In February 2021, the Employer’s Provident Fund (EPF) announced dividends of 5.2% for conventional savings and 4.9% for shariah accounts for 2020. Overall, I believe contributors were satisfied in view of the effects of the pandemic caused by Covid-19 which greatly affected both the local and global economy. At least their retirement fund continued to grow!
In Malaysia, EPF contribution is mandatory for both employers and employees as long as they are under full-time employment. This scheme allows workers to automatically save for their retirement from the day they start working. However, there is another category of people consisting of self-employed or business owners that might not contribute to EPF as it isn’t mandatory under business entities such as sole proprietors, partnerships or private companies (Sdn. Bhd.) and do not draw a salary from their company. Instead of drawing a salary, they get paid through director fees or dividends.
So should such income earners opt for voluntary contributions to EPF? Let’s look at this from various perspectives:
Compounding interest effect through long term savings
In order to have a comfortable life after retirement, we have to set aside money to create a pool of funds which must adequately cater for 20 years of retirement costs. Therefore it’ll be much easier to hit this target if you start saving immediately when you begin earning an income. If you understand the power of compounding interest, you’ll know that by starting to save early, your money will be put to work for you. Therefore a self-employed person should set aside a certain percentage of income or business profits for the purpose of retirement as early as possible.
The next question is why EPF? Why can’t I save the money in the bank? Firstly, we’re currently in the low interest era and it’s likely to remain that way for the foreseeable future. EPF dividends are much higher than what banks are offering for fixed deposits, currently between 1.8% and 2.2% depending on the amount and period.
One might argue that contributors can’t withdraw the money as they wish except under certain criteria from time to time, such as the i-Sinar scheme due to the Covid-19 pandemic. The restriction on withdrawal serves its purpose to secure your future; otherwise, there’s a good chance that it will be withdrawn and spent for a variety of reasons along the years.
Discipline in regular savings is one of the key success factors in achieving your desired retirement goal. Another will be the determination of keeping those funds for your later years and not simply withdrawing it for unimportant matters. This should be your last resort of getting financial assistance, as naturally it’s much easier to spend money than save it. Furthermore, early withdrawal of the funds has a long-term impact on the accumulated funds due to the effect of compounding interest.
Apart from the benefits of compounding interest, as business owner should draw monthly salary from the business and contribute to EPF according to the mandatory contribution rate. In such a scenario, there’s an advantage in terms of tax savings as the amount contributed by the company is tax deductible against company profits up to 19% of the salary drawn from the company. As the business is self-owned, it’s just a matter of transferring one side of the pocket to another while enjoying tax savings simultaneously! Of course the criteria is that the company is profitable and has sufficient cash flow to do so.
Fixed income in investment portfolio
Some might argue that instead of comparing to bank savings, why not invest in other investment tools like shares or unit trusts which can generate better returns. Provided the risk is well-managed, it could indeed be a better option than to keep savings in the bank.
To structure an investment portfolio for retirement purposes, it’s advisable to split into different asset classes for risk diversification and liquidity. Normally a conservative asset class will form part of the portfolio to provide security. In this case, you can treat EPF savings as the more secure tool that generates a fixed income of 5.5% returns on average. Other resources in the form of cash will be allocated to more aggressive tools such as unit trusts that aim for higher returns of 8%-12% for example, to enhance the overall returns of your retirement portfolio.
After much discussion on the importance and benefits of long term savings through EPF contribution, it’s advisable for the majority of people to do so. The exception will be an individual that has the capability and time to manage all their direct investments and is very disciplined in setting aside money for retirement funds, in addition to managing risk and return very well.
Otherwise do start your retirement planning as early as possible and leverage on the expertise of our country’s established retirement scheme to ensure you have a comfortable retirement. Last but not least, it’s also recommended that non-income earners such as housewives also contribute voluntarily to EPF for their future security with support from their spouse.
About the author
Dennis Chin is a financial advisor, approved and licensed by Bank Negara Malaysia and the Securities Commission Malaysia. He can be contacted at email@example.com