Light For Sunset Years

The new pension scheme promises much better security.

Pensions in the existing Indian retirement savings system means restricted access, no choice of investment options, oppressively tiresome and time-consuming transfer of accounts on change in jobs or transfers, extremely low returns, lack of transparency in handling of the money… The list of the inadequacies of the existing retirement savings system for the average Indian worker — the Employees’ Provident Fund Organisation (EPFO), Public Provident Fund (PPF) and Employees’ Pension Scheme (EPS) — is prohibitive and unending. Thus, any move to improve it is bound to seem a giant leap forward.

That alone, however, isn’t the reason to look forward to Finance Minister P. Chidamabram’s decision to ask the Pension Funds Regulatory and Development Authority (PFRDA) to design a new scheme for the average Indian worker, including the non-salaried, along the lines of the New Pension Scheme (NPS) currently running exclusively for government employees hired after 1 January 2004. “We have asked PFRDA to frame a scheme (that will be applicable) for any citizen,” announced Chidambaram in Mumbai last month. PFRDA has said it is planning to roll out the voluntary scheme by the first quarter of next year.

COMPARATIVE ADVANTAGE
The New Pension Scheme will be thrown open to all employees, which could ease some of the irritants of the existing options

INVESTMENT CHOICES: EPFO, PPF and government pensions do not provide any investment choice. The new scheme will allow savers to choose from four-five options across asset classes.

PORTABILITY: It is tiresome and time consuming to shift accounts in EPFO, while PPF can be operated from anywhere. The NPS will be operationalised from banks and post offices, enabling easier transfers.

RETURNS: EPFO and PPF offer low returns but have attractive tax benefits. The NPS has sought tax parity with PPF, and will deliver market-determined returns.

TRANSPARENCY: Existing pension plans run by private fund managers, such as Ulips, are expensive and somewhat opaque. In the case of EPFO and PPF, the government bears the high and non-transparent administration costs. The NPS will offer greater accountability and transparency.

AWARENESS: Across all existing schemes, a large number of members still do not understand what they are or how they work. The regulator plans to develop the market and work towards greater financial literacy.

ACCESS: EPFO, PPF and private schemes cater to 37 million civilian workers between 18 and 59 years. Over 284 million are not covered of whch 143 million earn less than Rs 36,000 per annum. They are not on the private sector’s radar and could benefit from the NPS.

Benefits Galore
“The new scheme that Chidambaram has commissioned will benefit the middle class the most because, for the first time, they will be able to save for their post-retirement years,” says Ashish Aggarwal, a director at Noida-based Invest India Micro Pension Services (IIMPS). “To encourage low-income workers to join the scheme, the government would need to incentivise their savings through co-contributions.” IIMPS is focused on delivering retirement savings to low-income workers and has enrolled more than 20,000 such workers in a pension scheme in Rajasthan in which the state government annually co-contributes up to Rs 1,000 per worker.

For existing members of PPF, EPFO and EPS, too, the new scheme will provide a superior voluntary alternative retirement savings option. “For non-government sector — organised or unorganised, employed or self-employed — NPS efficiently fulfils the objectives of accumulation of earnings for pension and its management,” says Ashvin Parekh, partner and national leader of financial services at Ernst & Young.

Financial planners have welcomed the new pension system because of the transparency and efficiency it will bring. Members of the new scheme will get individual PINs (personal identification numbers) for accessing their account details and NAVs, or net asset values, through 24x7 call centres and the internet. The National Securities Depository-promoted Central Recordkeeping Agency (CRA) will manage the accounts. Thus, it will be possible to move jobs and locations without having to worry about transferring their money.

PFRDA hopes to be able to introduce the systems by the end of the year, starting with the existing NPS members (about 600,000 central and state government employees who joined work after January 2004). Since April this year, the NPS has been managing Rs 4,000 crore for these members by deploying 85 per cent of it in debt and the balance into equities. The nationwide, satellite technology-based CRA system is expected to benefit the enormous physical-based and cumbersome employees’ pension system similar to the depository’s impact on equity investors 12 years ago.

The other benefit is the potential ability to choose between multiple pension fund managers and investment options to ensure better returns. EPFO and PPF’s predominant government treasuries-driven investment strategy — forced by the Left parties and trade union leaders who dominate its governing bodies — has robbed savers of superior market-determined returns. Typically, the returns have hovered around 8.5-9.5 per cent over the past few years, which is currently less than even the rate of the devaluation of money due to inflation. Not surprisingly, there is a growing view for employees (for their contribution to EPF) and employers (for their side of the contribution) to get a direct say in choosing their fund managers instead of the government-nominated investment agency deciding on their behalf.

