Covid-19: Time for Liberal Retirement Options for Retirement Funds – Analysis
We are in the midst of a serious economic and financial crisis. With the tendency of coronavirus disease (Covid-19) to infect an unusually large number of older people, pension plans become an absolute necessity, both for medical support and to avoid the resulting economic crisis.
As Nobel laureate Milton Friedman writes: “Only a crisis, real or perceived, produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are out there. “
Such a crisis exists in the delivery of retirement benefits to subscribers of the National Pension System (NPS) of India.
We have an example in the Thrift Savings Plan (TSP), a retirement plan for American officials, which is an efficient and publicly managed social security scheme. The account is managed individually for each subscriber, and contributions flow to exclusive accounts. And the risk is borne by the subscriber. It offers three ways to withdraw money at retirement, with the option to choose any one or a combination of all three.
One, lump sum withdrawal. Lump sum withdrawals are large and a TSP member can take single or multiple withdrawals at the time of retirement. It is similar to the total withdrawal of the provident fund (PF) when withdrawing from the service by the subscribers of the Employee Provident Fund Organization (EPFO) or up to 60% withdrawal of the total corpus by a subscriber from NPS.
Two, installment payments. TSP allows an officer to receive monthly, quarterly, or annual payments until the total amount in the TSP account lasts. The participant has the option to start, stop or change installment payments at any time.
The Employee Pension Plan (EPS), one of three plans administered by EPFO that allows a subscriber to receive monthly pension payments. Pension contributions continue to be invested in the fund. Although the PF account is managed separately for each individual, pension contributions flow into a pooled pension fund. The risk is shared by employers and the central government. The pension is guaranteed by EPS. Currently, he does not have a provision of monthly pension payments for an NPS subscriber.
Three, life annuity. An annuity pays a lifetime benefit to the participant. The holder of a TSP account purchases an annuity from an insurance company linked to TSP. In NPS, a minimum of 40% of the corpus must be used to compulsorily buy an annuity at retirement to ensure a regular income during the retirement period. There is no annuity at EPFO.
It does not change the accumulated pension corpus, it simply redefines the ways in which the withdrawn benefits are used.
Among the three alternatives available to a TSP subscriber, the most popular is the withdrawal of a lump sum at retirement. However, their downside risk is that retirees often outlive their pension wealth.
An important factor affecting future retirement benefits for DC plans like TSP or NPS is the annuity conversion factor (the annuities actually paid to a subscriber in retirement), which for countries in the OECD is 90%.
The annuity conversion factor is much lower in India. The annuity market is not well developed anywhere in the world, and India is no exception. It represents less than a fifth of the total investment of the Indian insurance business. The reward to annuity providers appears to be disproportionate to the risks they take to obtain a guaranteed income. Adequacy of benefits is also an issue in annuity plans and particularly in a low-interest environment.
Unlike TSP, annualization for NPS retirees is mandatory. They must use a minimum of 40% of the corpus to purchase an annuity. The objective of the Pension Fund Regulation and Development Authority (PFRDA) is to develop and regulate pension funds and protect the interest of their subscribers, not to promote the insurance industry.
PFRDA has an efficient IT-based architecture for contribution collection, low cost investments, electronic account record keeping, and partial withdrawals in service. Unlike EPFO, NPS started in the digital age and has a robust digital infrastructure. The individual accounting infrastructure to provide flexibility in withdrawal options is in place, and the same could be leveraged for an innovative approach to serve subscribers. In fact, PFRDA is in a unique position to offer flexibility in withdrawal options based on subscriber choice.
It is time to change the NPS. PFRDA could emulate TSP by liberalizing retirement options and individual choice for retirees by providing alternatives and flexibility in benefit delivery. In particular, the annuity must be made optional. Similarly, a provision for monthly pension payments could also be introduced for NPS subscribers, while the remaining corpus may continue to be invested with the NPS fund. This would benefit NPS subscribers since larger groups of assets would be less expensive to manage per unit, since economies of scale would reduce administrative costs, increasing the benefits withdrawn.
PFRDA, the regulator and the government will find it difficult to resist the idea of a much better retirement option that could act as a “crown” for its subscribers in tumultuous times like the coronavirus pandemic.
Anuja Choudhary is Research Associate at IMI New Delhi
The opinions expressed are personal.