from
MGS has led to the reduction in dividend rates since 1995 up to 2001 as can be
inferred from Table 9.3.1 (previous page). As emphasised by Asher (1998), the main
reason is that MGS have provided traditionally risk-free, guaranteed, rather high
rates of return to the provident fund. Other investments though deemed to provide
higher returns, exhibit higher volatility and risk as well. For example, the provi dent
fund strategy to invest in equity market was a wrong decision due to the collapse of
the stock market during the 1997 financial crisis. Another reason for the drop in
returns of investment income is that provident fund investment has been channelled
to finance government projects or to bail out inefficient government development
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
projects during the financial crisis. This information, although it is not formally
admitted by the government or the EPF itself, has come to the attention of the public.
Even though the government backs up the provident fund, provident fund members
will still bear the financial burden for any failure of investment projects (Asher, 2001).
Members pay the price in regard to lower returns to capital. Would diversification in
the choice investments be a good move, to increase the rate of return? Is it time then
to privatise or partly privatise the social security retirement programmes in Malaysia?
Privatisation would mean that the schemes would be more competitive, being able to
invest in a greater variety of investment channels. The introduction of a privatised
pension scheme might increase the rate of economic growth and improve the
standard of living for both the general and the elderly population (Williamson and
Pampel, 1998). The Latin American countries (Chile and Argentina, for example) fully
or partially privatised their social security retirement programmes and so far this has
been producing positive results. Or should the Malaysian social security retirement
programmes be more decentralised, like that of Australia, to ensure more openness
and efficiency in the administration and operation of the schemes?
Diversification of investments, particularly into equities and properties, might produce
a higher return rather than concentrating on government development projects i.e.
infrastructure. Diversification of investments could be accomplished through
privatisation. For a developed capital market, this could be accomplished easily as
private pension funds are allowed to compete with each other. In developing
countries, however, with a less developed financial market, privatisation cannot
guarantee a substantial positive impact on the economy unless privatisation itself
leads to the development of the capital and financial market.
5.0 Nature of the Schemes
The World Bank (2004) suggests The Three Pillar Model of a pension scheme. The
first pillar is the public defined benefit or pay-as-you-go (PAYGO) scheme aimed at
poverty reduction through redistribution. The second pillar is a mandatory private
defined contribution scheme aimed at consumption smoothing, and the third pillar is
a voluntary saving account. The Malaysian social security retirement scheme can be
regarded as falling under the second pillar.
While the main objective of the provident fund is to assist with retirement income, the
fund itself allows for withdrawals for housing, medical as well as pre-retirement
benefits. This is a typical administration of a provident fund. Graphically, following
Asher (1998), the accumulation and decumulation phases of a provident fund can be
depicted as in Figure 1 below. The cumulative balance in the graph is net cumulative
balance (contributions – withdrawals) plus interest accrued. Saving is accumulated
and earns interest during the accumulation phase i.e. working period. Even though
withdrawals are allowed, they should be set at a minimum level to ensure a positive
amount in the fund for further accumulation of saving. In the second phase, savings
are withdrawn either lump sum or periodically, which leaves the fund to deplete to
zero.
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
The allowable withdrawals decrease the accumulated saving for retirement purposes.
More stringent rules need to be adopted to ensure that withdrawals are limited and
that the aim of putting money aside for retirement years is accomplished. As the
withdrawal scheme has been in the system for a long time, removal of the withdrawal
scheme would not be the solution as it would lead to resistance among the
contributors. One alternative would be to treat withdrawals as a means of borrowing
from the fund. Any withdrawals made from the fund should be replenished by the
amount equal to, less than or up to a certain percentage amount equivalent to the
withdrawals made. The replenishment could be made by extra contributions from the
members. This would ensure that at least more money is put in after the withdrawal
and the accumulated saving would not deplete by as much as when withdrawal is
made without any replenishment. A probably stricter rule should apply to the civil
servants who only contribute for three years into the fund. Since the contributions of
the civil servants are lower than those made by the private workers, their
accumulated saving is much lower. Hence, withdrawal should be prohibited by this
group to ensure at least, that during retirement, in addition to the pension to be
received from the government, they will have at least some extra disposable income.
The lump sum benefits at retirement cannot be regarded as an appropriate form of
social protection (Beattie, 1998). Realising that periodical benefits payment is
essential to secure adequate income during retirement years, the provident fund
proposes periodic payment to its members. However, as of the end of 1996, fewer
than 120 people had opted for phased withdrawal. The provident fund then
introduced a voluntary annuity scheme in the year 2001, but this was abolished a
year later due to the limited response. To guarantee at least a minimum adequacy of
retirement benefits, the provident fund should propose to make periodic benefit
payments compulsory. While an individual should be permitted to make their own
spending decisions from their retirement money, the fact that individuals tend to be
myopic will mean that they would likely opt for the one lump sum payment and finish
the money.
While individuals are allowed to choose between a lump sum and a periodical
benefit, there is, then, a very strong tendency that the individuals will opt for the
former (Beattie, 1998). In addition to the situation in Malaysia, this is apparently the
case in Fiji. The Fiji National Provident Fund offered its members the choice between
the traditional lump-sum benefit and a pension for life. The attractiveness of choosing
a pension is that the annuity factors used to convert individual balances into pensions
are generous at 25% for single-life pensions and 16.7% for joint-life pensions as
compared with the actuarial annuity factors which have been calculated as 10% and
8%, respectively. Only 10% of the balances are converted into pensions and the rest
continue to be withdrawn as lump sum payment.
