pension funds - some varied perspectives
TRANSCRIPT
Pension Funds – Some Varied Perspectives
Submitted By:-
Harish K. Raman
Symbiosis Law School, Pune
(Constituent of Symbiosis International
University)
BBA.LL.B(C)
P.R.N. No.-13010124268
E-Mail Address - [email protected];
Pension Funds - Some Varied Perspectives
Abstract :-
“Will I have enough to live on when I retire?” This question of old age financial security is
being asked across the world with growing apprehension. India is no exception. Three reports
have examined old age financial security for Indians and are now being studied for
implementation by the government. Keeping this in mind a brief introduction into the
functioning and need of pension funds has been given. PFRDA has been focused on.
Background of PFRDA and NPS has been explained as also their applicability. National
Pension Scheme has also been discussed. Implementation and Impact of NPS has been
explained in detail. Employees' Provident Fund Organisation is another organ set up by the
Government whose role has been looked into. Changes around the world and the change in
global finance markets has been discussed. Wealth and Investments which form an important
part of any financial system have also been explained. Operating Expenses which herald a
change in markets have been focused on. Answer to an ongoing debate in today’s world
Public or Private Management and which to choose has been provided. Several practical
recommendations which can improve the financial standing and gain have also been
discussed.
Key Words: Pension Fund, Pension Fund Regulatory Development Authority (PFRDA),
National Pension Scheme (NPS), Employees' Provident Fund Organisation (EPFO), Public
Pension Fund Management
Pension Funds - Some Varied Perspectives
Introduction
Nearly one eighth of world’s elderly population lives in India. The vast majority of this
population is not covered by any formal pension scheme. Instead, they are dependent on their
own earning and transfer from their children. These informal systems of old age income
security are imperfect and are becoming increasingly strained. People above the age of 60
years have grown at an annual rate of growth of 3.8 percent (75.9 million in 2001 and 55.3
million in 1991) during the period 1991-2001, as against the annual growth of 1.8% for the
general population.
A Pension Fund is basically a fund established by an employer to facilitate and organize the
investment of employees' retirement funds contributed by the employer and employees. The
pension fund is a common asset pool meant to generate stable growth over the long term, and
provide pensions for employees when they reach the end of their working years and
commence retirement.
Pension funds are commonly run by some sort of financial intermediary for the company and
its employees, although some larger corporations operate their pension funds in-house.
Pension funds control relatively large amounts of capital and represent the largest
institutional investors in many nations.
Pension Policy in India has traditionally been based on financing through employer and
employee participation. As a result, the coverage has been restricted to the organized sector
and a vast majority of the workforce in the unorganized sector has been denied access to
formal channels of old age financial support. Only about 12 per cent of the working
population in India is covered by some form of retirement benefit scheme. Besides the
problem of limited coverage, the existing mandatory and voluntary private pension system is
characterized by limitations like fragmented regulatory framework, lack of individual choice
and portability and lack of uniform standards. High incidence of administrative cost and low
real rate of returns characterize the existing system, which has become unsustainable.
Pension Fund Regulatory Development Authority and National Pension
Scheme
By a notification issued by the Ministry of Law and Justice dated September 18, 2013, the
Pension Fund Regulatory and Development Authority Act, 2013 ("Act") was brought into
effect. Before this, the Pension Fund Regulatory and Development Authority ("PFRDA") was
an interim regulator. The Act intends to promote old age income security by establishing,
developing and regulating pension funds and to protect the interests of subscribers to its
schemes. The Act covers National Pension Scheme ("NPS") and any other pension scheme
not regulated by other enactment like Employees' Pension Scheme, 1995, Employees'
Provident Funds and Miscellaneous Provisions Act, 1952 etc.
In light of the above development, the present bulletin highlights the applicability of the Act
and NPS which is a voluntary retirement savings scheme and has been designed to enable the
subscriber to make optimum decisions regarding his future and provide for his old age
through systemic savings. The bulletin discusses the proposed structure and any implication
on private companies.
