What is a Provident Fund?
A provident fund is a compulsory, government-managed retirement savings scheme used in Singapore, India, and other developing countries. In some ways, these funds resemble a hybrid of the 401(k) plans and Social Security used in the United States. They also share some traits with employer-provided pension funds. (For related reading, see "Provident Fund vs. Pension Fund: What's the Difference?")
Workers give a portion of their salaries to the provident fund and employers must contribute on behalf of their employees. The money in the fund is then held and managed by the government, and eventually withdrawn by retirees or, in certain countries, their surviving families. In some cases, the fund also pays out to the disabled who cannot work.
How do Provident Funds Work?
Why the Funds Began
The money held in private savings accounts continues to grow in many developing countries, but it's still rarely enough to provide most families with a comfortable life in retirement.
The challenge of retirement has been further deepened by social change. Societies in the developing world are still catching up with the rapid rise of industrialization, the movement of citizens from rural areas to urban centers, and changing family structures. In traditional societies, for example, the elderly were provided for by their extended families. But declining birth rates, widely dispersed family members, and longer life expectancies have made it more difficult to sustain this age-old safety net.
For these reasons and more, governments in many developing countries have stepped in to provide long term financial support to retirees and other vulnerable populations. A provident fund finances such support in a way that readily scales pay-outs to the available balance and enlists employers and workers to help cover the cost.
Contributions and Withdrawals
Each national provident fund sets its own minimum and maximum contribution levels for workers and employers. Minimum contributions can vary depending on a worker’s age. Some funds allow individuals to contribute extra to their benefit accounts, and for employers to also do so, to further benefit their workers.
Governments set the age limit at which penalty-free withdrawals are allowed to begin. Some pre-retirement withdrawals may be allowed under special circumstances, such as medical emergencies. In Swaziland, provident fund payouts can be claimed at any age if the worker is emigrating permanently. In many countries, those who work past the minimum retirement age may face restricted withdrawals until full retirement.
If a worker dies before receiving benefits, his or her surviving spouse and children may be able to receive survivors' benefits.
Provident Fund vs. Social Security vs. 401(k)
As is the case with U.S. Social Security, for example, the money in provident funds is held by the government, not by private financial institutions. And the government or a provident-fund board largely or entirely decides how contributions are invested. Some countries such as Singapore even guarantee workers a minimum return on their contributions, much like some countries' social security plans.
But if provident funds thwart individuals who want to manage their own money, some at least hold accounts in individual members’ names. Participants then get back the money they and their employers contributed to their own accounts, along with interest or investment returns. With such provident funds, the ownership and balance resemble the arrangements with a U.S. 401(k).
A final note: Provident funds differ from another vehicle sometimes used in the developing world, the sovereign wealth fund, which is funded through royalties obtained from the development of natural resources.