Why India needs pension reforms
Of the 500 million working population, only 7% are in the organised sector and are covered by some form of social security in the form of a defined benefit scheme for government pension for public sector employees recruited before 2004 and Employees Pension Scheme (EPS) for subscribers of Employees Provident Fund Organisation. The remaining 93% workers in unorganised sectors do not have any safety net to fall back after their retirement. Which is why India needs a pension reform that will help provide some sort of income in the old age to its workers.
When was the pension reform initiated
The BJP-led NDA government initiated the reform by setting up a Pension Fund Regulatory and Development Authority (PFRDA) in 2003 and by launching a New Pension System in 2004, now rechristened as the National Pension System (NPS), for new recruits of central government employees. The Congress-led UPA government tried to carry forward the reform by introducing the PFRDA Bill in Parliament in 2005. The Bill has recently been passed by both Lok Sabha and Rajya Sabha. The legislation will give statutory status to PFRDA and enable it to regulate the sector better. It will also allow foreign fund managers to forge joint ventures with 26% stake and offer their expertise in managing long-term savings, foster competition and ensure higher returns to investors. The long-term investment by pension funds add depth to equity and bond markets, and helps stabilise the markets over a period by smoothening out short-term volatility. The economy will also gain as the long-term savings can be channelised to the productive sectors like infrastructure.
What is NPS
NPS is a pay-as-you-go scheme that allows the working population to accumulate their savings until they turn 60. After attaining retirement, the NPS investor will get back 60% of the accumulated corpus and invest the remaining 40% in an annuity scheme that will generate monthly pension. The higher the accumulation and longer the savings, the returns will be better during old age. Since withdrawal is not allowed except in some cases, the chances that the pension corpus generating higher returns over a few decades are high. Investors get tax exemptions during the contribution and accumulation stages.
What's the rule on contribution towards NPS
The government staff who joined NPS since 2004 contributes 10% of their salary towards NPS. For individuals working with private companies in the organised sector, the minimum contribution is Rs 6,000 per annum. The workers in the unorganised sector has to contribute a minimum R1,000 and maximum Rs 12,000 per annum in a special scheme Swavalamban, where government pays a subsidy of R1,000 for each individuals.
Who manages the NPS funds
PFRDA has so far allowed three pension fund managers (PFMs) promoted by government-owned financial institutionsLIC, SBI and UTI AMCto manage the NPS corpus of government staff. Apart from the PSU PFMs, the PFRDA has also allowed private PFMs floated by ICICI Bank, HDFC, Reliance Capital, Kotak Mahindra Bank and DSP BlackRock to manage the savings of private sector employees in the private firms. For offering annuity to NPS subscribers after retirement, the regulator has empanelled seven life insurersLIC, SBI Life, ICICI Prudential, Bajaj Allianz Life Insurance, Star Union Dai-ichi Insurance, Reliance Life and HDFC Standard Life.
Where do the fund managers invest the pension money
PFRDA caps investment of pension funds in equity at 50% while there is no restriction for investment in government or corporate bonds except in case of a default or auto choice scheme. Investors can choose their portfolio mix as per their risk appetite. For instance, the younger generation can invest up to 50% in equities and the remaining half in corporate bonds to reap the benefits of higher returns even though it comes with higher risks. As the retirement age nears, an investor can cut equity exposure and switch to government bonds which are safe to conserve his/her wealth.
The option to invest heavily in equities and corporate debt gives the investor an opportunity to let the NPS corpus grow faster than other forms of investment such as fixed deposits, small savings, EPF and PPF. The facility to switch the portfolio any time of the year also helps the investor avert the risks of a downturn
What if a subscriber can't make a portfolio choice
To assist those who are not so market savvy and may not be able to strike a balance between risk and return, PFRDA offers the auto choice scheme where the equity exposure is as high as 50%, investment in corporate bonds is 30% and government bonds at 20% until the investor is 35 years of age. The proportion of the equity and corporate bond exposure comes down gradually to just 10% each by the time the investor turns 55 while that for government bonds rises to 80%.
The government included a provision in the PFRDA Bill that will allow a subscriber to invest in a scheme that offers a minimum assured return to be notified by PFRDA.
What happens to the NPS account when an employee leaves a job
NPS offers a permanent retirement account number (PRAN) which is portable the account number does not change after the change in job and the subscriber can keep contributing to this account. This differentiates NPS from its competitors like EPFO or even the bank accounts opened by an employer when a new employee joins an organisation. PRAN is of immense benefit to poor migrant workers as in the construction sector as also for the new generation job-hoppers.
How has NPS performed in terms of subscribers and returns
The NPS subscriber base increased to 52.83 lakh by the end of August from just 4.3 lakh at the end of March 2009 as employees of 26 states, PSUs, private corporates and unorganised sector workers started enrolling. The NPS corpus has grown from just R2,277 crore in FY09 to R34,965 crore in August 2013.
The growth in enrolment was not without reasons as the NPS offered fabulous returnsthe central government scheme offered 12.39% return in FY13 while the state government scheme offered 13%. The net asset value of NPS Lite grew 13.4% last fiscal.
In terms of asset classes, the Scheme-G that invests in government bonds yielded 13.52% while the Scheme-C that invests in corporate bonds rose 14.19% and Scheme-E or equity portfolio grew 8.38% during FY13. The return for an individual investor will depend on the portfolio mixfor instance, a portfolio comprising of 50% equity and 25% each in government and corporate bonds have yielded around 11% last year.
What is the prospect of NPS
India's pension sector has the potential to grow exponentially in coming years as the retiring population is set to grow from 61.1 million currently to 205.7 million by 2050, according to global investment firm Greater Pacific Capital. India will need $9 trillion of pension assets by 2050 to match the benefit levels of retirees in developed nations given its rising incomes, inflation, real GDP growth and shifting demographics. In order to fully fund the future pension requirement with an average 6-7% return, a defined benefit scheme would need $0.7-1 trillion or 37-53% of GDP by 2050 to lay the ground for a safety net equivalent to those in developed nations. But with a pay-as-you-go scheme like NPS, the pension cost will drastically come down to 0.6-0.7% of GDP every year over the next four decades to attain the same goal.