The UAE government is understood to be mulling the introduction of a state pension scheme for expatriates, like the plan already in place for UAE nationals. Traditionally, end of service gratuities have been offered to expats in the GCC instead of a pension – but how do they differ?
About pension plans
A pension, also known as a retirement plan or superannuation plan (‘super’), is a is a retirement account that an employer maintains on a monthly basis, which is calculated according to a person’s salary to give you a fixed payout when you retire.
There are two main types – defined benefit pensions and defined contribution pensions – both seen as a means of savings for retirement.
Defined benefit pension
- The employer serves as the main contributor.
- The benefit on retirement is determined by a set formula, rather than depending on investment returns.
- The old-fashioned (and quite rare) final salary plan, in which the pension paid is equal to the number of years worked, multiplied by the member’s salary at retirement and multiplied by an accrual rate determined by the employer, is an example of a defined benefit (DB) pension or retirement plan, because the actual benefit can be calculated and defined.
Defined contribution pension
- Contributions can come from the employee or employer.
- Most commonly, a specific amount or percentage is deducted from the employee’s monthly salary, which the employer will match or surpass.
- In a defined contribution (DC) plan, contributions are paid into an individual account and invested, perhaps in the stock market. Returns are credited to the individual’s account and, upon retirement, the account will have produced a lump sum which may be used to purchase an annuity, which then provides a regular income. In this case the contribution can be defined but the benefit cannot be until retirement, although it can be estimated for planning purposes.
- With a DC pension, the investment risk and rewards are assumed by each employee, not by the employer.
For the most part, businesses today lean towards the defined contribution option, as it is seen as less of a financial burden, and puts much of the responsibility on the employee to save.
Some companies in the UAE are already offering contributory pension schemes or savings plans – a recent survey by human resources consultancy Towers Watson found that 48 percent of employers now offer such a scheme, up from a third of businesses in 2010.
The National Bank of Abu Dhabi got in on the act in 2013 with the Wealth Builder Plan, a retirement scheme for both local and international companies to offer their employees.
Unlike major financial centers such as Singapore or Hong Kong, the UAE does not offer a government-sponsored pension scheme -although such a change now looks like it may be in the works.
So why have end of service gratuities (known formally by the Ministry of Labour as end of service remuneration) been the preferred option in the UAE and elsewhere?
Firstly, the country’s expat population is still very transient, and a pension scheme requires long-term commitment and financing.
According to a recent HSBC survey, only 13 percent of expats who are resident in the UAE say they will retire here and53 percent keep their retirement pot in their home countries.
Secondly, gratuities are well established, far less costly and simpler to administer. Many expats prefer them as they give an instantly accessible lump sum, unlike pensions, which cannot be touched until retirement.
Around for some 40 years, ESGs are also available to expat workers in other GCC countries – Saudi Arabia, Bahrain, Kuwait, Qatar and Oman. According to law firm Al Tamimi & Co, the total estimated value of ESGs offered by employers in the region tops US $15m.
How do gratuities work?
End of service gratuities are paid out as a lump sum at the end of a contract, and are based on the employee’s basic salary (excluding benefits such as accommodation, car allowance or food) at the time they leave the company, multiplied by the number of years completed.
Under the UAE Labour Law an employee is entitled to the following gratuity (under Article 132):
- Nothing, if they have served less than one year.
- 21 calendar days’ basic salary for each year for the first five years, pro-rated after one year of service as days of service.
- 30 calendar days’ basic salary for each additional year, also pro-rated for any partial years of service.
A few caveats to the gratuity entitlement:
- The total gratuity cannot exceed two years’ wages (Article 132).
- If an employee on an unlimited contract voluntarily leaves after serving more than one year but less than three, they are entitled to one-third of the total gratuity. From three to five years they are entitled to two-thirds. (Article 137).
- An employee on a limited contract voluntarily who leaves will not be entitled to any end of service gratuity unless the period of service exceeds five years (Article 138).
- The employer may deduct any amounts due to him from the employee’s gratuity (Article 135).
- In the event of his death, the employee’s gratuity shall be paid to his legal heirs (Article 136).
- If the employee is dismissed for any of the reasons listed in Article 120 of the Labour Law or resigns and leaves without giving due notice, no gratuity is due (Article 139).
Pension or gratuity?
Pros of pensions
Many personal finance experts in the UAE have long been proponents of pension schemes. Although it requires employees to wait a longer period of time to get their hands on any money, those in favor of pensions argue that it would encourage more people to save and to stay with their employer for the long haul, as well as giving individuals more peace of mind in the event of early termination.
Cons of pensions
Those who argue against it tend to emphasize the high cost associated with implementing such a scheme at a federal level, as well as the potential complications that could arise after a worker has left the UAE to retire at home or elsewhere. There is also the need to monitor the implementation of such schemes; there is a lot of fine print when it comes to pension plans. Investing is always somewhat risky: in a solid economy, conservative growth can mean a very profitable return but, as we have learned, in turbulent times you can also see the value of your life savings plummet.
For many expats, the gratuity system is still considered to be an attractive option, with a predictable outcome and lump sum. Yet, as more people decide to stay in the country long-term, pensions could serve as a key benefit that would enable them to save smarter for the long haul.