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Wednesday, October 29, 2014

Tax Planing and Retirement Funds

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Most people do not have sufficient funds at retirement but they should enjoy their golden years, spend quality time with their loved ones and live their dreams after working hard for all their life. Retirement ranks last when Malaysians are asked about investment, their savings of choice or purpose for saving. According to a survey conducted by TNS for Manulife Malaysia, bank savings rank the highest as the investment of choice among Malaysians (98%) followed closely by fixed deposits (10%) while the penetration for retirement investment or savings rank the lowest at 4%. This shows the inadequacy of the financial literacy among Malaysians. At the core of this is the Private Retirement Schemes (PRS) initiative, a range of investment funds intended to offer Malaysians the option of building up a private pension as a supplement to a state pension and the existing mandatory private pension scheme administered by the Employees Provident Fund (EPF).

Contributors to the Employees Provident Fund (EPF) earning a monthly wage of not exceeding RM5,000 will enjoy a boost in their retirement savings when the revised employers’ statutory contribution rate of 13 per cent takes effect from January 2012. The one per cent increase from the current 12 per cent benefits 5.3 million working Malaysians, comprising 92 per cent of EPF’s active members. However the employees’ contribution rate remains at 11 per cent. As for employees who are 55 years and above and earning wages not exceeding RM5,000, they will also benefit from the revised rate as their employers are now required to contribute at 6.5 per cent which is an additional 0.5 per cent from the current 6.0 per cent, while the employees continue to contribute at 5.5 per cent. While the EPF, being a public provident fund, is approved, not every private provident fund is approved. To gain approval, a scheme must comply with the rules set out by Inland Revenue Board (IRB), one of which relates to investment policy. Another rule stipulates that upon dissolution, the fund monies must be paid into the individual employee’s EPF account.  An added benefit of EPF contribution is that it qualifies for tax deduction by way of personal relief.  Dividends generated from EPF are also exempted from tax.
Establishing a pension source is one additional stream. How do you do this? Join an establishment organisation that provides a pension after retirement. In Malaysia, the government does not set aside a part of its tax revenue to pay its senior citizens a pension. Instead, each individual is expected to look after himself in retirement, either with his savings in the EPF, or on his own. PRS was brought to order upon recognising the need for a better pension system to address the EPF’s shortcomings, a government joint-agency task force comprising the Ministry of Finance, Bank Negara Malaysia, Securities Commission Malaysia and the Economic Planning Unit has been established to review the country’s pension system. According to the Economic Transformation Programme (ETP), Malaysia envisions having a model pension system and vibrant private pension industry. By 2020, we expect the private pension industry to grow to RM73 billion, with more than 2.7 million participants. Specific exemption is given to pensions as follows:
1.      Pensions payable under a written law or an approved scheme to a widow, widower or orphan;
2.      Pensions derived from Malaysia from a former employment in Malaysia. Conditions that must apply are:
·         Pension is payable under a written law (as in public service), or under an approved scheme; and
·         Pension is payable for ill health, or upon reaching the age of 55, or the compulsory age of retirement.

In the case of a foreigner who decides to take up residence in Malaysia, such as under the Malaysia, such as under the Malaysia My Second Home programme, any pension he receives from his home country is, prima facle, subject to tax in Malaysia. However, the foreign pension is not derived from Malaysia as it is not in respect of an employment exercised in Malaysia. As receiving a pension is often not a viable option, one has to “create” one’s own pension source. This takes us to deferred annuity.

A deferred annuity, is one in which the first payment is due only after a period longer than one payment interval. In fact, there is normally a spread of a few (or a lot) of years between the date of purchase and the time when the payment begins. The PRS is offered by Unit Trust Companies and governed by the Securities Commission of Malaysia, while the deferred annuity scheme is offered by Insurance Companies and governed by Bank Negara Malaysia. The unique feature of deferred annuity will provide a regular income after retirement as well as death benefits. Unlike in the UK, deferred annuities are not a common pension source in Malaysia. Going forward, we are likely to see more of these now that the authorities have been encouraging this approach. One such measure is a provision where premiums for deferred annuity are eligible for tax relief. The premium paid for a deferred annuity (issued by an insurer registered under the Financial Service Act) and for approved PRS are jointly allowed a maximum deduction of RM3,000 per year for resident individuals. This is separate and distinct from the RM6,000 for EPF and life insurance premium. One interesting point to note is that an individual may purchase a deferred annuity for his spouse, oarent or children (that is, he is the policyholder who pays the premiums, owns the policy and has the legal rights to the policy, while the annuitant is another individual), and he will still qualify for personal relief of up RM3,000 per year. For more details, refer to Example 9 of the Public Ruling 4 of 2014.

As for PRS, any withdrawal on or after age 55 will be tax-exemp, while any withdrawals from PRS account can be made before retirement age of 55 at 8% tax penalty to be paid to Inland Revenue Board of Malaysia. With the PRS, you are not committed to contribute a fixed sum of money to the fund annually, ie. which means that  you have greater flexibility in determining how much you want to contribute to the fund, if you are the type who are not overly concerned about the personal relief for tax purposes. However, if the early withdrawal is by reason of permanent total disablement, serious disease (such as AIDS, Parkinson’s, cancer or renal failure), mental disability, death or leaving the country permanently, the 8% withholding tax is not applied, that is, the amount withdrawn is tax-exempt. Upon a person’s death, monies in the PRS account will be subject to the usual estate distribution conditions, ie. the immediate family member will need to apply for a Grant of Probate of Letter of Administration to unlock the deceased’s estate for distribution to the beneficiaries, which will take some time to do so. In the case of the deferred annuity, as this is an insurance product, passing on the benefits of the policy to the next of kin is easily effected through a proper nomination and the proceeds are released with relative ease.


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