Background of PFRDA and NPS
In the 2003-04 budget, a new pension system was introduced by the government based on
defined contribution, to be shared equally between the government and its employees. Under
such scheme there was no contribution from the government in respect of individuals who are
not government employees. The Ministry of Finance was empowered to oversee and
supervise the pension funds. The government approved the proposal to implement the new
restructured defined contribution pension system on October 10, 2003. PFRDA Bill also
known as Pension Bill was first time introduced in the Parliament in 2005 to replace the
ordinance that came in 2004 to set up PFRDA but could not be passed. An interim PFRDA
was constituted on November 14, 2008. The PFRDA Bill, 2011 was reintroduced on March
24, 2011 and was referred to the standing committee on finance on March 29, 2011 for
examination. Based on their recommendations of the standing committee, some amendments
were incorporated in the Bill, which was also approved by the cabinet. Both the houses of
Parliament on September 4, 2013 and September 6, 2013 respectively passed the PFRDA
Bill, 2013. The said Bill has also received the assent of the President on September 18, 2013.
Applicability of PFRDA and NPS
The Act applies to NPS but not to other specific pension schemes or funds or to the insurance
contracts under which payment of money is assured on death, any pension scheme exempted
by central government, persons appointed before January 1, 2004 to public services or All
India services. NPS is available to all citizens of India on voluntary basis and is mandatory
for employees of central government (except armed forces) appointed on or after January 1,
2004. All Indian citizens between the age of 18 and 55 can join the NPS.
The NPS will work on defined contribution basis and will have two tiers, Tier-I and Tier-II.
Both Tier-I (Pension Account) and Tier-II (Savings Account) will be pure retirement savings
products, the only distinction being Tier-I is a non-withdrawable account while Tier- II is a
withdrawable account to meet financial contingencies. Contribution to Tier-I is mandatory for
all government employees joining government service on or after January 1, 2004 whereas
Tier-II will be optional and at the discretion of government employees.
All assets, liabilities, debts, obligations, sums of money due, suits and legal proceedings
related to the "Interim PFRDA" has been transferred to PFRDA on and from the date of
establishment of the PFRDA.
National Pension Scheme
The NPS reflects government's effort to find sustainable solutions to the problem of
providing adequate retirement income. In NPS, every subscriber will have an individual
pension account (Tier-I). Withdrawals up to 25% of contribution are allowed by subscribers.
Recordkeeping, accounting and switching of options by the subscriber are the responsibilities
of Central Recordkeeping Agency ("CRA"). There is a facility of portability of pension
accounts in case of change of employment but the collection and transmission of
contributions shall be carried out through CRA only. There is no assurance of benefits except
market based guarantee mechanism. The subscriber will have to purchase an annuity from
any life insurance company while taking exit from NPS. A subscriber may also have an
additional account under NPS with an additional feature that the subscriber may withdraw
part or all of his money at any time from the additional account (Tier-II).
Implementation of NPS
In Tier-I, every subscriber shall have an individual pension account. A non-government
employee needs to contribute at least four times in a year and each contribution should not be
less than INR 500. Therefore, the minimum contribution3 to the scheme should not be less
than INR 6000 every year. Government employees will have to make a contribution of 10%
of their basic pay plus Dearness Allowance ("DA"), which will be deducted from his salary
every month. An equal contribution will be made by the government. Tier-I contributions
will be kept in Tier-I Account.
A government employee can exit at or after the age of 60 years from the Tier-I of the scheme.
At exit, it would be mandatory for him to invest 40% of pension wealth to purchase an
annuity from an Insurance Regulatory and Development Authority regulated life insurance
company, which will provide pension for the lifetime of the employee and his dependent
parents/spouse. In the case of government employees who leave NPS before attaining the age
of 60, the mandatory annuitization would be 80% of the pension wealth.
The Tier-II enables the existing Tier - I account holders to build savings through investments
over and above those in the Tier I pension account. Tier-II contributions will be kept in a
separate account that will be withdrawable at the option of the Government servant.
Government will not make any contribution to Tier-II account. No additional CRA charges
will be levied for account opening and annual maintenance in respect of Tier-II. However,
CRA will charge separately for each transaction in Tier II, the charges being identical to the
transaction charge structure in Tier-I. There is no limit on number of withdrawals. Separate
nomination can be made for Tier-II account. The subscriber would have the same choice of
Pension Fund Managers ("PFM") and schemes as in the case of Tier-I account. Facility of
only one-way transfer of savings from Tier-II to Tier-I is available. An active Tier I account
will be a pre-requisite for opening of a Tier-II account.