Alternatively, Malaysia could adopt a similar approach to that practised by the
Singapore Central Provident Fund. Instead of obliging members to convert the entire
saving in the fund to periodic payment for retirements, in 1995, it was ruled that a
minimum sum of S$40,000 should be put aside upon reaching the age 55 to finance
a regular monthly benefit. This minimum amount was gradually raised to S$80,000 in
the year 2002. Instead of just having the second pillar pension scheme, this method
could be used to set up a first pillar pension scheme. Setting a portion of saving
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
aside for periodic payment during retirement could ensure that at least the elderly
would have at least a minimum amount of money every month to support
themselves. It is so because, in addition to ensuring adequate retirement saving for
its members, the EPF should ensure at least minimum levels of benefits to its
members to comply with ILO standards. By having the first pillar pension scheme, it
could be possible to ensure a minimum retirement income each month throughout
the retirement years of the elderly.
Therefore, realising the inadequacy of retirement benefits both in the private and the
public sector, a third pillar retirement scheme as suggested by the World Bank could
be necessary. This however is voluntary, and getting people to save voluntarily for
retirement is difficult. The government may attempt to make private pensions
compulsory (could mean that workers may run down other voluntary savings, and if
there‟s a state safety-net, poorer workers will often choose to spend now rather than
to save). This third-tier system is yet to take deep root in Asia, even in countries such
as the Republic of Korea and Japan (Asher, 2002). A plan was drafted in May 2004
by the Malaysian Trade Union Congress (MTUC) for the establishment of private
pension plans. It is planned that the private pension scheme is put under the
administrative of the provident fund. This, however, could lead to an excess burden
on the provident fund in administering the provident fund. Even now, the provident
fund sometimes has problems in its processing of withdrawal applications. In early
April 2012, the securities commission (SC) has announced that it has given approval
to eight firms to offer private retirement scheme (PRS) to the public. The firms are
AmInvestment Management, American International Assurance, CIMB-Principal
Asset Management, Hwang Investment Management, ING Funds, Manulife Unit
Trust, Public Mutual and RHB Investment Management.
6.0 Coverage
The social security retirement scheme in Malaysia fails to cover all population,
especially those who are self-employed and agricultural workers. More than half of
the population works in the private sector, contributing to the provident fund. Hence,
the elderly population would definitely live in poverty during retirement and would still
have to depend on their children for financial support. People who are self-employed
are encouraged to contribute to the provident fund, but they are not too willing to
save for retirement through this channel. Those in the rural areas; working in the
plantation and agricultural sectors, who do not have any formal retirement schemes,
would definitely revert to their children for financial support or live in poverty during
retirement. It is not an easy task to ensure that the self-employed workers provide
voluntary contributions to the provident fund.
The Philippines has started to make it compulsory for self-employed workers to
contribute to a pension scheme. The Republic of Korea, for example, starting in
1995, has obliged self-employed workers such as farmers, fishing workers and the
rural self-employed to contribute three percent of earnings, a rate which is to be
increased by three percent every five years until it reaches nine percent. The
administration of the scheme and the cost of providing protection to this group of
people are subsidised by the government. The downside of this system is the extra
burden imposed on the employed workers and their employers. This is so because
Proceedings of 3rd Asia-Pacific Business Research Conference
25 - 26 February 2013, Kuala Lumpur, Malaysia, ISBN: 978-1-922069-19-1
the Korean pension benefit includes a relatively large flat-rate element, which means
that there is considerable redistribution towards pensioners who, during their working
lives have had the lowest insured earnings.
7.0 Conclusions
In this paper, discussion has centred on the evaluation of the credibility of the
provident fund in providing non labour income to the elderly and continuing providing
income throughout the elderly retirement years. This evaluation is particularly
important because of the increasingly elderly population in Malaysia. Even though
the rate of growth of the elderly population is low, if measures are not taken now to
ensure to meet the needs of retirement life, an abrupt and damaging situation will be
faced when the situation arrives. Without planning and counter solutions now, the
government will be left facing problems of poverty among the elderly and shortage in
the labour market. The latter is due to the early withdrawal of the elderly prior to
retirement and fewer of the young to take over.
The evaluation of the provident fund indicates that the accumulated saving is
inadequate to finance retirement expenses. The inadequacy of the fund is the
consequence of two major problems: investments in the MGS and inappropriate
government development projects have led to lower returns to the fund; and early
withdrawals for housing purposes and pre-retirement benefits have led to the
depletion of the accumulated savings in the fund. While the Malaysian financial
system is still young and volatile, privatisation is unlikely to ensure a better financial
governance of the system. However, a greater diversification in investments would
be a better approach to generate more income. While the government tries to
accommodate every single working group in certain social security retirement
programmes, it is impossible to cover every single cohort in the population.
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1
A Sharpe index > 1 indicates a good performance in relation to the level of risk
taken while a Sharpe index < 1 indicates not such good performance.
2
This is the range of minimum account required for maintenance provided that the
elderly does not have any more mortgages to pay and does not have to support any
more dependents.