<div><em>Relying on government which has a role to play in the first two pillars of your retirement may not help. It’s important to create self-funded retirement plan to move comfortably into your sunset years, says <strong>Sunil Dhawan </strong></em></div><div> </div><div>Probably the fastest growing economy in the world, India doesn’t have a proper old-age pension system in place. In a recent report by Melbourne Mercer Global Pension Index measuring pension systems on the sub-indices of adequacy, sustainability and integrity, India ranks the last among the 25 countries. </div><div> </div><div>Several efforts in the recent past including moving away from defined benefit (DB) to defined contribution (DC) through national pension system (NPS) or the social welfare schemes such as Atal pension Yojna, the results doesn’t seem to be encouraging and seems to be moving at slow pace.<br> </div><div>In India, similar to most other countries, we too have a three-pillar pension system.</div><div> </div><div>Under pillar I, pension funding is done by government through several of its social welfare schemes. It’s largely inadequate and doesn’t even each the desired beneficiaries. </div><div> </div><div>Under pillar II, there is EPF and EPS schemes to the rescue. As far the EPF is concerned, the average balance was Rs 30,000 as per studies done earlier. Such sum is grossly insufficient for anyone to meet retirement needs. Under EPS, there is provision of pension. Understandably, it’s restricted to salaried employee but again the benefits may not reach to a large portion of employees in unorganised sector. According to EY’s report on Pensions business in India in November 2013, “employment in formal sector still accounts for 29 per cent of the working population, who are covered under pillar two. Consequently, 71 per cent of the population (mainly comprising informal sector employees) does not have a reliable post-retirement support system.”</div><div> </div><div>Even in the organised sector, where most of us belong to, the Employees’ Pension Scheme (EPS), takes care of our pension needs. EPS is largely a government subsidised pension scheme that has a huge asset-liability mismatch, relying entirely on taxpayer’s money. Several studies in the past have put the actuarial deficit of EPS at about Rs 50,000 crore. Recent changes in the EPS scheme could have brought down the deficit to around Rs 10,000 crore. From September 1st, 2014, EPS is only for those new members earning less than Rs. 15,000. To know what you will get from EPS, here the formula:"<br> </div><div>(Pensionable Salary * service period) / 70. </div><div> </div><div>The pensionable salary is capped at Rs 15,000 and service period at 35 years. Thus, maximum would be Rs 7,500 per month pension. For most who are contributing before 1st Sept, 2014, it will much less as earlier pensionable salary was capped at Rs 6,500.</div><div> </div><div>Pillar II also represents several state government and other trusts having their own pension funds. Most of them fail to provide adequate pension during post-retirement phase. </div><div> </div><div>Lastly, it’s the Pillar III and is most crucial to one’s retirement as it represent self-funding. The third pillar is evolving in India but hasn’t taken off yet. There is the NPS being administered by PFRDA and is a DC scheme. Returns are linked to market and the product offers access to debt, equity or a mix of both. Recently, government has allowed additional tax benefit over and above section 80C in NPS but the taxation on maturity i.e. on annuity or the pension still keeps NPS an unattractive retirement option for investors. NPS carries the lowest fund management fees but hasn’t been that popular yet.<br> </div><div>PPF has always been a popular retirement focussed investment and is currently offering a tax-free return of 8.7 per cent per annum. Considering, its low real return, PPF may not help create wealth over long term.</div><div> </div><div>Life insurance companies are allowed to offer pension plans but the product structure had been tweaked by the regulator in order to provide a guaranteed return. Providing a guarantee in a long term instrument carries an actuarial risk of mis-managing asset-liabilities especially in falling interest rate scenario. This one mandate of providing guarantee has almost killed the insurer’s pension business. Very few insurers would be selling pension plans nowadays. </div><div> </div><div>This leads to mutual funds industry. There are few retirement focussed retirement schemes in the industry. One of them, reliance retirement fund is the only one that givers option to invest wholly in equities and is focused on retirement. </div><div> </div><div>But before you start self-funding your retirement, estimate the requirement. Get to know how much corpus is required and how much you need to save each month towards retirement. Initially, consider your monthly expenses at current costs and then assuming an inflation rate of about 5 percent inflate them for the number of years left for you to retire. This gives you the amount of inflated monthly expenses you would need to survive through your retired years. The reverse calculation comes here. Estimate how much you need to start saving from now till your retirement age to amass a corpus that could provide you the inflated monthly amount. Use retirement calculators on several websites to arrive at the figure. Without exactly knowing the monthly savings required, one should not venture into planning and savings for one’s retirement. </div><div> </div><div>If you are starting out early or are in early 30s, your mutual fund portfolio should be heavy on equity funds i.e. about 80 per cent. Aggressive investors can also look to invest 30 per cent of their equity funds portfolio in mid-cap and small-cap funds. Create a separate portfolio for retirement need and start SIP in 3-5 consistently performing mutual funds. Review it after every 3 years and take action. Importantly, start de-risking process by moving funds away from equity to less volatile debt assets when you are at least three years away from your goal.</div><div> </div><div>Choosing the right asset class is equally important. Many of us could be investing in low-yielding products. Here’s why investing in equities as compared to debt asset is important in order to create wealth over long term. Let’s assume one invests Rs 5,000 per month for 25-years. The difference in maturity amount is a huge 98 percent, if growth happens at 8 and 12 percent receptively. <br> </div><div>If pillar I,II proves inadequate, investors need to realize the important of retirement especially in these times when inflation is destroying purchasing power of money and longevity is increasing and create self-funded retirement plan to move into the golden years comfortably. </div><div> </div><div><strong>End note</strong>: The reform process in pensions sector had started long back in India and is largely based on these three reports submitted to the government - Project OASIS Committee Report, 2000, Pensions Reforms in the Unorganized Sector — IRDA Report, 2001 and Report of the High Level Expert Group on New Pensions System, Government of India; P. Bhattacharya Report, 2002. In spite of in-depth understanding of the India’s need and demographics, MERCER’s report leaves lot to ponder upon and take immediate corrective action. Its high time, NPS gets tax break on annuity and ensures a better tomorrow for us Indians. </div><div> </div><div> </div><div> </div><div> </div><div> </div><div> </div><div> </div>
