Tuesday, October 21, 2008

Don't Rely On Your EPF

Many Malaysians believe their Employee Provident Funds (EPF) savings can fund their retirement. This is unrealistic. By relying solely on your EPF savings, you underestimate the amount needed to retire and overestimate how much you can withdraw once retired.

Malaysia’s pension scheme is meant to provide contributors with the basic necessities. Unless you plan to make drastic lifestyle changes after you retire, there is a big chance of exhausting all your funds in just a few years, with escalating living costs and increased longevity.

Living on a quarter of your income

The amount that we have in our respective EPF accounts depends on how much we make. For salaried employees, the mandatory contribution rate to the country’s pension fund is 23% of the employee’s monthly salary; 12% is contributed by the employer and the rest is deducted from the individual’s pay. At age 55, contributors can opt to take the sum along with annual EPF dividends declared to finance the rest of their life. Any withdrawals made before this age, such as to buy a property or pay for medical and educational expenses, will reduce the amount that you receive at retirement age.

All things being equal, with a monthly contribution of 23%, those relaying solely on EPF funds for their retirement will have to live on slightly less than a quarter of their current income every month. Is it possible to live frugally on this sum?

Even EPF officials have consistently highlighted the need for contributors to supplement their retirement funds with other sources of income. According to Deputy Finance Minister Datuk Seri Ahmad Husni Hanadiah, the average Malaysian will have approximately RM120, 000 in their EPF account at the age of 55. This amount provides the retiree with RM500 a month to live on for 20 years. While it can be argued that this meager sum can be stretched to provide for basic necessities (families earning this amount are classified “hardcore poor” and are eligible for government aid), it is not sufficient to provide for those that live beyond the age of 75.

Inflation Surpasses Returns

Inflation is another reason why you should not depend solely on your EPF funds for your retirement.

Inflation pushes up the cost of living. At the very core, inflation means we have to pay more for the same amount (and quality) of goods and services consumed. It eats away the value of your EPF funds. For example, a yearly 5% dividend declared by EPF translates to a real return of 1% if inflation for that particular year averages out at 4%.

As shown in Table 1, the EPF’s annual dividends have been just slightly more than the country’s inflation rate, which is measured by the consumer price index (CPI).

Table 1: EPF and CPI





EPF Annual Dividends










*Bank Negara’s estimate
Source: EPF and Bank Negara

However, one criticism of the CPI is that it does not reflect the actual consumption patterns of different regions and different income groups. This is could be due to controlled prices for a generic brand of several items in the CPI’s basket of goods and services, including cooking oil, white bread and rice. Controlled prices do not reflect actual market prices paid by the majority of Malaysians, especially those living in cities.

Revisions to the CPI basket are also infrequent - the last revision was in 2005. Recognising these shortcomings, the government reportedly reassessed the composition of the CPI and is considering publishing separate inflation rates for urban and rural areas.

CPI is also a poor reflection of inflation experienced by individuals. In June 2008, the CPI jumped to a 26-year high of 7.7%. However, in reality, most people experience a jump in prices that exceed 7.7%. It is more likely that the good and services purchased, especially in the urban areas, reflect the 40% increase in fuel prices and the 18% increase in electricity tariffs.

As more and more producers start passing down rising transportation cost to consumers, we believe inflation will continue at higher levels for some time. This will eat into the value your EPF savings, especially if annual returns declared for this year do not surpass 5.7%, the estimated inflation rate for 2008.

What Can Be Done?

The first step is to stop depending on the EPF. Take responsibility for your retirement and invest with a clear goal in mind. The objective is to invest in assets such as equities that have historically been able to provide inflation-beating returns.

To get started, here are some tips:

1. Invest now.
The sooner you start investing, the sooner you start building your wealth. Take a long-term view and invest small sums over a long period.

2. Take a look at how much you will need to retire.
This is, at best, a guesstimate of the expenses that you will incur when retired. Aim for a higher percentage of your current income, for example 65% to 80% of what you are earning now to sustain the same lifestyle once you stop earning.

3. Diversify.
This can be easily done with unit trust funds. It is possible to invest your EPF funds in approved local funds but your selected investments must make better returns than EPF’s annual dividends. However you still need to diversify your portfolio with different asset classes and geographical coverage.

4. No matter what happens – whether the market falls or climbs - always keep retirement as a financial goal and stay invested.

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2 Responses to "Don't Rely On Your EPF"

  1. nice blog
    good explainations
    keep it up!
    we are the next investor..