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 U.S. They also share some traits with employer-provided pension funds.

Like a pension fund plan, workers give a portion of their salaries to the provident fund. Employers must also 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 The money in the fund is then held and managed by the government and eventually withdrawn by retirees or, in certain countries, their surviving families.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 a Provident Fund Works

The money held in private savings accounts continues to grow in many developing countries, but it's still rare 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, aging adults 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 payouts 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. Additionally, in South Africa, provident fund payouts can be claimed at any age if the person has been a non-resident for three years over an uninterrupted period. 

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, the 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, the money in provident funds is held by the government, not by private financial institutions. The government or a provident-fund board largely or entirely decides how contributions are invested.

Some countries such as Singapore outline the interest rate individuals can expect on their premiums. For example, through a longevity insurance annuity scheme, the government will provide up to 6% interest rates. Included in this is up to 2% extra interest provided by the Singaporean government.

Meanwhile, Social Security is managed by the Department of Treasury, where effective interest rates are determined by a formula originating in 1960. Broadly speaking, interest rates are similar to the average yield on Treasury securities which are four years from maturing. In 2020, the estimated effective interest rate on Old Age and Survivor Insurance was 2.6%.

Where some provident funds differ from Social Security is that they are held in individual accounts instead of a group account. With such provident funds, the ownership resembles the arrangements with a U.S. 401(k). However, unlike a 401(k), where the individual determines how the money is invested, the government makes the investment decisions instead.