Why PF doesn’t serve as a pension fund and doesn’t provide for old-age security

Published: December 20, 2017 3:51:55 AM

PFs require contributions from both employees and employers, and enable the employee to get a lump sum at the time of the retirement.

There is no need for compulsory savings schemes such as Provident funds. The contributions should only be towards pension funds. (PTI)

The saga of India’s social security system or welfare-oriented measures—manifest in the form of providing livelihood security to employees after their superannuation—has been a fascinating one, replete with the vicissitudes of the governing class. Provident funds (PFs) in India came out of the policy of the British government that established such funds in many of its colonial territories to provide retirement benefits to employees in regular wage employment. The first legislation in this regard is the Provident Funds Act 1925, enacted for creation and governance of PFs. The various rules of managing PFs for government employees were also framed under this Act. The PFs created before Independence by a few semi-government undertakings, and even a few private undertakings, functioned under this statue. It was only in 1951 that the Union government thought of bringing a separate Act to mandate the collection of Pfs for employees of specific private industries. The Employees Provident Fund & Miscellaneous Provisions Act 1952 initially applied to only three types of industries. Over the years, this Act has brought under its benign fold a large swathe of the private sector—a significant portion albeit is still out of the mandate.

PFs require contributions from both employees and employers, and enable the employee to get a lump sum at the time of the retirement. PF is a sort of pension fund, but in practice, it is working as compulsory savings scheme, especially advantageous to employees whose incomes are taxable given contributions to PF are exempt from income tax, of course, up to a limit. Over the years, employees have been given many opportunities to use their PF contributions much before the exit. In the EPFO, the outstanding amount at the time of retirement in case of employees mandated to contribute is often not more than Rs 10,000. Thus, PF absolutely does not serve as a pension fund and does not provide for old-age security, the primary purpose behind its founding. Perhaps this is the reason that PFs have been done away with for state and Union government employees, but this has not been extended to PSU and private sector employees. From 2004, state and Union government employees only contribute to the National Pension System (NPS). Further, the Union Budget speech of 2015 did talk of working for a pensioned society, but no concrete steps have been taken in this regard, because the amounts required could be humongous.

The need of the hour is to provide old-age security to the population which is already 11 million and is growing at a rapid pace. The country did take notice of the issue immediately after the World Bank brought out a report, Averting the Old Age Crisis: Policies to Protect the Old & Promote Growth, in 1994. Other international bodies such as ILO have also started talking of universal old-age security. These bodies talk of three types of social security nets; (i) a publicly-managed, tax-financed social safety-nets, e.g., old-age pension schemes of the government of Haryana or the National Old Age Pension Scheme of Union government; (ii) a mandatory, privately-managed, fully-funded contribution scheme, e.g, Employees Provident Fund Scheme or Delhi University Employees Provident Fund Scheme, etc; (iii) voluntary personal savings and insurance schemes, e.g., schemes run by insurance companies (even PPF will fall in this category). As PFs cannot provide the old-age security, time has come to rethink these. There is no need for compulsory savings schemes such as present PFs. The contributions by poor employees are, in a way, injustice to them as overwhelming numbers borrow money at three times the rate of return they get on their contributions to PFs. In the case of voluntary contributors, they contribute due to many unintended benefits.Perhaps that is why employees agreed to transfer approximately 70% of the employers’ share to the Employees’ Pension Fund.

It does, therefore, make eminent sense that, going forward, the contributions to PFs are done away with. The contributions shall only be made to a pension fund. For a salaried employee drawing less than double the minimum wage, only the employer shall contribute 10% of the gross salary to the pension fund of the employee. In case of employees drawing a pay between double the minimum wage and four times this, the contribution can be equally divided between the employee and the employer. In case of all other employees, the 10% contribution will be made by the employee. No employee, whatever be the income, will be exempt from payment to this old-age security fund. Even in the case of so-called honorary workers, such as anganwadi workers or ASHA workers, the employer will pay 10% of the total honorarium to the old-age security fund. All income tax assessees will also be mandated to pay 10% of the gross income towards the old-age security payment.

The old-age security fund also needs to be maintained in three corpuses. In case of employees drawing higher pay, the corpus can be used for investment in low-earning government securities, while, in the case of poor employees, the corpus shall be mandated to be invested in high-earning, risk-free investments. As the persons in the higher income brackets will enjoy income tax benefits, there can even be a cross-subsidy from the earnings of this corpus to the other. No person shall be allowed withdrawal from the pension fund. A decision recently taken in case of NPS to allow withdrawals is retrograde as it is against the underlying principle of providing old-age security to the members. There can be minimum and maximum pensions defined in the Act enacted for the purpose. Some percentage of earnings can be mandated to be transferred to a separate fund which can ensure a minimum pension to all contributors.

This simple decision will confer a few concurrent benefits. The industries and services sectors’ contribution to the social sector will come down and will be on a par with the international standards. These will become more competitive and help in ‘Make in India’ programme of the country. All the employees whether in private, PSU or government, will have the same treatment. The old-age pension fund corpus will increase substantially, at least 3-4 times (even now the majority of contribution to Employees Provident Fund is from voluntary contributions). This will make funds available for development purposes at a lower cost. These will also create significant employment, creating a virtuous circle. It is estimated that these simple steps will ensure coverage of approximately 35% of the old-age population by definite old-age security. It can be extended to the remainder, in whose case, a decision could be taken concerning the contributions. National Old Age Pension Scheme can also be a part of the same. A national register of pensioners will get created with Aadhaar linkage which will also help in eradicating malpractices in the pension space, especially in the schemes entirely funded by the state. In sum, if the actions suggested here are implemented, it would go a long and meaningful way in ensuring a win-win situation for all shareholders and stakeholders in a welfare society like ours.

KK Jalan
Former central provident fund commissioner, EPFO, and former secretary, MSMEs

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