Choices in Pensions

Retirement planning has three important constituents. An early start, a good choice of scheme(s) and a periodic stock taking exercise. The power of compounding is an accepted concept that conveys the need to start early. Some tend to dismiss it as sales rhetoric manufactured by financial services firms to meet targets. An early start helps in many ways; it gives your money time to grow. It ensures you don’t take disproportionate risks.

Having decided about the early start, it is important that you choose your plan well. We live in an era of choices. While there are choices aplenty in individual centric pension plans that insurers manage and other retail products, I will focus on the ones that are available at your workplace.

Most employers are mandated to offer Employees Provident Fund (EPF) and its allied schemes (Employees’ Pension Scheme and Employees Deposit Linked Insurance). In addition to these, some employers offer the National Pension System.

The EPF is an interest bearing plan where your employer and you contribute similar amounts. You are required to contribute 12 per cent of your basic salary into the EPF but can opt to add additional sums. The contributions are paid into your account that earns a rate of interest every year based on investments that comprise a mix of equity (up to 15 per cent) and bonds. On retirement, the balance in your account is paid to you as a lumpsum. A part of your employer’s contribution was once paid to a scheme called the EPS which was closed to new entrants, unless they earn less than Rs 15,000. There is also an insurance component in the EPF. This is paid for by your employer. You have little or no choices in membership, contribution and investments.

The NPS is a product that offers more flexibility. It lets you choose the amount to contribute. You may choose your money manager among a list of empanelled managers. You may also choose where your money is invested. There are controls on where the investments are made. On turning 60, you can opt to receive a part of the balance in lumpsum and a part as pension.

So which one should you choose? Most of us work for firms that are covered mandatorily by the EPF and may not have choices, but if you have to choose, I suggest you ask the following questions:

1. Which plan delivers better investment outcomes?

2. Which plan has better administration?

Investment outcomes are linked to three factors: where funds are invested, fees that you pay and the presence of tax breaks. If you have many years to go before you retire, the NPS stands a better chance of outperforming the EPF, due to its investment mix. Empirical proof suggests that higher exposure to equities delivers higher returns and this is where the NPS scores decisively over the EPF. The fees charged by the NPS are lower than that by the EPF but the incidence of fees queers the pitch. The EPF charges fees to your employer, while the NPS charges you. On taxation too, the NPS scores higher with an extra Rs 50,000 break.

Administration efficiency is a function of usage of technology, presence of processes and accountability. In these, the NPS scores over the EPF. Money not paid on time is akin to default.

Once the choice is made, we often make the mistake of forgetting about it. A periodic review is the simplest thing that is a must. In the NPS, this could involve an annual check of the returns of your funds and the returns of alternative fund managers and any resultant action. In the EPF, this annual check could be of the balances and getting your EPF passbook updated. This is important in a country where record keeping is abysmally flawed.

As is evident above, the essentials of managing your occupational pension is all about doing simple things in a disciplined manner. Start today. You will not regret it.

Amit Gopal is Senior Vice President at India Life Capital

olmdesk@outlookindia.com