Reforming the private pension system

(Conclusion)

It is a Constitutional mandate for the State to promote a just and dynamic social order, free the people from poverty and improve the quality of life for all. Toward this end, the State, from time to time, is mandated to review pension and other benefits due to retirees.

It is therefore imperative to cure the pressing problems and weaknesses of the current pension system as laid down in the first part of this article (published on Sept. 5) A robust and fully functioning pension system breaks generational poverty. It provides sufficient income for retirees, enabling their children to build wealth not only for themselves but for their descendants, rather than for their ascendants.

The interconnectedness of pension, capital growth and economic development sparked the call of the Capital Markets Development Council for pension system reforms. House Bill (HB) No. 9343, or Capital Market Development Act of 2021, sought to widen the domestic institutional investor base, creating a big pool of funds that will flow to the capital market, a natural repository of long-term financing that is essential for national development. Unluckily, this bill got stuck in the Senate despite the overwhelming approval in the Lower House.

HB 9343 proposed drastic changes to the private pension system. It will operate like the Social Security System (SSS) and Government Service Insurance System (GSIS): mandatory with comprehensive coverage, except that the pension fund is created individually under the name of the employee, privately managed under the employee’s sole discretion or with the assistance of accredited investment managers and under a strictly regulated environment.

Voluntary pension system has failed to flourish in the country despite attractive tax exemptions. The Personal Equity Retirement Act (Pera) Law, an individualized voluntary pension, has attracted about 5,000 individual participants only, and the Employee Retirement Fund under Republic Acts No. 4917 and 7641 captured only 5 percent of total business enterprises. Hence, the bill sought a compulsory framework, as it was thought that any nonmandatory system would fail.

Highlights

Under the bill, an employee entering the workforce for the first time shall create an employee pension retirement income (EPRI) account bearing the national ID number (PhilSys), which will be one’s permanent account until retirement. Any amount accrued to this account—employee and employer contributions, and investment income—is accumulated and carried along as an employee transfers from one employer to another, from being employed to self-employed, or from private to government employment. The buildup of funds continues until retirement, when the funds can be withdrawn either in lump sum or in annuity. Early withdrawal is generally not allowed and subject to heavy penalties.

All employees and employers as defined under the Labor Code are compulsorily covered. Those outside its coverage, such as the self-employed in the gig economy, professionals, government workers, domestic helpers, overseas Filipino workers, can opt for voluntary coverage.

But unlike the SSS, the EPRI is completely privately managed and under the full control of the employee. The government will only provide the regulatory framework, including the accreditation of qualified administrators and investment managers, custodians, investment products or plans and fees. For employees who are unable to make an investment choice, there will be default investment products, low-risk if not risk-free, to be prescribed by regulators. In line with this, financial literacy programs for employees are made mandatory.

To ensure undiminished pension benefit upon retirement, the full pension cycle is made tax-free. The pension assets shall be kept separate and not considered as assets of the EPRI owner for purposes of insolvency and estate taxes.

In summary, the proposed pension reform combines the features of SSS and Pera. Mandatory contribution is tied to salaries like SSS, but investment is privately managed like Pera.

What has HB 9343 achieved?

Clearly, there is a shift from the current Defined Benefit (DB) plan where pension payment is tied to length of stay and amount of salary, to a Defined Contribution (DC) plan where benefits are determined based on amounts accrued in a fully funded pension account. The benefits of a shift to DC are:

• Portability. The EPRI account is permanent, and it accepts contribution regardless of shifts in employment.

• Equitable burden among employers. Unlike the current system that burdens the last employer alone, this will make all employers who benefited from one’s labor proportionately responsible for pension cost.

• Fully funded. This removes the risk of nonpayment in case of employer’s bankruptcy. And as the contribution is accumulated, investible funds will flow into the capital market.

• Adequate. Pension contributions are mandated to be reviewed every five years; It can adjust to changes in the environment.

• Comprehensive. It can cover those in the gig economy, the self-employed, professionals, overseas workers, domestic helpers and government workers under a voluntary scheme.

• Managed investment risks. It sets the regulatory environment to manage investment risks. Risk-free or low-risk investment options are provided for those who are unable to make a choice. Intermediation and management fees are capped.

• Free from political intervention. Investment decisions are solely the choice of the owner, with assistance from advisers if desired.

• Funds are held to vesting period. Early withdrawal is not permitted to allow accumulation of wealth.

• Freedom in designating a beneficiary. The EPRI owner can freely designate beneficiaries, without being limited to legitimate heirs.

• Completely tax-free, and

• Promotion of financial literacy.

In his explanatory note, the proponent of the bill, Rep. Junie Cua says, “I firmly believe that the successful reformation of the corporate pension system will secure our future in two senses. One, it will ensure that upon retirement, we will be able to live a comfortable life and afford our basic needs ‘hanggang sa pagdating ng dapit-hapon’. Second, and more importantly, this will allow for the efficient funding of productive, long-term projects that will improve the lives of our children, grandchildren and the members of the future generation of Filipinos.” INQ

The author is chair of the MAP Tax Committee, and founding partner and CEO of Du-Baladad and Associates (BDB Law). Feedback at [email protected] and [email protected].