The whys and wherefores of pension adequacy in India

While a pension of 50% of last salary may seem reasonable in view of the fact that some expenses such as on commuting, housing and dining get reduced after retirement, other expenses, such as on health care, travelling and insurance increase and offset savings to some extent. Some financial planners speak of the 80% rule, which states that one needs 80% of last salary to have a reasonably comfortable life after retirement. There is some merit in this argument

There is no universal understanding of adequacy of pension nor are there universal means to measure it. However, most pension plans aim to either alleviating poverty with a minimum sustenance level or providing a replacement income as near to pre-retirement levels as possible. The test of adequacy would therefore be to see if these objectives are met.

We could examine whether the pension plans currently in force in India, especially the public plans, meet these objectives.

Some of the major government funded non-contributory pension plans are under the National Social Assistance Programme (NSAP), which seeks to provide social assistance to poor households in the form of pensions to BPL individuals who are elderly, widowed or disabled. Their flagship scheme is the Indira Gandhi Old Age Pension Scheme for the elderly, which currently provides Rs 300 monthly pension to 23 million beneficiaries. This pension is supplemented by the state governments, which contribute varying top up amounts. However, even with these supplemented pensions, the monthly pension in the hands of the beneficiaries is less than half of what unskilled labourers receive as minimum monthly wages-Rs 5,340. One can gauge how far the NSAP pension goes in meeting its objective of improving the lot of the poor. By any yardstick, the NSAP pension cannot be considered adequate.

For organized labour, comprising government employees and the workforce in large establishments, the pension objective is to provide a standard of living which is above the minimum and which enables the retiree to live reasonably comfortably. In other words, pension should be a replacement income during retirement, high enough to maintain a standard of living almost similar to the pre-retirement period.

Government employees were formerly covered under the Old Pension Scheme (OPS), where a guaranteed pension approximating to 50% of last drawn pay was given. After 2004, the National Pension Scheme {NPS} became applicable, under which market returns linked pension is payable, which by definition is not a guaranteed amount. Pension is paid from annuities purchased from insurance companies at the time of retirement out of a minimum of 40% of the retirement corpus. Since few employees in NPS have served a full term of office, the scheme which only started in 2004, it is too early to talk about the amount of pension that would be received by retiring government employees. However, studies made at the time of inception of the NPS scheme showed that pension would not be dissimilar to the OPS.

For organized labour, covered under the EPFO, pension is linked to salary, similar to government employees. After members were permitted to draw higher pension linked to their pensionable salaries, the pension benefit is now akin to that of government employees under OPS.

While a pension of 50% of last salary may seem reasonable in view of the fact that some expenses such as on commuting, housing and dining get reduced after retirement, other expenses, such as on health care, travelling and insurance increase and offset savings to some extent.

Some financial planners speak of the 80% rule, which states that one needs 80% of last salary to have a reasonably comfortable life after retirement. There is some merit in this argument, especially when one factors in rising living costs, and the fact that neither EPFO nor NPS pension is inflation linked. In NPS, however, there is a provision of increasing the pension amount by reducing the lump sum payment, and this could help bridge any shortfall. In EPFO, after the recent Supreme Court judgement, pension can be claimed on current salary level, and not on a capped level of Rs 15,000 pm, as in the past. Although pension is paid as per the formula that has been laid down, it can be considerably higher under the current dispensation.

These redeeming features of NPS and EPFO tend to reduce the burden of expenses in retirement.

For organized workforce, therefore, it can be said that pension does enable retirees to maintain a standard of living not much different from the past.

For pensioners who are members of voluntary pension schemes, such as NPS and schemes of insurance companies and mutual funds, there is greater freedom to choose an appropriate pension plan. Pension adequacy, therefore, depends on the choices made by individuals and their saving capacity. The freedom to choose, however, calls for better understanding of risks and rewards associated with each scheme and tend to benefit more those who understand these issues well.

In conclusion one can state that while the pension benefits to the organized workforce more or less meet the objective of maintaining a satisfactory standard of living, the same cannot be said of the pension benefits extended to the poor.

(The author is former chairman of Pension Fund Regulatory and Development Authority (PFRDA))