For the first time since the Mandatory Provident Fund (MPF) system was founded 11 years ago, Hong Kong authorities are considering changes to the way the benefits can be paid upon retirement. Although authorities may loosen rules on how benefits can be withdrawn, comparisons to Singapore’s pension scheme are premature.
The Mandatory Provident Fund Schemes Authority (MPFA) in December tabled a consultation paper on changes to the way that MPF benefits are paid upon retirement as well as the cases in which early withdrawal of MPF benefits would be allowed. The proposed changes would apply only to mandatory contributions as benefits from voluntary contributions are not subject to withdrawal restrictions.
Under current rules, scheme members may only withdraw their benefits before turning 65 if they retire early, are leaving Hong Kong permanently, have less than HK$5,000 ($645) in their account, are incapacitated or die. The MPFA is proposing to allow early withdrawal if the member has a terminal illness.
Another change being proposed is how the funds are drawn upon retirement. Under current rules members may withdraw their funds at any time they wish after they turn 65, but they must do so in a lump sum payment. The MPFA is proposing to offer flexibility so that member can withdraw their funds gradually if they wish to.
Many in the industry, including Kelvin Lee, head of institutional business at Schroders Investment Management, say the review is timely and needed in order to keep members interested in making voluntary contributions. “The response from the public is still low and people are quite resistant. If contributions are to increase the MPFA and the government need to do a lot of lobbying and offer some more sweeteners.”
Not everyone is as enthusiastic. Stewart Aldcroft, senior advisor for Securities and Fund Services within Citi’s Global Transaction Services, sees the MPFA’s proposals as a sop for members who have long been unhappy with the restrictive nature of the scheme. Resentment towards the MPF is high, particularly over the lack of choice offered to members. “They’re probably trying to water down demand for change. You can look at these options but not actually do anything. In my view they’d be better off not doing anything.”
“If contributions were to be significantly higher and if voluntary contributions were tax advantaged, it’s maybe something you’d want to have a look at.”
Lump it or Leave it
Mike Button, chairman of the Hong Kong Retirement Schemes Association and a senior consultant at Towers Watson, says allowing gradual withdrawal of benefit may prompt reconsiderations of Hong Kong’s tax laws and could require members to think more carefully about their retirement strategy. The current lump sum payment fits with Hong Kong’s existing tax law that allows lump sum pension withdrawal tax-free but taxes pension income. “You don’t live on lump sum payments, you live on income.”
“The lump sum amount needed to generate livable income has gone up dramatically in the last 15 years.”
At 65 years of age members need to make financial plans for about another 20 years, creating a financial management challenge upon lump sum withdrawal. Lump sum withdrawal also means that a member needs to consider market timing when planning to draw their benefits.
Button says that given the current low interest rates, annuities are not appealing for a 65-year old person who has just been paid their benefits in a lump sum, forcing them to seek other investment options for their lump sum. “It would be better to just allow the investor to stay invested and draw down from that balance.”
The MPFA says the changes would encourage providers to develop a range of payout options to meet the needs of different individuals.
Lee predicts the development of more short term target date funds instead of the long-term, retirement focused products that currently dominate the MPF, and that the frequency of switching would likely increase as well. He says increasing the MPF options would push providers to act more like investment advisors.
“If this thing really happens the entire market dynamic will change to become more retail focused, with more personal investment advice.”
The MPFA is proposing that terminally ill members who have been given only a short time to live - the length of that time has been proposed at six months to one year - be allowed to withdraw some or all of their benefits even if they are not yet 65. This is to accommodate those who are terminally ill but are not incapacitated, which already does allow early withdrawal. The proposal is being welcomed as a humanitarian gesture.
The percentage of benefits that can be withdrawn in this situation may be capped in order to provide for the member in case they recover from their illness.
“For these scheme members, the prospect of providing for an income after age 65 has lost its promise and preserving benefits in MPF accounts for old age protection may no longer be necessary,” the MPFA says in the consultation paper.
The proposed change to allow withdrawal in case of terminal illness has drawn comparisons to Singapore’s Central Provident Fund (CPF), which allows members to withdraw benefits for a variety of needs such as education, home and insurance purchases and medical costs. However, the MPFA paper discusses the CPF’s wider range of withdrawal options within a Hong Kong context.
“In view of the relatively low level of contributions and the relatively small amount of accumulated benefits so far, it is not considered feasible or practicable to try to use the MPF System to address different needs at this time,” the MPFA says.
The MPFA points out that Hong Kong has an affordable public hospital system to address medical needs, and therefore it is unsuitable to make MPF benefits available to cover medical costs. Similarly, using MPF benefits for home purchase would require higher contribution levels, while the government has announced other measures to help low and middle income families achieve home ownership. As for allowing withdrawal to pay for education, the MPFA said that the government provides several different education finance schemes to meet this need.
“At this rate, if cash is taken out for other purpose such as housing and medical bills, it will defeat the original purpose of the MPF, which was to save for retirement,” Lee says. “If you look at the retail market in Singapore it’s hard to find a person who buys mutual funds from their bank. Most of the saving is done via the CPF.”
One of the key complaints about the MPF has been its low level of contributions. The maximum you can contribute is HK$24,000 per year, while in Australia, which has a similar system, maximum contributions are about five times as high. In Singapore, which has a broader multi-purpose social service savings scheme, contributions average about 36% of annual salary, which is more than three and a half times the contribution levels to the MPF in order to allow for a wider range of withdrawal options.
The investment industry has long called on the government to offer tax breaks to encourage higher contribution levels, and some predicted that this would be the next major change to the system.
“If you increase contribution rate the entire MPF market will expand and there will be more players,” Lee said. “A bigger pie will increase the economies of scale and drive costs down.”