Who should opt for higher EPS pension, what could go wrong if you opt for it Find out if you should opt for it
Till some years ago, the pension that subscribers to the Employees’ Pension Scheme (EPS) received after retirement was not worth talking about. The cap on the annual contribution meant that the pension was too low. A person who contributed the maximum Rs.1,250 every month to the EPS for 30 years would get a monthly pension of Rs.6,857. Little wonder that three out of five respondents to an online survey by ET Wealth in 2013 were not even aware that they were eligible for pension after retirement. Fast forward to 2023, when a Supreme Court ruling has transformed the EPS pension from a peripheral benefit into potentially the principal source of income in retirement.
The apex court has removed the cap on contributions to the EPS, so subscribers can opt for a higher pension equal to 50% of the basic pay. ET Wealth looked at three subscribers from different stages of life to understand the impact of opting for a higher pension. On the face of it, the prospect of getting an assured pension equal to 50% of your basic pay for life seems very tempting. Someone with a basic pay of Rs.1 lakh will get Rs.50,000 every month for life. It can easily become the principal source of income in retirement. Of course, this enhanced pension will come for a price. If a subscriber wants to get a higher pension, the contribution to the EPS has to be 8.33% of the basic pay.
Till now, the contributions to the EPS were capped. Members were contributing as little as Rs.5,000 a year (`416 a month) till November 2001. This was raised to Rs.6,500 a year and currently stands at Rs.15,000 a year (Rs.1,250 a month). To get the higher pension, a person will have to increase his contribution to the EPS as well as deposit the deficit payments as well as the interest earned on that since the time of joining the EPS. A person who joined EPS at 28 in 1995 when his basic salary was Rs.10,000 per month will have to deposit Rs.20.5 lakh in the EPS if he opts for higher pension. His monthly contribution to the EPS will also increase more than five-fold from Rs.1,250 to Rs.8,200, which means the inflow into the EPF will be that much lower. The calculations assume that the salary increased by 8.5% every year. Interest deficit has been calculated using historical interest rates offered by the Provident Fund.
Should you go for it?
Financial planners are divided on whether one should opt for the enhanced pension. Some say the higher pension is a good opportunity for subscribers. “Retirement planning is the most neglected financial goal in India. The option to get an enhanced pension would help individuals get an assured income in retirement,” says Amol Joshi, founder of PlanRupee Investment Services. “It will be especially useful for those who may not have been able to save enough for retirement,” says Dheeraj Sharma, a Delhi-based wealth adviser. As our calculations show, opting for the higher pension makes perfect sense for subscribers in almost all situations. “The lump sum amount that will shift from the Provident Fund to the EPS will come back within a few years. The return is much higher than what a regular annuity offers,” points out Sharma.
Boomer aged 56 who will retire soon
Opting for higher pension seems like a golden opportunity.
Note:If opting for higher pension, monthly contribution to EPS will increase from Rs.1,250 to roughly Rs.8,200At the same time, some financial advisers say that EPS takes away flexibility from the individual. “A young person with a long-term investment horizon may be better off investing in more lucrative options where he has greater control over where and how much to invest,” contends Deepti Goel, Associate Partner of wealth advisory firm Alpha Capital. For instance, if someone aged 25 years with a basic salary of Rs.50,000 opts for higher pension, he will have to put Rs.4,165 in the EPS every month. Assuming his income increases by 8.5% every year, he would put some Rs.81 lakh into the EPS over the next 33 years and get a pension of Rs.3.4 lakh.
“The option to get higher pension from EPS would give individuals an assured income after retirement. Everybody should opt for it.”
AMOL JOSHI
FOUNDER, PLANRUPEE INVESTMENT SERVICES
Instead of putting in the EPS, if that money is put in a mutual fund to earn 10% returns, he would have a retirement corpus of almost Rs.3.2 crore in 33 years. But this 10% return is not assured while the pension from the EPS comes with government assurance. Another key difference is that the EPS guarantees pension even in case of early death of the member. If a member dies during service, his widow will get his pension for life or till she remarries. Two children will get an additional sum equal to 25% of the pension. If there is no widow, two children of the deceased will receive 75% of the pension till the age of 25. If there are more than two children, the benefit will continue till the youngest is over 25.
Gen X employee aged 46
Even more compelling reason to opt for higher pension.
Note:Monthly contribution to EPS will increase from Rs.1,250 to roughly Rs.7,200. This will increase 8.5% every year with rise in income.
Interestingly, the development would help individuals realise the advantage of compounding and patience. The EPS pension is linked to the number of years a member contributes to the scheme. People who withdrew their Provident Fund corpuses and pension contributions every time they changed jobs will not get as much as those who kept their retirement savings untouched. The withdrawn amount is often blown away on discretionary spending and disrupts the compounding. As the legendary investor Charlie Munger once said, “The first rule of compounding: Never interrupt it unnecessarily.” What’s more, if a member has contributed to EPS for 20 years or more, two bonus years are added to the calculation. So, if a person with a pensionable salary of `1 lakh has contributed for 19 years, he will get a monthly pension of Rs.27,142. But if he contributed for 22 years, the pension calculation will give him two bonus years and give him Rs.34,285 per month.
