India is the second most populated country in the world. About 50% the population was under the age of 25 years as per Census 2011, almost 90% of the population was below the age of 60 years and the working age population proportion stood at 44% in 2015. But the population is also ageing with each passing day. A WHO report revealed that India’s life expectancy has also been on the rise – going from 62.5 in 2000 to 68.8 in 2016. United Nations Population Fund (UNFPA) has pointed that in India, persons above 60 would increase from existing 8.9 per cent of the population to 19.4 per cent of the population and persons above 80 would increase from the existing 0.9 per cent to 2.8 per cent by 2050. Formal pension coverage is merely 14-15% of the population i.e. approximately 1 in every 8 Indian and is largely limited to Government employees and formal or organized sectors of the economy.
India has a fragmented pension landscape consisting of several pension schemes and products. The World Bank’s 5 pillar framework helps in classifying the pension landscape as follows:
- Non-contributory Pillar 0: Schemes in this category provide basic protection in old age. State pension schemes and Indira Gandhi National Old Age Pension Scheme (IGNOAPS) fall under this category. These are non-contributory and provide a guaranteed minimum income. These schemes are budget financed.
- Mandatory Pillar 1: In this category, the contributions to a pension scheme are linked to varying degrees to earnings with the objective of replacing some portion of lifetime pre-retirement income. The old defined Government pension and the National Pension System (NPS) for Government sector employees fall under this category.
- Mandatory Pillar 2: Schemes in this category typically consist of individual savings account (i.e. defined contribution plan) with a wide set of design options including active or passive investment management, choice parameters for selecting investments and investment managers, and options for the withdrawal phase. Schemes are mandatory for organized private sector. Employee Provident Fund (EPF) & Employee Pension Scheme (EPS) administered by Employee Provident Fund Organization (EPFO), NPS for public sector, Superannuation Funds established by corporate fall under this category.
- Voluntary Pillar 3: Schemes include individual savings for retirement, disability or death. The schemes may be employer sponsored and are essentially flexible and discretionary in nature. Public Provident Fund (PPF), NPS for unorganized sector, Atal Pension Yojana (APY), various pension products launched by Mutual Funds & insurance companies fall under this category.
- Non-Financial Pillar 4: Consists of access to informal support (such as family support), other formal social programs (such as health care and/or housing).
The EPFO has more than 4.5 Crore active members and more than 65 lakh pensioners. There are over 69 lakh Central & State Government subscribers under NPS. There are around 10 lakh corporate subscribers under NPS and around 13 lakh subscribers in the unorganized sector. The APY boasts of over 2 Crore subscribers – all belonging to unorganized sector.
However, retirement accounts play a very limited role in household balance sheets, even at the top of the wealth distribution. Indian households tend to borrow later in life and are more likely to reach retirement age with positive debt balances, which is a source of risk given that they are no longer earning income during these years. Currently, employees in the formal/organized sector consider retirement benefits/pension to be a prerogative of the employer and have a tendency to ignore retirement planning. A few reasons for this are as follows:
- Historical bias – in the past, pension was synonymous with Government employment while the EPFO was established for the organized private sector. However, due to the defined benefit component of the pension systems, the employees had no say in the decision-making process regarding their retirement.
- Lack of ownership – due to the historical bias and as mentioned above, pension is viewed as something for which only the employer is responsible and hence employees display a lack of ownership of their pension accounts
- Inertia – it takes effort to actively consider and execute retirement planning especially when it is not the norm
- Lack of long-term vision – people consider retirement as a far-off event which might not necessitate consideration or planning in advance
- Miscalculating the odds – people often feel that just like disease or disability, old age poverty is something which they will not face. People tend to overestimate their savings (and returns) and still believe in the fading familial support structure. Further, people don’t consider longevity risk i.e. the risk of outliving one’s retirement savings.
Defined Benefits pension systems need actuarial valuation to set sustainable rates so that the pension system does not fail. As Indian economy grows and matures, the interest rates are likely to fall and remain depressed. The defined benefit plans that offer fixed returns are often linked to the prevailing interest rates and pay only a little premium. For eg- PPF and EPF. However, populistic approach to economic decisions leave such plans vulnerable to over-optimistic rate setting and increases the risk of failure of the plan. As Government guarantees such plans, the deficits (as and when they occur) of such plans are borne by the Union budget, which is ultimately funded by the tax payers’ money.
Defined contribution pension systems where the rate of return is actual market return generated by the professional fund managers is more sustainable. The only concern of the people/employees should be about adequacy of the pension income that will be generated once they retire. For this, people should take the matters of pension planning in their own hands just like their bank accounts. One can utilize online calculators to estimate the corpus needed to ensure a sufficient income replacement rate after retirement. Once a broad estimate is arrived at, one can plan for the amount of contribution, asset class mix and duration of investments in order to achieve the long-term goal of a financially secure old age.
The NPS Trust website hosts an online pension calculator that calculates the retirement amount a person may receive by investing in NPS. The calculator takes date of birth (for age), monthly contribution amount, time period for contribution, expected return on investment, annuity rate and % of annuitization of corpus as inputs. Since pension is a long term goal, the professional pension fund managers invest the funds in an efficient way across asset classes such as equity, corporate bonds, government securities, mutual fund units etc. so as to generate optimal real returns (over inflation) for the subscribers.
Based on the NPS Trust calculator, the below table provides a snapshot of various scenarios for retirement planning to receive a monthly pension of Rs. 30,000, assuming 100% annuitization of corpus at retirement and a 5% annuity rate (return on investment after purchasing annuity).
|Time period of contribution||Monthly contribution amount (approx.)|
|Assumed return on investment: 8%|
|10 years||Rs. 40,000|
|20 years||Rs. 12,500|
|30 years||Rs. 4,800|
|Assumed return on investment: 9%|
|10 years||Rs. 37,000|
|20 years||Rs. 11,000|
|30 years||Rs. 4,000|
|Assumed return on investment: 10%|
|10 years||Rs. 34,000|
|20 years||Rs. 9,500|
|30 years||Rs. 3,200|
The above table clearly shows the power of compounding. Since compounding of money happens exponentially, even small sums of money invested for a long term can reap huge rewards. Therefore, young people have a great advantage of time that can work in their favour. People can follow such a target based approach to formulate appropriate savings plan and secure their long term financial goals.