7B.2 The World Bank's Five-Pillar Pension Framework in the Malaysian Context
Key Takeaways
The World Bank framework has five pillars: a non-contributory pillar zero, a mandatory first pillar, a mandatory second pillar, a voluntary third pillar and a non-financial fourth pillar.
Malaysia's pillar zero is the Social Welfare Department's means-tested old-age financial aid for low-income citizens.
The study guide states that the mandatory pay-as-you-go first pillar is not available in Malaysia.
Malaysia's mandatory second pillar includes the EPF, KWAP and LTAT.
PRS is Malaysia's main voluntary third-pillar scheme, partly because EPF is not mandatory for the self-employed and many retirees exhaust their EPF lump sum within three to five years.
Why a Multi-Pillar Approach?
The World Bank uses a five-pillar model to evaluate countries' pension and social security reforms. Its view is that a multi-pillar system is more flexible, serves different groups better and gives better protection against economic, political and demographic risks than relying on one source.
The Five Pillars and Malaysia
| Pillar | World Bank description | Nature | Malaysia |
|---|---|---|---|
| 0 – Non-contributory | Basic social assistance financed by government so people with low lifetime income are cared for in old age | State | Social Welfare Department old-age financial aid, means-tested |
| 1 – Mandatory, publicly managed | Contributions linked to earnings to replace part of pre-retirement income; usually defined benefit, financed pay-as-you-go; exposed to demographic and political risk | Mandatory | Not available in Malaysia, according to the study guide |
| 2 – Mandatory, individual savings | Typically defined contribution plans with choices of vehicles, managers and withdrawal options; clear link between contributions, performance and benefits | Mandatory | EPF, KWAP and LTAT |
| 3 – Voluntary | Many forms (defined benefit or contribution, individual savings); discretionary and flexible, filling gaps left by other pillars | Voluntary | PRS, unit trusts, fixed deposits and insurance, section 150 employer-sponsored schemes, additional EPF contributions, annuities, unfunded occupational gratuity schemes |
| 4 – Non-financial | Informal support: family support from the younger generation, universal healthcare, subsidised elderly housing, home ownership, reverse mortgages | Voluntary | Mainly traditional Asian values: the young caring for parents and elders |
The first pillar's weakness
The study guide's example of a first pillar is Japan's national pension, which pays a basic pension to residents from age 65. Such pay-as-you-go systems suffer demographic risk: as the population ages, fewer workers support more pensioners, contributions fall short and governments come under pressure to fund the gap.
The study guide also says Japan's basic pension is paid at 65 to people who have paid premiums for 25 years or longer. That detail is out of date: Japan cut the qualifying period to 10 years of total coverage in August 2017, and the Japan Pension Service now pays the Old-age Basic Pension from 65 on that basis. The point of the example is the demographic risk of pay-as-you-go funding. If a question repeats the 25-year figure, recognise it as the study guide's wording.
Why Malaysia Needs a Strong Third Pillar
PRS was introduced to supplement EPF (for employees) and other second-pillar schemes:
- EPF does not cover everyone. It has comprehensive coverage of the employed and healthy returns, but it is not mandatory for the self-employed. PRS aims to encourage this group to save seriously.
- EPF savings run out. Studies show most retirees exhaust their EPF lump sum within three to five years of retiring, made worse by pre-retirement withdrawals for housing, healthcare and education.
- Concentration risk. Relying on a single source of retirement savings is risky. PRS adds another source of fund management expertise, and members can choose between competing providers.
Comparing the pillars' risks
| Pillar | Who bears the main risk | Typical weakness |
|---|---|---|
| 0 – Social assistance | Government budget | Benefits are basic and means-tested |
| 1 – Pay-as-you-go defined benefit | Government and future workers | Demographic and political risk as populations age |
| 2 – Mandatory defined contribution | The individual member | Savings may be inadequate or withdrawn early; investment returns vary |
| 3 – Voluntary saving | The individual member | Depends on people choosing to save; needs incentives and good products |
| 4 – Family and informal support | Families | Weakens as families shrink and the population ages |
A multi-pillar system spreads these risks so that no single weakness leaves retirees without income.
The fourth pillar is weakening
Family support works when many young people support a few elderly. In an ageing society, the burden on fewer young people grows enormous, which is another reason to build self-funded voluntary saving (section 7B.4).
A Diagram of the Malaysian Mapping
Applying It
Case: Encik Rosli, 42, is a self-employed graphic designer with no EPF account. Under the World Bank framework he has no mandatory second-pillar savings, so apart from means-tested aid (pillar zero) and family support (pillar four), his retirement depends on what he saves voluntarily. PRS gives him a third-pillar vehicle with a choice of providers and funds, tax relief of up to RM3,000 a year and withdrawal rules that discourage spending the money early. (He could also consider EPF's voluntary i-Saraan programme for the self-employed, covered in section 7B.3.)
Exam Pointers
- Pillar 0 = social assistance (Social Welfare Department).
- Pillar 1 = not available in Malaysia.
- Pillar 2 = EPF, KWAP, LTAT.
- Pillar 3 = PRS (plus other voluntary savings).
- Pillar 4 = family support.
Classification Traps
The pillar depends on how the saving happens, not on which institution holds the money:
| Item | Pillar in the study guide | Why it catches candidates |
|---|---|---|
| Mandatory EPF contributions | 2 | The obvious second-pillar scheme |
| Additional voluntary contributions to EPF | 3 | Same institution as pillar 2, but the extra saving is voluntary |
| KWAP and LTAT | 2 | Public-sector bodies, yet grouped with EPF as mandatory schemes |
| Employer-sponsored schemes approved under section 150 of the Income Tax Act 1967 | 3 | Run by employers, but voluntary |
| Annuities and unfunded occupational gratuity schemes | 3 | Listed with PRS as voluntary options |
| Home ownership and reverse mortgages | 4 | The World Bank's fourth pillar covers informal and non-pension support, so these are not third-pillar savings |
The study guide describes the third pillar as discretionary and flexible: its flexibility makes up for the rigidity of the other pillars and lets each person top up whatever is missing from their own retirement plan.
Under the World Bank framework as applied to Malaysia in the study guide, which pillar does PRS belong to?
Pillar 4
Pillar 2
Pillar 0
Pillar 3
Which Malaysian schemes does the study guide place in the mandatory second pillar?
Family support and reverse mortgages
EPF, KWAP and LTAT
Social Welfare Department aid
PRS and annuities
Which reason does the study guide give for developing PRS as a third pillar?
The fourth pillar of family support is growing stronger as the population ages
EPF is mandatory for the self-employed, so they are over-saving
Malaysia already has a strong pay-as-you-go first pillar
Studies show most retirees exhaust their EPF lump sum within three to five years of retirement
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