This has to be the hottest topic in town lately. The government recently announced that the monthly EPF deductions for employees will be cut from 11% to 8% for a period of 24 months from January 2009. Since then, there have been quite a number of controversies on this move.

Controversies aside, the key question on every Malaysian's mind is to retain the EPF deduction at 11% or accept the lower EPF contribution of 8%. Here, I will share my personal opinion on this issue.

Before we begin, we should look at how much savings an average Malaysian can expect in his/her EPF account at the time of retirement. To do that, we will be using these assumptions, which we assume should be typical for a graduate employee in Malaysia:

1. The EPF pays an average dividend of 5% per annum;

2. Monthly contribution is 11% by employee and 12% by employer;

3. Salary increment of 5% every year;

4. Start first job at age 23, with a starting monthly salary of RM2,000;

5. Retirement upon reaching the age of 55, thus giving us 32 years of EPF contributions;

6. No withdrawals of any form from EPF until retirement.

Based on the above assumptions, this typical graduate should retire with total savings of slightly over RM800,000 in his/her EPF account*. However, this is based on very strict assumptions as highlighted above. Changing any of the assumptions may have quite a significant impact on the final figure.

Just for illustration purposes, we add a further assumption that this employee receives a promotion every 5 years and the promotion comes with a 20% pay rise. This employee will then have a total of RM1.22 million in his/her EPF savings at retirement.

Now that we have an idea of how much we can expect from our EPF account on our retirement age, we can consider another factor of EPF savings – the dividend rate.

Over the past five years (since 2003), EPF has declared an average dividend rate of 5.04%, with the following rates:

2003: 4.50%

2004: 4.75%

2005: 5.00%

2006: 5.15%

2007: 5.80%

No doubt, EPF has not been doing a great job. It has almost consistently under-perform the KLCI. But in all fairness, it’s a tough job running a humongous fund like EPF. But it is not the intention of this post to discuss how well (or poor) EPF has done over the years. However, the point here is that EPF’s dividend rate has consistently been higher than the fixed deposit rates offered by Malaysian banks.

We can go on and on about how we can do better than EPF in managing our own investments and why FD rates are lousy benchmarks for funds like EPF. But the fact remains that the majority of average Malaysians know nuts about investing. If you were to reduce your EPF contribution and take the extra 3% to invest on your own, where would you put your money in?

For the more learned investors, I am sure you balance your portfolio to ensure that you have a certain proportions of high, medium and low-risk assets. Typically, the low-risk assets are in fixed deposits or cash-like investments. In this case, the 3%, if continued to be placed with EPF, can be considered as part of your low-risk assets. And this amount is likely to earn you more returns that any other low-risk assets you can find in town. (Of course, the only setback is that this low-risk asset is for very long term)

A factor to consider is the compounded amount of this 3% reduction in EPF contribution. In other words, we examine what is the total amount of reduction in your EPF savings if you reduce your monthly EPF contribution by 3% for two years. We used the same assumption that EPF pays a dividend of 5% per annum.

The results under various scenarios of current monthly salary is presented below:

Click to enlargeFor example, if you earn RM5,000 in year 2009 to 2010 (assuming no increment in between) and you opt to reduce your EPF deductions to 8% from 11%, you would have RM3,600 excess cash to spend over the two-year period. Effectively, this also means your EPF savings will be lesser by RM3,794 (including the compounded effect of a 5% p.a. dividend rate) at the end of two years. If you are retiring in 25 years’ time (i.e., you are 30 years old now), then your EPF account will have RM11,652 lesser in your account when you retire.

This is, of course, a very “back-of-the-envelope” method of calculation. Nevertheless, it gives you a rough idea of how much impact this 3% reduction would have on your retirement fund.

We have seen how much we can expect in our EPF account at our retirement age, consider EPF as a low-risk long-term savings instrument, and examine the impact of a 3% reduction in EPF contribution for two years.

In conclusion, if you are really finding it hard to make ends meet due to the high costs of living now, take the excess cash to help tide things over. Otherwise, consider if it is necessary to further reduce your retirement funds which is already insufficient to begin with. Even if you think you can do better than EPF in investment, consider this 3% as part of your low-risk asset mix. Another factor to consider is the tax implications (see post on 25 November 2008). In the end, the choice is yours^.

* For workings and to modify the spreadsheet to better estimate your own EPF savings at retirement age, drop me an email.

^ As the government motive is to put cash in your hands to generate more domestic spending, the 3% reduction is automatic. If you decide to retain the EPF deduction at 11%, you will need to submit an application to EPF. The form can be obtained in EPF's website.