PERA in your pocket

I’m not often given to hyperbole and avoid using adjectives such as “landmark” to describe a decision or a law, but I’ll make an exception in the case of Republic Act No. 9505. Signed by the President on Aug. 22, 2008, RA 9505, whose title is “The Personal Equity and Retirement Account Act of 2008” —PERA, for short, is “landmark”. While existing pension legislation (e.g., SSS, Pag-Ibig, GSIS) also have retirement security as their goal, PERA goes one step further as it gives an individual greater control over his retirement plans by allowing him to create and manage his own personal retirement fund. While it is not intended to replace traditional government social security, the law provides a real alternative to this and may just make the traditional system less relevant. By offering a host of tax incentives, the law encourages individuals to save, thus increasing the national savings rate. Simultaneously, the law deepens the capital markets as it channels these savings into a wide variety of regulated financial instruments which represent either equity or debt. Also, it simplifies in one stroke, the Gordian knot of tax rates on these instruments. Finally, and more importantly, PERA may change the way Filipinos think about the relevance and value of financial investments in their daily lives. These are why it is “landmark”.

PERA is a type of defined contribution plan. This means that the benefits one enjoys from the plan are determined by one’s contribution to the plan (plus increases in value of the underlying instruments, income earned from sales of underlying assets, or less any losses in value or losses in income sustained). In this way the law takes after US 401k accounts, so called as they are authorized under Section 401(k) of the US Federal Income Tax Code. This is the opposite of a defined benefit plan which specifies how much the beneficiary is to earn from the plan — SSS is an example of this type of plan.

The law allows an individual (called a “Contributor”) to voluntarily establish, and make financial contributions to, his own PERA account. The contents of the account should be investment products that are specified by the law. Under Section 3(g) these products may be unit investment trust funds, mutual funds, annuity contracts, insurance pension products, pre-need pension plans, shares of stock and other securities listed and traded in a local exchange, exchange-traded bonds or any other investment product or outlet that a PERA Regulatory Authority may allow. The law establishes the criteria of PERA-eligible investment products: they must be non-speculative, readily marketable, and with a track record of regular income payments to investors. A Contributor may create and maintain a maximum of five PERA accounts, provided that his total maximum contributions per year do not exceed P100,000, or its equivalent in foreign currency prevailing at the time of the actual contribution. In the case of overseas Filipinos, as defined by the law, they can invest up to double this amount. PERA provides that the Secretary of Finance may, in the future, increase this maximum allowable amount.

How would a Contributor go about establishing a PERA account? With the passage of the law, financial institutions such as banks, trust institutions, investment companies/houses, stockbrokerages, pre-need plan companies, and insurance companies shall be able to set up PERA facilities and products that, over time, would eventually be available off the shelf. Known as an Administrator, such a financial institution shall be responsible for such “core functions” as reporting to the Contributor on his contributions, computing the values of the investments, enforcing PERA contributions and withdrawal limits, and so on. Section 3(a) of the law makes this enumeration, but I think that the most important ones would be ensuring that all PERA contributions are invested according to the prudential guidelines set by the regulators, such as the Bangko Sentral ng Pilipinas, Securities and Exchange Commission, and the Insurance Commission. As PERA products become more varied, a Contributor may engage the services of an investment manager to make investment decisions on his own behalf.

One of the PERA primary goals is to encourage savings among Filipinos. It does this by holding out the following tax benefits to a Contributor:

• Income tax credit equivalent of up to five percent of the total PERA contribution. (However, while a Contributor may opt to contribute in excess of the maximum allowed by the law, the excess shall not enjoy the income tax credit).

• Tax exemption of all income earned from the investments and reinvestments of the maximum amount allowed. Investment instruments that fall out of PERA are subject to the regular rates of tax under existing laws;

• Distribution of the proceeds shall likewise be tax exempt provided that the Contributor has reached the age of 55 and has made contributions to PERA for at least five years. Distribution can be made either in lump sum, for a definite period, or in a lifetime pension, at the option of the Contributor. Complete distribution shall be made upon the death of the Contributor, irrespective of his or her age.

While employers are not mandated to contribute to an employee’s PERA, the law encourages them to do so. Without forsaking the mandatory requirements of the SSS Law, an employer may contribute to the extent of the Contributor’s maximum allowable amount. Such contributions shall be allowed as a deduction from the employer’s gross income. Employers can use this to design more attractive compensation and benefits packages. In a very competitive market for talent, this is an added benefit. An employer can contribute to the PERA account based on, say, tenure in the company, performance, or any other criteria for which reward or remuneration should be forthcoming.

One interesting question in this regard is whether the employer’s contributions to an employee’s PERA is taxable as employee’s compensation. On the one hand, the law is silent on such an exemption. However, note that Section 6 of the bicameral committee report deleted the phrase that the employer’s contribution “shall be treated as part of employee’s compensation for tax purposes”. This would give value to the argument that the lawmakers had intended employers’ contributions to be exempt from individual income tax. This conclusion finds support in the general tax code provisions: National Internal Revenue Code Section 32(B)(6)(c) exempts from gross income “social security benefits, retirement gratuities, pensions or other similar benefits received by resident or non-resident citizens of the Philippines”. It will be interesting to see what the BIR has to say on this matter – under Section 16 of the law the BIR is in charge of administering all aspects of tax administration relating to PERA.

Through PERA, the law equalizes the widely disparate tax treatment of investment products.    For example, the sale of exchange-traded shares of stock is taxed at _ of 1% of the gross selling price of the shares; interest from trust funds and deposit substitutes are taxed at 20%; while gains from the redemption of shares in a mutual fund is exempt. To the extent of the income from the maximum allowable contribution to one’s PERA account these tax rates are rendered irrelevant. A contributor can now choose his investments based on a cooler assessment of market factors, without being distracted by artificial or non-market distortions caused by the unequal tax rates. This is important given that the income group that will benefit the most from PERA is the working middle class for whom the ABCs of investments must be simple.

There are positive developments afoot with the enactment of PERA. However, while PERA encourages Filipinos to save and actively plan for retirement, making any kind of investment requires risk. The value of one’s PERA account may increase or decrease with the market value of one’s PERA investments. But that is what makes PERA interesting – a contributor can, depending on his appetite, be conservative or more aggressive in his choice of investments, and thus reap the corresponding rewards – or losses. But this does not absolve all other players in the PERA picture - administrators, investment managers, and regulatory authorities – from ensuring that PERA gains widespread acceptance. Administrators and investment managers will have to spend more on educating the public on the various types of investments and their pros and cons. On the other hand, the regulators, who have the initial task of coming out with the law’s regulations, must put in place the necessary controls without needlessly making the setting up and maintenance of a PERA account difficult for the average investor.    

 (Emmanuel P. Bonoan is the Chief Operating Officer and Vice-Chairman for Tax & Corporate Services of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email [email protected] or [email protected]).