MAPping the FutureColumn in INQUIRER
Reforming the Private Pension System (2nd of 2 Parts)written by Atty. Benedicta "Dick" Du Baladad - September 19, 2022
(2nd of 2 Parts)
It is a Constitutional mandate for the State to promote a just and dynamic social order, free the people from poverty and provide an improved quality of life for all. Towards this end, the Constitution likewise mandates that the State, from time to time, shall review to increase the pensions and other benefits due to retirees of both the government and the private sectors (Art. 16, Sec. 8, 1987 Philippine Constitution).
It is therefore imperative that the pressing problems and weaknesses of the current pension system, as laid down in the first part of this Article, must be cured. A robust and fully functioning pension system, breaks generational poverty. It provides sufficient income for old-age retirees and frees their children from having to spend for their needs, thus enabling the children to build wealth not only for themselves but their descendants, rather than ascendants. The reform of the private pension system is long overdue.
The inter-connectedness of pension, capital growth and economic development sparked the call for the Capital Markets Development Council (CMDC) to push for the reform of the pension system. House Bill (HB) 9343 known as the Capital Market Development Act of 2021 was a measure meant to reform the private pension system to address the shallow capital market in the country. As structured, the proposed reform will widen domestic institutional investor base, creating big pool of funds that would find its way to the capital market as 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 current private pension system. It will operate like the SSS and the GSIS that is mandatory with comprehensive coverage, except that the pension fund is created individually under the name of the employee, privately managed under his sole discretion or with the assistance of qualified accredited investment managers, under a strictly regulated environment to ensure its rapid development and safety.
Owing to the failure of our voluntary pension system to develop and flourish despite attractive tax exemptions, it was thought that, in this country, a pension system that is not mandated will fail. Hence, it was made compulsory. The Personal Equity Retirement Act (PERA) Law which is an individualized voluntary pension has attracted about 5,000 individual participants only, and the Employee Retirement Fund under Republic Acts 4917 and 7641 resulted to about 5% only of total business enterprises with employee retirement funds.
Under the bill, an employee entering the workforce for the first time shall create an ‘employee pension retirement income’ (EPRI) account bearing his National ID Number (PhilSys), which shall be his permanent pension account until retirement. Any amount accrued to this account consisting of employee and employer contributions, and investment income is accumulated and carried along as one transfers from one employer to another, or from employed to self-employed, or from private to government employment. The building up of funds continue until retirement when the retiring employee shall be entitled to withdraw the funds either in lumpsum or in annuity. Early withdrawal is generally not allowed and is subject to heavy penalties.
All employees and employers as defined under the Labor Code, all businesses whether registered or unregistered, domestic or resident foreign, regardless of the number of employees, are compulsorily covered. Those outside of its coverage, such as the self-employed in the gig economy, the professionals, the government workers, domestic helpers, overseas Filipino workers, can opt to be covered voluntarily.
But unlike the SSS, the EPRI is completely privately managed. It is owned, held, managed under the full control of the employee. The government will provide a safe and secure regulatory framework, including the accreditation of qualified administrators and investment managers, custodians, investment products or plans and fees, but all investment decisions are that of the employee. In the case of employees who cannot, or are unable to make an investment choice, there will be default investment products, low-risk or risk-free, to be prescribed by the regulators. In line with this, financial literacy programs for employees is made mandatory for employers, employee associations and unions, investment managers, government regulatory agencies and educational institutions, among others – somehow a way to achieve financial inclusion.
The Regulatory Authority over EPRI is composed of the DOF, BSP, SEC and Insurance Commission (IC) which shall have joint responsibility. The DOLE, on the other hand, together with the tripartite council, shall approve adjustments or increases in contribution, as may be proposed by the DOF taking into consideration the desired replacement rate to be achieved. As it is, the replacement rate of our overall pension system is only 3%, a far cry from the international average of 70%.
To ensure an undiminished pension benefit upon retirement, the full pension cycle is made tax-free under an Exempt-Exempt-Exempt (EEE) tax regime. The contribution of the employer is an allowed deduction from taxable income, the investment income is tax-free, and the distribution of benefits to the pensioner likewise tax-free. The pension assets cannot be assigned, alienated, pledged, encumbered, attached, garnished, seized, or levied, by or under any administrative, legal, or equitable process. It 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 – a mandatory contribution tied to salaries like SSS, but the 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 is carried along by the employee, and accepts contribution regardless of shifts in employers or type of employment.
- Equitable burden among employers. Unlike the current system that puts the burden over the pension of a retiring employee to the last employer alone, this proposed change will make all employers who benefited from one’s labor proportionately responsible for the pension cost of the employee.
- Fully-funded, removing the risk of non-payment in case of bankruptcy of the employer. And as the contribution is accumulated and built-up, there is a pool of investible funds created that would flow into the capital market for long-term financing of businesses and government projects.
- Adequate. The adequacy and sustainability of the pension contributions are mandated to be reviewed every 5 years to adjust to the desired replacement rate. It is flexible to absorb changes in the environment.
- Comprehensive. It can cover those in the gig economy, the self-employed and professionals, the OFW, domestic helpers and government workers under a voluntary scheme.
- Managed investment risks. The bill put in place a regulatory environment to manage investment risks. Default investment options that are risk-free or low-risk are provided for those who are unable to make a choice. Intermediation fees and management fees are capped.
- Free from political intervention. Investment decisions are solely the choice of the owner, with assistance from advisers if he so desires.
- Funds held to vesting period. Generally, no early withdrawal is permitted to allow accumulation of wealth that vests upon retirement when the employee loses his source of income.
- Freedom in designating a beneficiary. The EPRI owner can freely designate his beneficiaries as he wishes and not limited to legitimate heirs. No hierarchy observed other than the wishes of the owner.
- Completely tax-free, and
- Promotes financial literacy.
In his explanatory note, the proponent of the bill, Cong. Junie Cua says, “Today marks the first year that we went into lockdown due to the COVID-19 pandemic, and this has made us realize the importance of keeping ourselves financially secure for the rainy days.
I am sponsoring this bill because 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.”
(The author is Chair of the MAP Tax Committee, and Founding Partner and CEO of Du-Baladad and Associates (BDB Law). Feedback at <firstname.lastname@example.org> and <email@example.com>.