The hullabaloo over changes in EPF and NPS norms has brought to focus the importance of planning for a regular income post-retirement. Planning for pension is equally important for employed and self-employed persons.
The flow of income for life after work is generally ensured through annuity plans, unless a person has enough capital assets to generate regular income, for example rental income. One can self manage the annuity or can get it through superannuation or pension schemes.
Superannuation schemes may be of defined benefit plan or of defined contribution plan. The pension system of government employees, who had joined service before 2004, comes under defined benefit plan.
To shift the investment risk to the employees, the government introduced national pension system (NPS) under the defined contribution plan in 2004. Now, a government employee can join superannuation scheme under the defined contribution plan only.
Annuity options
Annuity means a series of periodic payments, typically for rest of life after retirement or from the date of commencement of the payments. Following are some popular annuity options.
Employees’ pension scheme (EPS): This scheme is part of provident fund (PF) scheme, which is compulsory for private sector employees having basic salary of Rs 15,000 (which is revised periodically). It is optional for employees having basic salary of over Rs 15,000 per month. The basic salary includes basic wages, retaining allowance and dearness allowance (DA), including the cash value of any food concession. The scheme is optional for organisations with less than 20 employees and for PSUs.
“PSUs and other semi-government organisations may also opt to join the scheme. One of such organisation is DTC (Delhi Transport Corporation),” said regional provident fund commissioner Vineet Gupta, while explaining fine print of the scheme.
Out of 12 per cent matching contribution by employers, 8.33 per cent goes to EPS. Out of the total 24 per cent (12 per cent employee contribution plus 12 per cent employer contribution), 15.67 per cent goes to EPF. The central government also contributes 1.16 per cent of eligible basic salary. Other outgoes are 0.5 per cent for employees’ deposit linked insurance (EDLI), 0.85 per cent for EPF administrative charges and 0.01 per cent for EDLI administration charges.
Employee’s entire contribution and contribution of the employer up to Rs 15,000 per month are tax exempted under section 80C of the Income Tax Act.
An employee is eligible for pension if he/she has rendered eligible service of 10 years or more and retires at the age of 58. One may also opt for early pension if he/she retires at an age of 50 after rendering eligible service of 10 years or more. However, the amount of pension is reduced by 4 per cent for each year if taken in advance before 58 years of age.
The amount of pension is calculated by the following formula: X=AxB/70 (X=monthly pension, A=pensionable salary, B= pensionable service).
Pensionable salary is average monthly pay drawn during the contributory period of service in the span of 12 months preceding the date of exit from the membership of the PF. The maximum pensionable salary is limited to Rs 15,000 per month, unless if at the option of the employer and employee, contribution is paid on salary exceeding Rs 15,000 per month from the date of commencement of this scheme or from the date salary exceeds Rs 15,000, whichever is earlier, and 8.33 per cent share of the employer thereof is remitted into the pension fund.
Pensionable service is determined by the contribution received or receivable in the employees’ pension fund. “If an employee renders 20 or more years of eligible service, 2 years will be added to the pensionable service, provided he/she retires at the age of 58,” said Gupta.
On the death of the member, the family (spouse and thereafter two below-25 children) is entitled to receive monthly family pension.
Earlier, options of part commutation of pension fund and also three options of pension having conditional return of capital were available, which has been discontinued now.
“The options of commutation and return of capital were abolished in 2008,” said Gupta.
NPS: The national pension system (previously new pension scheme) is a new contributory pension scheme introduced be the central government for the benefit of its employees, who have joined after December 31, 2003, unorganised sector employees and self-employed professionals. The NPS, which was earlier restricted to government employees only has been made available to general citizens with effect from 2009.
To open an NPS account, an individual is required to submit a registration form with POP (point of presence) appointed by pension regulator PFRDA or online for e-NPS. Persons joining NPS are allotted a unique permanent retirement account number (PRAN), which will remain the same for the rest of the person’s life and may be used from any location.
