Provident Fund

AG (Aktiengesellschaft)

What is a contingency fund?

A provident fund is a mandatory government-managed retirement savings system used in Singapore, India and other developing countries. In some ways, these funds look like a hybrid of the 401 (k) and social security plans used in the United States. They also share certain features with the pension funds provided by the employer.

Workers donate part of their wages to the provident fund and employers have to contribute on behalf of their employees. The money in the fund is then held and managed by the government, then withdrawn by retirees or, in some countries, their surviving families. In some cases, the fund also pays to people with disabilities who cannot work.

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How do contingency funds work?

How a contingency fund works

The money held in private savings accounts continues to grow in many developing countries, but it is still rarely enough to provide most families with a comfortable retirement life.

The retirement challenge has been further compounded by social change. Societies in developing countries are still catching up with the industrialization boom, the movement of citizens from rural areas to urban centers and the evolution of family structures. In traditional societies, for example, the elderly are cared for by their extended families. However, declining birth rates, dispersed family members and increased life expectancy have made it more difficult to maintain this age-old safety net.

For these reasons and more, the governments of many developing countries have intervened to provide long-term financial support to retirees and other vulnerable populations. A provident fund funds such support in a way that easily adjusts payments to the available balance and recruits employers and workers to help cover costs.

Contributions and withdrawals

Each national provident fund sets its own minimum and maximum contribution levels for workers and employers. Minimum contributions may vary depending on the age of the worker. Some funds allow individuals to make additional contributions to their benefit accounts, and employers can do so to benefit their workers more.

Governments set the age limit at which withdrawals without penalty can begin. Some withdrawals before retirement may be allowed in special circumstances, such as medical emergencies. In Swaziland, provident fund payments can be requested at any age if the worker emigrates permanently. In many countries, those working after the minimum retirement age may be subject to limited withdrawals until full retirement.

If a worker dies before receiving benefits, their surviving spouse and children may receive survivor benefits.

Provident fund vs. Social security vs. 401 (k)

As in the case of American social security, for example, money from contingency funds is held by the government and not by private financial institutions. And the government or a provident organization decides largely or entirely how the contributions are invested. Some countries like Singapore even guarantee workers a minimum return on their contributions, as do the social security systems of some countries.

But while contingency funds thwart individuals who want to manage their own money, some hold at least accounts in the names of individual members. Participants then recover the money that they and their employers have contributed to their own accounts, as well as interest or return on investment. With such contingency funds, the property and the balance resemble agreements with an American 401 (k).

A final note: contingency funds differ from another vehicle sometimes used in developing countries, the sovereign wealth fund, which is financed by royalties from the development of natural resources.

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