“It is the individual’s money, and there is enough merit in his being able to give it to any fund manager he chooses,” says V.R. Narasimhan, chief compliance officer at Kotak Mahindra Asset Management Company. PFRDA’s new scheme will make this possible. It will give its members a choice of options on the allocation of savings between government debt, corporate debt and equity-related investment instruments depending on individual goals and comfort levels. At the highest level, not more than half the investible funds would be deployable in equities. A default option for the financially illiterate too is likely to be provided.

“Valuation norms will be worked out and NAVs declared periodically,” says PFRDA Chairman D. Swarup.

If that isn’t reason enough to begin investing in the new scheme once it is operationalised, consider this: EPFO and PPF are hardly ever audited, and do not disclose the investment details to their members. Scams and cases of missing accounts have been reported often. PFRDA’s new scheme will not be as opaque, and will have greater accountability. Most importantly, a large number of people who do not understand what pension schemes are, will be educated. The regulator has plans to undertake the task of spreading financial literacy and developing the market. At present, questions such as do you know what EPFO’s scheme is doing for you? How does it work? How much you will get under EPS share? draw a blank. In the case of Ulips and schemes run by private asset managers, the awareness is mostly about product selling.

Since it would be a fully contribution-driven scheme with market-determined rates of return, the new pension scheme would also be a relief for the exchequer. In the case of EPFO and PPF, the government bears the administration cost — it is high and hardly ever disclosed. Also, often EPFO has to dip into its reserves to make good shortfalls between the interest outgo and the returns it makes on its investments in government debt.

THE EXISTING PENSION SYSTEM
About 37 million, or 11.53 per cent, of the paid workforce in the age group of 18-59 years are covered under pensions

22 MILLION civil servants who joined office before 1 January 2004 are under the civil service-defined benefit pension. Pensions are inflation-indexed, and can go up to 50 per cent of the lastdrawn salary.

15 MILLION are under the defined contribution to employee provident fund. Employees with monthly earnings of Rs 6,500 or less at firms with 20 or more members are compulsorily covered by the Employees’ Provident Fund Organisation (EPFO). Firms not covered under EPFO can run their own pension and provident fund for their staff.

ABOUT 5 MILLION workers opt for some kind of voluntary coverage, including Ulips and private sector-run schemes.

WAGE EARNERS in industries, factories, mines, oil fields, plantations, ports, railway companies, and shops and commercial establishments having 10 or more employees are also entitled to lump sum benefits in the form of gratuity.

SOCIAL ASSISTANCE is available to the needy elderly above 65 years in the form of a monthly pension of Rs 450 under the National Old Age Pension Scheme, jointly administered by the central government and the various state governments.

0.6 MILLION central government employees and employees of 19 state governments who joined service after 1 January 2004 are entitled to a defined contribution system of the New Pension Scheme. They contribute 10 per cent of basic salary, which the employers match. The annuity factor is not yet determined.

Option, Not Replacement

Unfortunately, the PPF, EPS, PPF will continue to run as they have, and workers will not have the option to shift their accounts to the new scheme. Nor can they opt to have the statutory deductions from their earnings parked with it rather than the existing inferior schemes. “My clients, particularly the young, do ask me whether they can remove their monies held in their EPF and EPS and invest in equities where they hope to get better returns,” says Uday Dhoot, COO of International Money Matters, a Bangalore-based financial planner. Yet, a top bureaucrat handling the policy matter in the ministry of finance clarifies that the new scheme will only be an additional voluntary option and not a replacement for the current statutory obligations towards EPS and EPF.

To operationalise the scheme, PFRDA has said it will appoint points of service — such as banks, and those post offices that are computerised — for collection of contributions from people. Just as it appointed public-sector fund managers Life Insurance Corporation of India, State Bank of India and UTI through competitive bidding for the new scheme for government employees a few months ago, the regulator plans to call fresh bids, including from the private sector, for the operationalisation of the new scheme. “PFRDA plans to call for bids from prospective fund managers including those in the private sector to select a few more managers,” says Swarup. Each pension-account holder will get to choose the fund manager — public or private.

PFRDA has also set up a committee chaired by HDFC Chairman Deepak Parekh to evolve a set of regulations and guidelines for the investment and management of the funds. With so much money belonging to the vulnerable classes flowing into the equity and money markets, there is sure to be a heightened sense of expectation of the regulators overseeing them to sharpen their vigilance and further tighten the regulations.

“There is also need for the government to give tax benefits to the new scheme that are on a par with what EPS and PPF enjoy,” says IIMPS’s Aggarwal. The contributions made to the two schemes are tax-free, and so are the returns. In the case of the new scheme, however, unless the government specifically provides the parity, the withdrawals from the scheme would be taxable. In the case of PPF, the withdrawals too are tax-free. The thrust of NPS, therefore, ought to move into the next, higher orbit of reforms. As Ernst & Young’s Parekh very aptly sums up, “The real effectiveness is where the pension system gets working such that instead of actively selling pension, people get inclined on their own to buy pension.”