PRAN provides two personal accounts: Tier-I pension account is a mandatory account for an employee and an individual, the contribution and savings to which is eligible for tax deductions u/s 80C. Withdrawal allowed from this account is subject to conditions. Government employees have to contribute 10 per cent of their basic+DA+DP into this account on a mandatory basis every month and the government also make matching contribution. Tire-II savings account is a voluntary account, in which there is no limit on number of withdrawals, but contribution to this account is not exempt u/s 80C. Facility of one-way transfer of savings from tier-II to tier-I is there. To open a tier-II account, an active tier-I account is necessary.
A person investing in NPS may opt for active choice or auto choice for their asset allocation.
Under active choice, one out of the following three has to selected: asset class E - investment in predominantly equity market instrument; asset class C -investment in fixed income instruments other than government securities; asset class G - investment in government securities.
Under auto choice, the investments will be made in a life-cycle fund. Here, the fraction of funds to be invested across three asset classes will be determined by a pre-defined portfolio (which would change as per age of subscriber).
In Union Budget 2015, additional deduction of Rs 50,000 u/s 80CCD is allowed for contribution to NPS.
The NPS savings were earlier fully taxed at the time of withdrawal or retirement. In this year’s budget, 40 per cent of the withdrawal at the time of retirement at the age of 60 years has been exempted. At least 40 per cent of such withdrawal must be used to purchase a life annuity from any Irdai-regulated life insurance company. If withdrawal is made before retirement, at least 80 per cent of the withdrawn amount must be used to purchase life annuity.
Annuity schemes of insurance companies: Apart from NPS tier-I subscribers, who have to purchase an immediate annuity plan of a life insurance company of their choice, any person can take such policy. A non-NPS customer may buy both deferred as well as immediate annuity depending upon his/her age and requirements.
Mutual funds (MFs): Mutual funds are good options for persons who are capable of self managing the annuity. During accumulation phase, one may also take advantage of section 80C through equity-linked savings schemes (ELSS), and after retirement, regular income may be ensured through systematic withdrawal plan (SWP), preferably after shifting the corpus to debt funds to avoid market risks. Good self-management skill is required to ensure effective use of the corpus created through PPF, endowment insurance products and lump sum receipt of GPF, EPF, gratuity, leave encashment etc. received at the time of retirement.
However, many things need to be taken into consideration to compare SWP and annuity plans. Explaining the technicalities, certified financial planner (CFP) Rahul Ranjan said, “Before deciding which is better, SWP or annuity, we need to understand features first.”
“You can get better returns in debt mutual funds than annuity plans of life insurance companies,” said Ranjan.
Explaining the inflation and taxation aspect, he said, “Once your debt MF units completes 36-month period from purchase date, it qualifies under long term capital gain, and you get benefit of indexation. As returns are generally around the rate of inflation, you either pay nothing as tax or pay very little tax after indexation. Therefore, I can easily say debt mutual fund SWPs are more tax and inflation efficient.”
“While in case of annuity whatever amount you will get as pension (principle plus interest) will be considered as income and taxed according to your tax slab. This means your principle is also taxed apart from your interest,” he added.
“After analysing above two parameters I can conclude that SWP in debt funds is better than getting pension from annuity plans,” said Ranjan.
A seasoned financial planner, Ranjan, however, throws caution in the air saying SWP is not everyone’s cup of tea. “But we have to also consider the better side of annuity also,” he says.
Emphasising the need of financial discipline to self manage the post-retirement income, Ranjan said, “God has created human beings to do financial mistakes in life, and that is the reason 90 per cent of people in any society suffers tremendously even after earning decent income. Generally people do not maintain the discipline of withdrawing a predetermined fixed amount from the retirement corpus every month. In most cases people redeems big amount, which depletes the corpus and within few years the entire corpus vanishes.”
Continuing his argument for annuity, he said, “All amount, which you will get as annuity, is prefixed and generally cannot be changed and you have to manage your financial affairs accordingly. This way you get pension for your lifetime, and if you opt, your spouse will also continue to get a prefixed amount according to terms and conditions.”
Ranjan also said, “Once you have a good retirement corpus which is very easy to get redeemed in case of MFs, your children or relatives will create such an emotional situation that you will be forced to redeem a big portion or the entire corpus for them, and will be left with nothing.” Adding, “In case of annuity these type of situations can be dealt with ease.”
So, despite inferior return and tax inefficiency, annuity scores over SWP in steadiness of post-retirement income for majority of people.
