A) Current System
India has a rather unusual and complex pension system with many kind of pension plans for people in different circumstances. The basic structure are the following 3 Pillars:
Pillar 1: State Pensions
Pillar 2: Occupational Pensions
Pillar 3: Private Pensions/Annuities
B) Pillar 1: State Pensions
The National Old Age Pension scheme has been introduced in 1995. Only the elderly below the poverty line are eligible for this plan. It provides monthly benefits of € 3,4 (INR 200). An increase from € 1,3 (INR 75) in 2006. It is estimated that only 20 million people are entitled to these benefits.
C) Pillar 2: Occupational Pensions Civil Servants
The Old Age Pension coverage for civil servants is the most developed part of the system. The ‘Central Civil Service Pension Scheme’ and the ‘Civil Service Provident Fund’ are mandatory plans for civil servants. They were created in 1972 and 1981.
A] Civil Service Pension Scheme
It is an unfunded defined benefit scheme. The employer pays 8,3% and the government pays 1,16%. Employees do not have an own contribution. To qualify for a pension at least 10 years of service is required. The retirement age is 58. The maximum benefit is 50% of the final salary. 33% of the pension value may be withdrawn as a Lump Sum.
B] Civil Service Provident Fund
It was designed as a provident fund on a defined contribution basis. In reality though, it functions on a pay-as-you-go basis. Thus current contributions are used for financing the pension benefits of current pensioners.
The employer does not pay contributions. Members have to contribute monthly. They can decide which amount they would like to contribute as long as it is between 6%-100%. The government credits the accounts with an interest rate which is set each year. At the moment it amounts to 8,5%. Benefits are paid as a Lump Sum after at least 20 years of service.
Conclusion: Both mentioned plans resulted in too high costs for the government. Thus access was closed for new entrants as of 2004 and replaced by the NPS.
C] New Pension System (NPS)
The Government of India established the Pension Fund Regulatory and Development Authority (PFRDA) in 2003 in order to develop and regulate the pension sector.
The NPS is a defined contribution system that started with the decision of the Government of India to stop defined benefit pensions for all its employees who joined after 1 January 2004. (Except Armed Forces.)
It has since mandatorily covered new entrants to the central government's civil service. Most state governments have indicated that they also plan to join the scheme.
These NPS Tier-1 accounts are the mandatory pension accounts for civil servants without the possibility of premature withdrawal.
Employers and employees contribute each 10% of the wages. The contributions are placed in individual accounts. The minimum retirement age is age 60. Taxation is based on mandatory annuities for 40% of the accumulated capital. 60% of the final capital can be received as Lump Sum at retirement age. The targeted replacement rate is 50% of final wages.
The Pension Law that will provide all details of the new system has not yet been passed. Thus implementation has only begun for central government employees as this does not require parliamentary approval. For the time being, contributions are held by the central government and awarded a rate of return of 8%.
D) Pillar 2: Occupational Pensions Organized Private Sector
A] Mandatory/Provident Fund
Workers in the organized portion of the private sector are covered by Mandatory Plans. They are operated by the ‘Employees Provident Fund Organization’(EPFO). It contains two fully funded defined contribution pension schemes providing Lump Sum capital at retirement age.
The provident fund system is the largest benefit program in India. These schemes provide retirement benefits to 10 % of the labor force. Workers and private employers contribute between 10 – 12% of monthly earnings.
B] Opting Out/Exempted Funds
(Only) Employers can decide to opt out of these schemes and establish ‘Exempted Funds’.
Exempted Funds can be established as a substitute for the EPFO plans, provided that benefits at least match the ones of the EPFO plans and that the EPFO agrees.
If employers set up Exempted Funds to substitute the EPFO, employees must participate in the plan. They are established as independent trusts and governed by employer and employee representatives as trustees.
Contribution levels are the same as in the EPFO system and must provide the same rate of return. The retirement age is between age 58-60. Employer and employee contributions are tax-deductible, investment income is tax-exempt and benefits are taxed.
There are strict and risk evading investment regulations for the Exempted Funds:
- 25% of assets must be invested in central government bonds.
- 15% of assets must be invested in state government bonds or bonds of public sector enterprises guaranteed by central or state governments.
- 30% are required to be invested in bonds of public financial institutions/enterprises.