In cases of discharge/death of the employee, the amount of accumulated funds in the NPS
account will be paid to the employee/family of the employee. The amount of monthly-
annuitized pension from the date of discharge/death will be worked out in accordance with
the regulations notified by PFRDA.
Impact of NPS
NPS has been notified for tax benefit purposes. Under this, both employee and employer's
contributions are eligible for income tax deduction up to 10% of basic plus DA under section
80CCD5 of the Income Tax Act, 1961 within INR 1 lakh limit as specified under Section
80CCE6. The employer can claim tax benefit for its contribution by showing it as business
expense in the profit and loss account.
The NPS contribution will be in addition to Employee Provident Fund investments. Employer
can simply deduct the contribution from employee's salary. It saves a big part of the salary
and helps in availing tax exemptions too. Other than central and state government employees,
mandated to make contribution to NPS, those working in entities registered under the
Companies Act, Cooperative Acts, registered partnership firms, proprietorship concerns,
trusts and societies can avail additional tax exemption under this model. Corporate houses
willing to join NPS can do so by tying up with one of the PFRDA-approved points of
presence ("POP"), which facilitate account opening and act as an intermediary between the
subscriber and NPS intermediaries such as CRA. It is also beneficial for professionals as they
can become the part of CRA and can also act as PFM. Due to the above mentioned benefits,
many private limited companies are switching to NPS.
The limitation under this scheme is that the total amount of the contribution should not be
more than 10% otherwise the additional amount will not qualify for the tax benefit.
Person will be eligible for Pension under following Circumstances:
1) On Superannuation
Age 58 years or More and atleast ten years of service
The member can continue in service while receiving this pension On attaining 58 Years of age, a EPF member cease to be a member of EPS automatically.
2) Before Superannuation
Age between 50 and 58 years and atleast ten years of service
The member should not be in service.
3) Death of the member Death while in service or. Death while not in service
4) Permanent Disability Permanently and totally unfit for the employment which the member was doing at the time of such disablement
No pensioner can receive more than one EPF Pension.
Employees' Provident Fund Organisation
The Employees' Provident Fund Organisation (EPFO) is a statutory body of the Government
of India under the Ministry of Labour and Employment. It administers a compulsory
contributory Provident Fund Scheme, Pension Scheme and an Insurance Scheme. It is one of
the largest social security organizations in the world in terms of the number of covered
beneficiaries and the volume of financial transactions undertaken.
The EPFO has the dual role of being the enforcement agency to oversee the implementation
of the EPF& MP Act and as a service provider for the covered beneficiaries throughout the
country. To this end, the Our Commissioners of the Regional and Sub Regional Offices of
Organisation are vested with vast powers under the statute conferring quasi- judicial authority
for search and seizure of records, assessment of financial liability on the employer, levy of
damages, attachment and auction of a defaulter's property, prosecution and arrest and
detention in civil prison.
Changes Around the World
Recent years have witnessed intense pension reform efforts in countries around the globe,
which have often involved an increased use of funded pension programmes managed by the
private sector. There is a growing need among policy makers and the regulatory community,
as well as among private sector participants, to compare programme developments and
experiences to those of other countries. Because funded arrangements are likely to play an
increasingly important role in delivering retirement income security in many countries, and
because the investment of pension assets will increasingly affect securities markets in future
years, the availability of an accurate, comprehensive, comparable and up-to-date body of
international statistics is a necessary tool for policy-makers, regulators and market
participants.
The Working Party on Private Pensions and its Task Force on Pension Statistics launched the
Global Pension Statistics' project (GPS) in 2002. The GPS provides a valuable means for
measuring and monitoring the pension industry, and permit inter-country comparisons of
current statistics and indicators on key aspects of retirement systems across OECD and non-
OECD countries. Data are collected on an ongoing basis so that trends can be readily
identified and analysed. The statistics cover an extensive range of indicators and relate to a
wide definition of private pension plans, themselves subdivided into detailed categories using
coherent statistical concepts, definitions and methodologies.
Structure of Pension Systems Private pension plans can be financed through pension funds,
pension insurance contracts, book reserves or other vehicles (bank or investment companies
managed funds). They could be linked to an employment relationship, making them
occupational pension plans, or they may be based on contracts between individuals and
private pension providers, making them personal pension plans.
