Some spare cash now, but bigger loss later, experts say of 3% EPF option

About RM14,000 plus compound interest over 30 years – that is how much a worker who makes RM5,000 a month stands to lose if he decides to cut his Employees Provident Fund (EPF) contribution by 3% a month, according to financial planners. This is based on the assumption that the EPF declares a constant annual dividend of 5% over 30 years. The trade-off is that the same worker would get RM150 per month or a total of RM3,300 in 22 months by slashing his EPF contribution from 11% to 8%. The above illustrates how much the 3% EPF deduction over 22 months can be worth, as the government is allowing workers to take the option as part of its revised Budget 2016. The EPF reduction was part of a slew of measures to put more money in the hands of Malaysians to help them get through a turbulent economy and to boost consumption. While independent financial planners did not disagree with the measure, they cautioned Malaysian workers against taking up the option if they could afford to get by. They also advised those who take the reduction to only use the extra cash to pay off debts and loans. This is because while the measure gives a worker slightly more to spend every month, the potential loss in earnings for retirement is substantial. And to begin with, most Malaysians already have poor retirement savings, according to EPF estimates. According to an EPF brochure, in 2013, the fund estimated that 69% of contributors had less than RM50,000 in their accounts, while 54% of members had less than RM20,000. “The difficulty in trying to convince people to save the money they have now is like talking about the dangers of climate change,” said a Kuala Lumpur-based financial manager who wanted to be known as Wilfred. “The effects of both are so far down the road that people can’t imagine them. But it’s easy to imagine what you can do with some extra cash now,” said Wilfred. Dividend rates After the budget revision, Deputy Finance Minister Datuk Johari Abdul Ghani said that a worker earning RM5,000 a month would get an extra RM150 a month by reducing the EPF monthly contribution from 11% to 8%, starting from March this year till December 2017, or a total of RM3,300 for the whole period. Using the same test worker, The Malaysian Insider calculated how in savings with compound interest that RM3,300 would be worth, if the 30-year-old worker had kept it until the age of 60 when he or she decides to retire. This calculation also assumes that the 30-year-old had no prior savings. If the EPF only pays the government-mandated 2% dividend or interest rate over those 30 years, that 3% would be worth RM5,977.49 due to compound interest. The amount of savings was arrived at using an online compound interest calculator. If EPF is able to maintain a 5% dividend over those 30 years, the amount would be RM14,262. If the dividend is 6%, it would be RM18,954. From 2000 to 2014, EPF dividend rates were between 5% and 6%, with dividends of between 4% and 5% for 2002, 2003, 2004 and 2008. The EPF has declined comment when approached. “From an individual standpoint, a 3% reduction will have considerable effects on one’s retirement pot,” said Malaysian Financial Planners Council vice-president Phang Kar Yew. “Only those who are in dire need of the funds should consider opting for the 8%. These are people who turned to illegal money lenders or who have very high credit card debts or who are unable to service their housing or car mortgage payments.” Income tax hike Wilfred added that workers earning more than RM4,001 a month should factor in a potential rise in income tax if they took the 3% reduction. “A 3% reduction in EPF essentially means you just got a 3% raise in your salary. So you have to pay more in income tax,” he said. Figuring out how much an extra income is taxed is tricky, as it is calculated based on income per year, while the EPF reduction is for 22 months. But a very rough calculation using the same test worker would yield these results: RM2,020 in income taxes a year with an EPF rate of 8% or RM1,900 in taxes if the EPF rate was 11%. This is assuming that in both instances, the worker files as a single person with no children or parents. This calculation is based only on two tax reliefs, the RM6,000 maximum relief for EPF and the RM9,000 personal income relief. The total tax could vary depending on the reliefs and exemptions that are available such as computer purchase, parents’ medical bills and books. While the above calculation was not done by MFPC, Phang admitted that workers would have to pay a higher monthly scheduled tax cut rate (PCB) if they reduced their EPF contribution. “However, there are tax exemptions and reliefs that are provided, and with proper planning, an individual could benefit too.” – February 7, 2016.