Rs.6,89,210 cr: was the corpus of the EPS as on 31 March 2022. The scheme receives infl ows of roughly `4,200 crore every month.Rs.37,327 cr: was the deficit projected in the EPS as on 31 March 2019. In November 2022, EPFO appointed actuaries for valuation of the scheme.72.73 lakh: pensioners were drawing pension from EPS as on 31 March 2022. 66% of these were members, while 33% were spouse and children.What could go wrong
But subscribers need to keep in mind a few things before they click on the option. First, the EPS pension will not be linked to the last drawn salary but to the average salary in the last 60 months. In most cases, this would be much lower than the last drawn salary. Secondly, there are concerns about the viability of the EPS scheme. In the past, various actuarial studies have projected very high deficits in the scheme. As on 31 March 2019, the deficit was projected to be Rs.37,327 crore. “With the increase in the number of pensioners, the amount disbursed as pension has also shown a steady increase over the years. However, the fund has not witnessed any cash flow problems till now, in spite of there being a projected actuarial deficit in the valuation of the fund,” notes the annual report of the EPFO for 2021-22.
“Pension equal to 50% of salary is tempting but the amount will remain constant. Inflation is one reason why EPS alone will not be enough.”RAJ KHOSLA
MANAGING DIRECTOR, MYMONEYMANTRA
“A young person with a long-term horizon may be better off investing in more lucrative options where he has greater control and flexibility.”DEEPTI GOEL
ASSOCIATE PARTNER, ALPHA CAPITAL
In November 2022, the EPFO appointed actuaries for the valuations of the pension scheme. The report is not out yet but it is not incorrect to assume that the higher pension option may further dent the sustainability of the scheme. The changing demographics of India only adds to the problem. Right now, there are more contributors than pensioners to the EPS. But as the population of the country ages and more contributors turn pensioners (with many of them drawing a higher pension), the scheme could face more difficulties in the years to come. This is already reflected in the decline in contributions to the scheme. Annual accounts for 2020-21 indicate a drop in contributions to Rs.50,562 crore from Rs.51,953 crore in the previous year.
Millennial worker who just joined
The long-term sustainability of the EPS is a major concern.
Note:The projected monthly pension looks enticing. But over 27 years, even 6% annual infl ation will reduce its value to Rs. 51,400. This is not to say that the EPS would default on pension payments. The scheme is managed by the government and will continue to pay the pension as promised. Even so, financial advisers ring a note of caution. “People who have retired or are just about to retire may not face any problem, but those who will retire 15-20 years from now should be wary,” warns Sharma. Another problem is that the EPS is for life but there is no option of return of principal to the nominee or the legal heir after the death of the subscriber. After the member dies, the spouse gets 50% of the pension for life. So the risk of early death, within a few years of retirement, would mean very low returns on the money that flowed into the EPS. On the flipside, living longer till the age of 85-90 or beyond would prove bountiful.
Don’t rely on EPS alone
Experts say while the EPS could provide a tidy income in retirement, one should not depend solely on this income. “Inflation is one key reason why even the enhanced EPS pension may not be enough in retirement,” says Raj Khosla, Managing Director of MyMoneyMantra.com. Unlike the pension for government employees, the EPS pension is not linked to inflation and will remain constant. This means its purchasing power will decline over time. Even a modest 6% inflation will reduce the value of Rs.1 lakh to less than Rs.54,000 in 10 years. In 20 years, it would be worth only Rs.29,000. “The EPS pension can be an important but not the only pillar of your retirement plan. The retirement savings should be spread across various instruments, including annuities, fixed income and equitybased investments,” says Joshi.
Benefits offered under EPS
The Employee Pension Scheme offers the following benefits to privatesector employees covered by the Employees’ Provident Fund.
Pension for life to member and spouse
Pension starts at the age of 58 and is based on the number of years of service and the basic salary.
Pension to widow
If a member dies during service, his widow will get his pension for life or till she remarries. Two children will get an additional sum equal to 25% of the pension.
Pension for orphans
If there is no widow, two children of the deceased will receive 75% of the pension till the age of 25. If there are more than two children, the benefit will continue till the youngest is over 25.
Disability benefit
If a member is permanently and totally disabled during service, he will get full pension for life.
Early pension
A member can opt for early pension after 50, but he will have to take a cut of 4% for every year before 58.
Bonus years for long-term contributors
If the member has contributed to EPS for 20 years, two bonus years are added to the calculation.
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This story originally appeared on: India Times - Author:Faqs of Insurances