Wealth and Investments
These indicators refer to the trend in pension fund assets and asset allocation. The default
queries are proposed for pension funds, therefore excluding data pertaining to book reserve
systems (as they exist in Austria and Germany for example), pension insurance contracts
(available in most OECD countries) and funds managed as part of financial institutions.
However, the default options can be modified to comply with users' needs.
Operating Expenses
Pension fund operating expenses comprise all costs arising from the general administration of
the plan/fund that are treated as plan/fund expenses (i.e. administrative costs and investment
management costs). The efficiency of private pension systems can be assessed by looking at
the costs in relation to assets under management.
Equity allocations by Japan pension funds have risen from 22% in 2003 to 40% in 2013,
while equity allocations by U.K. pension funds have fallen from 65% to 50% in the same
period. The Netherlands’ equity allocations fell from 40% to 35%, and Canada’s allocation to
equities fell from 55% to 48%. U.S. and Australia pension funds have maintained the highest
allocation to equities over time, reaching 57% and 54% in 2013, respectively.
Japan pension funds still have the highest allocation to bonds (51%), but this represents a
significant reduction since 2003, when 71% of its assets were in bonds. Netherlands pension
funds have increased their allocation to bonds during this period (from 45% to 50%), as have
U.K. funds (31% to 33%) — the only two countries in the study to have done so.
Allocations to alternative assets, especially real estate (and to a lesser extent, hedge funds,
private equity and commodities), for the P7 markets have grown from 5% to 18% since 1995.
In the past decade, most countries have increased their exposure to alternative assets, with
Australia increasing the most (from 8% to 25%), followed by Canada (from 8% to 21%) and
the U.K. (from 3% to 14%). Allocations to alternatives in the Netherlands and Switzerland
have remained constant during the same period.
There is a clear sign of reduced home bias in equities, with the average weight of domestic
equities in pension fund portfolios falling from around 65% in 1998 to just over 44% in 2013.
Perhaps surprisingly, during the past 10 years, U.S. pension funds remained the market with
the highest bias to domestic equities, while Canadian funds have had the lowest allocation to
domestic equities. Regarding home bias in fixed-income investments, the average allocation
to domestic bonds as a percentage of total bonds has remained high since the inception of this
research, when it was over 88%. Last year, it was around 80%.
During the 10-year period from 2003 to 2013, the CAGR of DC assets was 9%, compared to
5% for DB assets. DC pension assets have grown from 38% in 2003 to 47% in 2013.
Australia has the highest proportion of DC to DB pension assets: 84% to 16%, compared to
83% to 17% in 2012. Only Australia and the U.S. have a larger proportion of DC assets to
DB assets.
Japan, Canada and the Netherlands are markets dominated by DB pensions, with 97%, 96%
and 95% of assets, respectively, invested in these types of pensions. Historically only DB,
these markets are now showing small signs of a shift toward DC.
In the U.K. and Australia, the private sector holds the biggest portion of pension assets,
accounting for 88% and 84%, respectively, of total assets in 2012. Japan and Canada are the
only two markets where the public sector holds more pension assets than the private sector,
holding 71% and 55% of total assets, respectively.
Public or Private Management
Indians do not have the first pillar funded and supported by government and, therefore, the
second pillar becomes the basic pillar – a core retirement plan. In this plan people are looking
for secured income when they retire, and, therefore, as recommended by the World Bank the
plan should be publicly managed. Problems with privatization include the following:
1. Current retirement benefits are barely adequate and a retiree wants a reliable source of
income. Privatization contains no social insurance components like disability and survivors’
benefits. Retirees would have to buy them separately. Benefits may be reduced by as much as
30 per cent in some cases.
2. Having individual retirement accounts in private pension funds would be prohibitively
expensive to administer. In some cases where contributions are small (say Rs. 100 a month),
administrative costs may be as high as 25 per cent of contributions.
3. Privatization gets the employer off the hook. Risk shifts from corporations to employees.
Most employees prefer the stability of pension plans to higher volatile monetary value of the
fund. For less wealthy, assured income has always been economically better than higher but
volatile and uncertain financial wealth.
