Old age is a stage where two concerns weigh high on an individual. One is the possibility of running out of pension, which would help make ends meet and two is the possibility of inevitably becoming a burden on others.
While we cannot really control the latter, we can surely take better decisions to achieve the former. In India there are three basic pension schemes, namely, Employee Provident Fund (EPF), National Pension Scheme (NPS) and Superannuation Funds.
Despite these schemes, there has been no major growth in the size of India's employee pension schemes. A recent white paper by FICCI-KPMG analyzes these schemes and studies the challenges that impact the growth of these pension schemes. Here is a detailed analysis of the same.
INDIAN SYSTEMPension system in any country has high co-relation with the family structure of that country. If the family structure of a country is joint, then the urgency and the dire need of having a good pension scheme is not that high. However, if the family structure is not an extended one, then it becomes imperative for pension schemes to be robust.
In India, the concept of joint family system is losing its relevance as more and more people are going nuclear. This is unfolding when advancements in healthcare sector are pushing life expectancy in the country.
In such a situation, when life expectancy has risen and families are going nuclear, there is a greater need for an efficient and better pension system in India. There are three basic ways by which pension can be accumulated by an individual in India. These are Employee Provident Fund (EPF), National Pension Scheme (NPS) and Superannuation Funds.
In EPF, employees with monthly salary of up to Rs. 15,000 are required to become members. However, the salary cap does not apply to international workers and employees of newspaper establishments. In general, contribution rates are 12% of the salary (defined as per the EPF Act), by the employer and employee. Employee contribution is eligible for deduction from employees' taxable income up to Rs. 1,50,000.
For tax benefits, employer's contribution up to 12% of defined salary is not included in employees' taxable income. And from a tax perspective, withdrawals from EPF are tax-exempt. In NPS, any person who is a citizen of India, whether resident or non-resident, aged 18 years to 60 years can become a member of NPS. Contribution rates are flexible in this pension scheme.
For tax benefits, employee contribution up to 10% of defined salary is eligible for deduction from employees' taxable income subject to a cap of Rs. 1,50,000. Also, an additional deduction of Rs. 50,000 from taxable income on employees' contribution is considered. And from income tax perspective, lump sum withdrawal and annuity proceeds may be taxable subject to tax regulations in the year of the withdrawal or the annuity.
Under the Superannuation Fund, the SAF Trust, through its trust deed and rules, prescribes eligibility criteria of membership for employees. Contribution rates are flexible in SAF. As per the Income-tax Rules, 1962 the total employer's contribution towards any provident fund and SAF should not exceed 27% of the employee's salary.
In terms of tax benefits, an employee's contribution is eligible for deduction from employees' taxable income up to Rs. 1,50,000 and employer's contribution up to Rs. 1,00,000 per annum is not included in employees' taxable income. And from a tax perspective, the lump sum withdrawal amount is non-taxable (subject to the fulfilment of conditions laid down under the Income-tax Act, 1961). Annuity would be taxable as salary.
Despite these advantages, there are certain factors, which have impacted the growth of employee pension schemes in India. Here are a few important ones:
One big factor is tax treatment. The tax treatment for EPF, NPS and SAF are quite different. Withdrawals may be taxable under NPS, while they are tax exempt if the service period is more than five years under EPF. Contributions beyond Rs. 1,00,000 per annum are taxable under SAF. A consistent tax treatment may increase pension coverage in India.
Typically, firms with less than 20 employees are not required to set up any pension plan for their employees. Consequently a large number of employees in the micro and small enterprises are deprived of any pension coverage. Employees earning a monthly salary of more than Rs. 15,000 and without the existing membership of PF may also be excluded from participation in the otherwise mandatory EPF regime. A flexible option to incentivize greater pension participation may be considered by the government.
The self-employed do not get tax incentives at par with the employed individuals as employer contribution is not available.
Low Wage Earners
No flexibility in contributions is provided for low wage earners who find it difficult to save for pensions. The contribution rate of 12% may be very high for them, which in some cases may incentivize evasion.
Under the EPF regime, pre-retirement withdrawals are allowed. Further, those not able to make contributions for three years stop earning interest on their accumulations, thus encouraging them to withdraw.
Beyond Retirement Age
Under NPS, contributions are compulsorily stopped even if the employee is still working and wants to make a contribution after the age of 60. Contributions may be enabled as long as the employee is working.
The accumulated corpus of EPF, NPS and SAF are not inter-plan portable. This results in lack of consolidation of retirement corpus that may lead to inadequate pensions.
The employer pension plans survey carried out by KPMG in India clearly establishes the importance of tax incentives provided by the government to increase enrolment in pension plans and stimulate higher contributions to them.
In addition to this, the study on pension lays stress on creating parity in pension plan tax benefits, and facilitating employee education on pension planning. The study by KPMG says, "We believe that a comprehensive intervention from the government would help immensely. It could cover mandatory pension participation for all employees, regulation of pre-retirement leakage of funds, better tax incentives and greater transparency."
It adds, "The government needs to consider higher tax incentives, consistent tax treatment of various pension plans and transparency in regulations to augment pension coverage in India. Employers not only need to give a pension platform to their employees, but also need to educate them on the various pension plans and their respective benefits. Employees need to outline their retirement objectives and choose pension plans that will help them build a terminal corpus, which will realise these goals."
HERE ARE SOME IMPORTANT FINDINGS OF THE SURVEY
- The system of automatic enrolment of employees under the EPF regime, irrespective of salary, is largely prevalent (done by 89% of the respondents of the survey).
- Nearly 73% of the respondents confirmed that employees in their organizations exercise the option of contribution to VPF.
- 22% of the respondents companies have registered for the National Pension System (NPS). Further, of the total companies not registered for NPS (35 compaines out of total respondents of 45), almost half are considering registration for NPS.
- Tax benefits for their employees is seen as the primary motivator for NPS registration (52% of the respondents), 44% mentioned employee empowerment as the primary motivator while 4% deemed being at par with industry peers as the primary motivator.
- Majority of respondents (70%) who have registered/considering registering for NPS, said that only managers and senior level employees are opting for NPS.
- Only 36% of respondents have set-up superannuation fund (NYSE:SAF) for their employees. Of the respondent companies, which have SAF or are considering setting it up, 82% revealed that SAF is not meant for all the employees.
- There was unanimity among respondents on the importance of tax benefits for voluntary contributions to PF, NPS and SAF.
The government and the employers need to make a concerted effort to deal with the aforementioned challenges in the growth of employee pension schemes in India. Today, over 50% of India's population is below the age of 30.
Unlike Japan, which is an aged economy, India has time to deal with these challenges and the sooner the government and employers address these challenges, the better it would be for employees during their old age. Because being financial ill-equipped in old age is a far bigger challenge than it is when young.
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