- The remaining assets can be invested in the same asset categories.
- Since 1998 trustees have the option of investing maximum 10% in private sector bonds.
C] Voluntary/Superannuation Funds
There are also voluntary pension schemes in the organized sector called ‘Superannuation Funds’. A main reason to set up voluntary funds is the income limit in the Employees' Provident Fund. Thus those group pension plans often only cover senior executives.
Superannuation Funds provide additional pension benefits. Mostly by means of defined contribution plans. They can be run internally as a Trust Fund or externally through Life Insurance Companies.
The maximum for employer as well as employee contributions is for each set at 15% of the wages. Contributions are tax-deductible, as is investment income. Benefits are taxed. Tax exemption for employer contributions applies up to € 1.718,- (INR 100.000) per employee. The same limit is applicable for all employee contributions to pension and life insurance schemes.
Regarding the pay-out method for Superannuation Funds, 30%-50% of the capital can be taken out as a Lump Sum. The rest has to be used for buying an annuity from a Life Insurance Company.
Superannuation Funds have the same investment regulations as for Exempted Funds if they are managed in-house by trustees. Externally managed funds increasingly offer investment choices for members.
A relevant issue is if Superannuation Funds should have the option to invest in approved funds of the New Pension System in the medium term.
E) Pillar 3: Private Pensions/Annuities
Voluntary private pensions/annuities are available for the self-employed and for workers in the organized and unorganized sectors.
F) New Voluntary NPS System
A] Open to every citizen
The New Pension System scheme (NPS) will be mandatory for new civil servants as of 2004 but as of 2009 voluntarily open to every Indian citizen between the age of 18-60.
So employees from the organized and unorganized sectors as well as the self-employed will be able to participate. Their participation will be voluntary and thus employers will not be obliged to contribute.
It is not yet known when the voluntary component of the NPS will become effective.
B] PRAN: Permanent Retirement Account Number
NPS gives each citizen a unique personal registration number called PRAN. It is meant to be used for the entire lifetime and from any location in India.
C] Asset Location Management
As soon as the system is active, participants can choose between three kind of investment funds with different risk-return profiles. If no choice is made, their contributions will be transferred to a safe default fund. Asset managers will need to be licensed.
D] Nation Wide Distribution
To ensure nationwide distribution the NPS foresees that contributors can access 58 kind of Points of Presence like Post Offices, Private and Public Banks and Private Financial Institutions. These Points of Presence will be service providers for all kind of NPS matters like opening accounts or collecting contributions.
These contributions will then be directed to the Central Recordkeeping Agency (CRA). Which forwards the capital to the various fund managers who will invest it in the chosen fund. At the CRA recordkeeping, administration and customer service functions are centralized in order to keep costs low.
E] Tier 1-2 Accounts
The NPS will have Tier-1 and Tier-2 accounts. Which will each have its own section in the personal PRAN registration number.
Tier-1 accounts are the mandatory pension accounts for civil servants without the possibility of premature withdrawal.
Tier-2 accounts are voluntary. They will consist of savings that can be withdrawn, are subject to minimum contributions to the Tier-1 account and will not enjoy tax advantages!
Tier-1 account: Charges associated to the Tier-1 account, including Annual PRA Maintenance charge, are paid by the employer.
Tier-2 account: In case of a Tier-2 account, the activation charge and transaction charges are paid by the participant.
G] Annuity Service Providers (ASP)
They are responsible for providing a regular monthly pension to the participant after exit from NPS.
H] Positive aspects of NPS
Relevant benefits of the NPS system:
- It is transparent: regarding the costs, kind and amount of investments on day to day basis.
- It is simple: All the participant has to do is to open an account and get a Permanent Retirement Account Number (PRAN).
- It is portable: Each participant is identified by a unique number and has a separate PRAN which is portable and will remain the same even if the participant gets transferred to any other office.
- It is regulated: NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA), with transparent investment norms & regular monitoring and performance review of fund managers by NPS Trust.
- Tax benefits regarding the Tier-1 account and only taxation as of pay-out.
The NPS is quite innovative regarding the broad range of participants, distribution and investment choices. It has the potential to provide higher workforce coverage once it finally comes into effect.
The success of the NPS will depend among other things on the acceptance by unorganized sector workers. The issue of how to cover unorganized sector employees is therefore likely to remain high on the agenda in years to come.