4. There would be the added problem of agency risk, which has not been taken note of.
Government would have to add a so-called ‘0 pillar’ that will guarantee a minimum pension
to employees whose own defined pension falls below a specified minimum. Along with tax
subsidy, policy makers should factor into the cost of government providing guarantees for
policyholders.
The priority should, therefore, be putting in place a policy vision and road map with specific
goals in relation to pre-determined milestones. These include the tax financed and means-
tested system for lower income groups. If government cannot afford it, then it has no moral or
political justification to even consider providing further tax benefits to privileged income
groups. If there are no government funds for the first pillar, the third pillar should remain out
of policy discussions. Emphasis should be on strengthening the second pillar.
Conclusion And Recommendations
Pension reforms would not occur overnight. Thus, the focus should be on improving existing
systems rather than replace them with new ones. Efforts should be made to find ways of
supporting new systems that may supplement existing systems. Since the tax-paying
population is small, an exclusive focus on tax incentives as a vehicle to encourage savings is
misplaced. Proper estimate of the “tax expenditure” (that is, forgone revenues) that results
from current tax preferences for retirement savings and explicit decisions about the
appropriate size and progressivity of these preferences need to be made. Government’s
contingent liabilities on account of minimum pension guarantee also need to be taken into
account before any change in policy is made. Participants’ interests and associated
government costs in the form of government grants, administrative costs by its agencies
(EPFO, post office, bank branches, etc.), and funds required to guarantee minimum pension
should all be taken into account in recommending any institutional arrangement.
In the government sector, reforms should focus on strengthening the existing PAYG system
through adjusting the system parameters. Pension outlays can be lowered by reducing the
replacement rates, that is, the ratio of pensions to wages, or by moving toward less generous
pension indexation formulas that give less weight to wages and more weight to inflation,
raising the retirement age in line with life expectancy, and rationalizing disability, survivors’
benefit, etc.
Private firms, particularly insurers and fund management companies, may be lobbying hard
to acquire new business or being hired by EPFO to manage its Rs. 500 billion corpus without
guaranteeing anything in return except lofty promises. However, government must be
cautious about these moves. In privatizing the basic pension system for its citizens,
intermediation costs and agency risk cannot be ignored. Since politicians cannot stop being
playing Santa Clauses and causing havoc with government finances, one should not imagine
that fund managers would discipline them and solve the problem. Given so many scams in
the past, it is more likely that they will join the bandwagon in sharing the spoils at
participants’ and/or government expense. All this serves to spotlight the role that the
government must play in creating a pension system with appropriate safeguards for inherent
risks and ensure that appropriate parties bear them. If private fund managers are willing to
guarantee performance, it may be worth trying. EPFO finances need closer scrutiny to
examine its viability and to provide efficient services it must have trained manpower and
technology savvy administration.
The priority should, therefore, be putting in place a policy vision and road map with specific
goals in relation to pre-determined milestones. These should include a tax financed and
means-tested system for lower income groups. If government cannot afford it, then it has no
moral or political justification to even consider providing further tax benefits to privileged
income groups. If there are no government funds for the first pillar in the World Bank
recommended multi-pillar system, the third pillar should remain out of policy discussions.
Emphasis should be on strengthening the second pillar. Suggested reforms neither enhance
efficiency nor make the social security system more equitable. It would only privatize the
gains while costs and risk for the government would increase considerably. It would only
help well-off segment of society in availing more tax concessions. Present problem in the
government pension system is due to successive governments behaving like Santa Clauses
ignoring the cost to exchequer. Fund managers would not be able to solve these problems.
It can be concluded that in order to effectively invest and manage huge funds belonging to a
large number of subscribers and to ensure the integrity of NPS, establishment of a statutory
PFRDA with well defined powers, duties and responsibilities would benefit all the
subscribers of the NPS. The new law could help in bringing new pension products in the
market, thereby giving choice to customers. Competition could also improve quality of
service and returns. If these measures are successful, these could help in mobilising
substantial long-term funds, which can be used to build infrastructure. It is mandatory to use
40% of pension wealth to purchase the annuity at the time of the exit (i.e. after the age of 60
years). This provision has been made in the New Pension Scheme with an intention that the
retired government servants should get regular monthly income during their retired life.
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