Currently, both private and public sectors offer occupation savings schemes in the shape of provident funds and gratuity schemes.

However, in their truest sense, provident funds and gratuity schemes are not retirement products. Fund withdrawal, job switching and loans against the schemes are a norm. Invariably, individuals are therefore left with depleted savings at the time of retirement.

To encourage better options, four private asset management firms were granted licences in 2007 by the Securities and Exchange Commission of Pakistan (SECP) to act as pension fund managers under the Voluntary Pension System (VPS) Rules-2005.

The introduction of VPS will aid mobilisation of savings, which, in turn, will help individuals become self-reliant in old age, reduce financial liability for government/employers and relieve financial obligation for younger generations.

The scheme is funded and the tax incentives enhance both-- savings and investment. Contributions received from investors are allocated proportionate to their respective preference.

Some salient features of VPS are as follows:

Overseas Pakistanis with national identity cards for overseas Pakistanis are eligible in the VPS. Pension accounts are customised according to the specific needs of the investor. Whether the contribution comes from an investor or an employer, the benefit of the investment goes to the individual investor and it is not dependent on the length of service or any other condition of employment.

The VPS is portable. In other words, an individual’s account will stay with the investor even if he/she changes jobs. Contribution can be resumed at any time either through the new employer or based on personal contribution. An investor can transfer the account to/from another pension fund manager.

The contributors in VPS are entitled to a tax credit (up to a maximum of Rs500,000) and the income thus accrued will be tax-free. Retirees will be taxed on the benefits they receive (in this case 25 per cent of the savings will be received tax- free while the remaining 75 per cent will be taxed).

Investors may contribute any amount; however they can claim only a tax credit for their contributions of an amount equal to 20 per cent of their taxable income, subject to a maximum credit of Rs500,000 per year.

Investors over the age of 40 years may claim an additional two per annum for each year subject to a maximum contribution of 50 per cent of the taxable income. Employers making contributions on behalf of their employees are also exempt from tax on the contribution amount. Pre-mature withdrawal (before retirement age) and benefits received after retirement are taxable.

Assuming that an investor chooses to receive a lump sum payment of up to 25 per cent of the accumulated balance, with the remaining portion of 75 per cent of the accumulated balance at the time of retirement, he may enter the Income Payment Plan (IPP) managed by the pension provider.

The IPP also comprises of the three sub-funds (equity, debt and money market) but will pay investors an income on monthly basis. The other option for him would be to purchase an annuity from a life insurance company.

Should an investor have to retire early due to any disability that renders him unfit for work, pension can be paid immediately from the accumulated balance in the pension account, subject to medical evidence.

Most of the licensed pension fund managers also offer a Shariah-compliant fund having the same features as the conventional fund, except that the investment will be Shariah-compliant.

VPS is different from the existing provident funds. Tax credit is not available on employees’ contribution to provident fund. Withdrawals from the provident fund, either temporary or permanent, are not subject to income tax.

The provident funds do not offer insurance cover as is done by most of VPS managers. There is no separate asset allocation for an employee in provident fund. Unlike VPS, a provident fund account is terminated at the time of job switch and the worker has to make a fresh start in terms of savings Provident fund is an omnibus investment vehicle. Hence, all employees despite varying age and risk profile are subject to the same investments.

Apart from the individuals, the government would also benefit from the VPS. One of the major benefits of VPS will be felt in the area of fiscal deficit. For example, the current pension liabilities of the government of Punjab is about Rs450 billion and the budget allocation for payment of pension is about 20 per cent of the total budget for the year 2007-08. Both the federal and provincial governments are considering funding its liability by moving towards defined contribution.

The recently promulgated Punjab Pension Act 2007 goes some way in trying to address the burgeoning pension liability of the Punjab. Sindh is following suit as well. The ministry of finance is also taking the initiative by contemplating the introduction of defined contribution pension for new civilian employees of federal government.

VPS will provide stability and add depth to our capital markets. The “irrational exuberance” that our stock market occasionally suffers from will subside when pension fund managers will make long-term investment. The scheme will act as a source of stability for the market even in times of bearish sentiment. Of course, the investment avenues will have to increase in time as large amounts of investments chasing limited number of scrips may create volatility. More public offerings will be required to ensure adequate diversification and lessen the chances of stock manipulation by major market players.

The growth in pension savings will lead to development of the debt market. Not only will private sector entities be able to raise funds through a growing debt market, but the government will be to raise finances for viable initiatives, namely infrastructure, health and educational projects. In the past, various governments had planned to raise finances for municipal bodies by issuing municipal bonds. Burgeoning pension savings will make this possible.

Pension reform has a symbiotic relationship with the life insurance sector. First, they both look to invest for the long- term. Any reform carried out, say, in our capital markets will surely benefit both sectors. Second, investors may choose to invest their VPS proceeds with an annuity provider. The problem, of course, is that the annuity market is almost non-existent. Thus, it is imperative that pension reform go hand in hand with insurance sector reform. The success of VPS and future pension reform is partly dependant on reforms in the annuity market.

VPS marks the first step towards pension reforms. However, to make the product marketable, the withdrawal of pension from VPS, after reaching the retirement age, should be exempt from income tax to make it compatible with pension schemes offered by the government and private sector

As non-resident Pakistanis and those on presumptive tax regime will not be availing tax credit on contribution, it would be inappropriate to subject them to income tax on pension withdrawal.

Self-employed individuals (auditors, lawyers, doctors and architects) currently under the presumptive tax regime, should be brought under the normal tax regime.

Some amendments in the Income Tax Rules, 2007 are required to enable transfer of Provident Fund balance to VPS.

The scope for VPS is enormous. The benefits for individuals are multi-fold. An individual can choose between competing pension fund managers, between various allocation schemes and have options before, at and after retirement.

The writer is the executive director, Atlas Asset Management Ltd