Retirement and end-of-service planning in the middle east is coming of age, and now is the time for employers to prepare to meet their lump sum payment obligations, writes Bethell Codrington.
Gratuity = a sum of money paid to an employee at the end of a period of employment. 'An end-of-contract gratuity of 20% of the total pay received' (Oxford dictionary).
Many employers in the Middle East are legally required to pay an EOSG, especially to overseas workers at the end of their contract, whether at retirement age or not.
The end of service gratuity (EOSG) is traditionally unfunded and simply an actuarial calculation on the employer's balance sheet. The EOSG in Dubai International Finance Centre (DIFC) for example is a defined benefit calculation based on 21 days' basic salary for each of the first five years of employment, which rises to 30 days' basic salary for each complete year of service over five years; subject to an overall cap of two years gross salary.
The amount that can be accrued by an employee is therefore not particularly generous, and there is normally no facility for employees to accrue additional 'gratuity' or any type of individual savings.
An employee with five years' service leaving on an EOSG-based salary of $100,000 can expect a lump sum of just $28,769 ($69,863 after 10 years), assuming the employer has not gone bankrupt in the meantime and has sufficient cash reserves to settle the liability when it becomes due. A contribution to a funded savings plan of 7.5% per annum with a 5% investment return (assuming the salary had escalated at 3% per annum) would have given a fund of $48, 215 ($83,224 after 10 years).
Not enough to retire on but a step in the right direction.
In the current economic climate, there are rumours of companies not only being unable to settle their liabilities as they themselves go into liquidation, but also asking employees to agree to receive their EOSG payment in instalments. A take-it-or-leave-it approach. Redundancies are a growing concern in the global downturn and company balance sheets are in a mess.
Where is all this cash going to come from? Could we be seeing the beginning of a perfect storm of corporate revenues falling whilst employee cash liabilities escalate?
Changes in the Pensions/Savings/EOSG world rarely come quickly and often with pain, delay and teething problems.
Years after rumours first started in the DIFC and with the expected initial pains and delays – not to mention Covid-19 – the DIFC introduced the DIFC Employee Workplace Savings (DEWS) plan earlier this year. Effectively, this replaced the unfunded EOSG liability with a funded plan whereby actual contributions are made into a defined contribution savings plan. Employer contributions are paid at a minimum rate of 5.83% of salary over the first five years of employment, rising to a minimum 8.33% thereafter. There is also the ability for employees to add personal contributions to this plan. Whilst DEWS is the default scheme set up by the authorities, it offers limited investment choice and is only available to DIFC employers and their employees. There are however regulations which allow employers to opt out into qualifying alternative schemes.
The one potentially contentious issue is what happens to the historical accumulated EOSG? Does this liability remain on the balance sheet of employers? Will employers be encouraged to actively fund 'off balance sheet', or will employees be encouraged to accept a cash equivalent transfer of their accrued EOSG? Is it advisable to give up a known defined benefit promise for an unknown investment return?
On 3 February 2020 the FTSE 100 stood at 7,326. Where is it today?
Retirement planning in the Middle East is coming of age. DIFC took the plunge and it is expected other financial centres in the UAE and around the Gulf will quickly follow, including on-shore. Employers outside of DIFC should look at what is coming down the highway and prepare.
There are several options available to employers:
(a) Prepare to take the EOSG liability off the balance sheet and into an employee trust. This can be done all at once or on a phased basis. With appropriate ongoing contributions driven by actuarial valuations and suitable investment advice, this fund should meet future liabilities.
(b) Set up a voluntary (salary deduction) savings plan for staff in advance of legislation requiring employer funding to replace EOSG.
(c) Set up a Master Trust plan for all employees across various borders. Rather than have separate DEWS/DIFC, Abu Dhabi Global Market (ADGM), Bahrain and on-shore plans, have one master trust for your employer group with jurisdictional appendices.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.