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Addressing the risk of a retirement fund’s short fall

(Article published in the Mar 12, 2008 issue of Manila Standard Today)  

The trustee is not, in most cases, the one at fault; but, most likely, human nature being what it is, the trustee will anyway be blamed, albeit almost always undeservedly.  When the investment performance of a defined contribution plan at the time an employee retires falls short of the defined benefit guaranteed to him by law, the employer must top up.  In the ensuing blame game, if not a suing one, the trustee is the easy target.  After all, it has the last touch.

          Last Friday, at the Makati Shangri-la Hotel, the trust department of Banco De Oro Universal Bank (BDO), the country’s number one trust entity in assets managed for the year 2007, told its clients and friends about the ongoing shift in retirement benefit planning by many multinationals, particularly Americans.  The first lecturer, Mr. Rado dela Cruz of Watson Wyeth, explained the reasons why and the ways how. The third, Mr. Noel Andrada, made the participants aware what administrative and investment services BDO offers should they so wish or are mandated by their head office, like IBM, to so shift.

In between and occupying the position known as the soft belly of a presentation trio, there I was explaining why in our country only less than 10 companies have followed suit and suggesting measures that could both assure the retiring employee his receipt in the future payment of his legally defined benefit and in the same breath permit the compliant employer to reap the present advantages of a defined contribution retirement plan. 


          Had it not been for Article 287 of the Labor Code, trust banks have a compelling case for their corporate clients to either set up (or, even better to shift from a defined benefit retirement plan to) a defined contribution plan. The government, in a rare instance of real concern for the working mass, has done a good job of giving the right incentives to employers to set up retirement plans for their employees. 

Employers are permitted by Section 34(J) of the Tax Code to deduct for ten (10) consecutive years from their gross income one-tenth per year of their contributions to the retirement plan funds that answer for what is technically known as “past service retirement liability” i.e. amounts due for credited years of employees prior to the time that the company set up its retirement plan.   At the same time, Section 34(a) considers their contributions that answer for retirement liability accruing during the year, called “current liability”, as ordinary and necessary business expense and, accordingly, permits deduction up to 100%. 

While these payments are in the hands of the trustee waiting for the employee to retire, earnings are, by Section 60(B), exempted from the income tax.  This generosity includes exemption even from the ubiquitous 20% final tax on deposits, deposit substitutes and income from trusts and other arrangements.

And when the employee retires, after having reached the age of fifty (50) and completed at least ten (10) years of service, all of his retirement pay is, pursuant to Section 32(B)(6)(a), not only income tax free, but also, according to R.A. No. 4917, likewise exempt from attachment, garnishment, levy or seizure by or under any legal or equitable process whatsoever except to pay a debt of the official or employee concerned to the private benefit plan or that arising from liability imposed in a criminal act.

In effect, the government has assumed the role of the employer’s co-contributor to a qualified retirement plan up to the extent, under existing regular corporate tax rates, of 32%, the trustee bank’s investment income generator, and the employee’s retirement income enhancer and protector. However, this offer of the carrot was not without the shadow of the stick.  Even as the government’s left hand grants assistance, by its right hand demands that, without or without any retirement plan and regardless of how the retirement fund investments perform, the retiring employee must be paid his due.

Article 287 of the Labor Code now provides that “in the absence of a retirement plan or agreement providing for retirement benefits of employees in the establishment, an employee upon reaching the age of sixty (60) years or more, but not beyond sixty-five (65) yeas which is hereby declared the compulsory retirement age, who has served at least five (5) years in the said establishment, may retire and shall be entitled to retirement pay equivalent to at least one-half (1/2) month salary for every year of service, a fraction of at least six (6) months being considered as one whole year.”

The Labor Code’s mandated retirement pay is obviously a defined benefit.  Hence, employers with fixed contributions plans are forced to explore together with their trustees ways of mitigating the risk, minimal though it may be in plans where  the employer’s contribution rate is well-thought out and the fund’s investments well managed, of the outstanding balance in the account of the employee is short of the amount guaranteed by law.

The best solution, if only our political leaders were angels, is for the establishment of a government corporation that will function like the Philippine Deposit Insurance Corporation.  Like the Pension Guaranty Corporation in the United States, which answers for the retirement benefits lost by employees of companies who go bankrupt, this company could, for premiums paid, pick up the tab for the shortfall of the retiree’s account and his mandated benefit.  If a public corporation is too grandiose, a fund similar to what the OWA maintains to answer for the repatriation contingencies of our overseas workers could perform the same function.

If government cannot be relied upon, then the insurance companies should, in exchange, say, for some relief from what the industry laments as its “over-taxed” situation, write policies to assume the risk.  There is no legal obstacle for such policy; all the industry needs is numbers to reduce the cost of premiums.

          A third alternative is for the Bureau of Internal Revenue to relax is regulation on the use of forfeitures, i.e. those amounts already paid into the fund but which the employee, for some valid reason like resignation prior to the vesting of benefits, is not entitled to receive.  Revenue Regulations No. 1-68, as amended, requires that the forfeitures “be used as soon as possible to reduce the employer’s contributions under the plan.”  The government will incur no real loss if it were to permit the employers and their trustees to use those forfeitures as a sinking fund to answer for the employers’ liability in the event of shortfall.