G) India’s Positive Demographics
India can expect much more positive demographic developments than most other Asian countries.
The current fertility rate stands at 2.8 children per woman. Significantly above the natural reproduction rate of 2.1. With a median age of 24 years, the current population is young. A shrinking population is thus not an issue in India. The country's population is expected to grow from 1,16 billion today to 1,66 billion in 2050.
Still, India's population will age, but at a moderate pace. The old-age dependency ratio will increase from 8 today to 21 in 2050.
H) Pension Planning for Expats from India
Many expats from India are highly educated professionals with very fine career prospects. Often they do not have substantial State and/or Occupational Pension claims in India. They often do have alternative investments in for example real estate in India.
Thus it seems logical to listen to the Old Age, Next of Kin and Disability pension coverage wishes of these expats and to try to cover these wishes while at the same time optimizing tax benefits regarding the future and if possible the past.
In this perspective the effect of compounded return on investment, lowest costs and optimal investments can not be overestimated. Thus it seems advisable to start with the highest premium infusion at the youngest age possible.
Regarding flexibility it finally seems advisable to also take into account if the expat might in the future reside in one or more other countries. As transfers of value might be possible but it is advisable to prevent to get stuck in one country if this in the end is not in the best interest of the expat.
I) News March 2019
India Pensions: Budget 2019: Government Announces Pension Scheme Targeting 100 Million Unorganised Workers
The government recently announced a pension scheme targeting at least 100 million workers in the unorganized sector, such as drivers, maids and cobblers, in a bid to woo a critical voter group that Prime Minister Narendra Modi is seeking to sway ahead of a general election due by May.
In the interim budget for 2019/20, acting finance minister Piyush Goyal said the government would spend 5 billion rupees ($70.06 million) to launch what could become “the world’s largest pension scheme”.
The unorganized sector of India’s economy is vast, employing an estimated nine out of 10 workers. But experts note that such targeted pension schemes already exist, and would likely have limited benefits. Others said that such schemes have failed to win much buy-in previously, and so might disappoint as a vote winner.
“Right now, the value would be in that they have announced it. By the time, it’s actually done the elections will be over,” said Sebastian Morris, an economics professor at the Indian Institute of Management in Ahmedabad.
The new programme, to be implemented this year, will provide an assured monthly pension of 3,000 rupees once workers reach 60 years.
“A worker joining the pension yojana (scheme) at 18 years, will have to contribute as little as 55 rupees per month only,” Goyal said in his budget speech, providing few other details.
India’s estimated 420 million unorganized workers - including daily-wage labourers, rag-pickers, rickshaw drivers and maids - have few social security nets, and were stung by Modi’s controversial decision in 2016 to withdraw overnight most of the country’s high-value banknotes from circulation.
“A programme along the lines of social security driven by worker contributions makes a lot of sense and provides a sense of security to the vast bottom of the pyramid,” said Sunil Sharma, Chief Investment Officer at Sanctum Wealth Management.
But pensions are not a popular investment option in India. A 2017 report by the country’s central bank noted that “Indian households are woefully under-pensioned relative to their counterparts in other countries”.
The bank also pointed to a 2015 study that showed 50 percent of those surveyed in a government pension scheme for the unorganized sector did not pay the required 1,000 rupees over a 12-month period, instead making smaller contributions.
There are also existing government pension schemes for India’s unorganized workers, including the Atal Pension Yojana (APY) that was launched by the Modi government in 2015. The APY has so far only drawn 12.4 million subscribers, according to government data released last November.
Ashok Varma, a partner at PwC India, said the new scheme seems to be an extension of the APY, but it would likely have different eligibility criteria and target a larger worker base.
For the government, however, the expenditure for a new programme would be limited in the short-term. “The corpus is built over a period so the government doesn’t actually have to provide for this outlay at this point of time,” Varma said.
Some experts are sceptical of the actual benefits it would bring down the line even if workers regularly invested in the proposed pension plan.
“Let’s assume that you are 30-35 years of age, for the next 30-35 years you will keep contributing something and the end of the time, when you are 60 years of age, you will get 3,000 rupees,” said Himanshu, an associate professor at Jawaharlal Nehru University, who specializes in development economics.
“Tell me what will be the value of 3,000 rupees 30 years from now?”