Covid-19: Time for liberal withdrawal options for retirement funds
We are in the midst of a severe economic and financial crisis. With the coronavirus disease (Covid-19)’s tendency to infect an unusually large number of elderly people, pension schemes become an absolute necessity – for medical support as well as to stave-off the resultant economic crisis.
As the Nobel laureate, Milton Friedman, writes: “Only a crisis – actual or perceived – produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around.”
Such a crisis exists in the delivery of retirement benefits for India’s National Pension System (NPS) subscribers.
We have an example in the Thrift Savings Plan (TSP), a retirement plan for American civil servants, which is an efficient and publicly-managed social security scheme. The account is managed individually for each subscriber, and contributions flow into exclusive accounts. And the risk is borne by the subscriber. It offers three ways to withdraw money on retirement, with an option to choose any or a combination of the three.
One, lump-sum withdrawal. Lump-sum withdrawals are large and a member of the TSP can take single or multiple withdrawals on retirement. It is akin to full provident fund (PF) withdrawal on retirement from service by the Employees’ Provident Fund Organisation (EPFO) subscribers or up to 60% withdrawal of total corpus by an NPS subscriber.
Two, instalment payments. TSP enables a civil servant to receive payments on a monthly, quarterly, or annual basis till the total amount in the TSP account lasts. The participant has the option to start, stop, or change instalment payments at any time.
The Employees’ Pension Scheme (EPS), one of the three schemes administered by EPFO that enables a subscriber to receive monthly pension payments. The pension contributions continue to be invested in the fund. While the PF account is managed separately for each individual, the pension contributions flow in a pooled pension fund. The risk is shared by the employers and the central government. Pension is guaranteed by the EPS. At present, it doesn’t have a provision of monthly pension payments for an NPS subscriber.
Three, life annuity. An annuity pays a benefit to the participant for life. A TSP account holder purchases an annuity from a TSP-empanelled insurance company. In NPS, a minimum of 40% of the corpus has to be compulsorily used to buy an annuity at retirement to secure a regular income during the period of retirement. There is no annuity in EPFO.
It doesn’t change the accumulated pension corpus, it merely redefines the ways the retiral benefits are used.
Among the three alternatives available to a TSP subscriber, the most popular is the lump-sum withdrawal at the time of retirement. Its downside risk, however, is that retirees often outlive their pension wealth.
An important factor affecting retirement benefits in the future for DC plans like TSP or NPS is the annuity conversion factor (the annuities which are effectively paid to a subscriber in retirement), which for OECD countries stands at 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 accounts for less than one-fifth of the total investment of the Indian insurance business. The reward to annuity providers appears to be disproportionate to the risks taken by them for a guaranteed income. The adequacy of benefits is also an issue in life annuity plans and particularly in a low-interest environment.
Unlike the TSP, the annuitisation for NPS retirees is mandatory. They must use a minimum of 40% of the corpus to buy a life annuity. The objective of the Pension Fund Regulatory and Development Authority (PFRDA) is to develop and regulate pension funds and protect the interest of its subscribers – not promote the insurance industry.
PFRDA has an efficient IT-based architecture for the collection of contributions, investments at low costs, electronic record-keeping of accounts, and in-service part-withdrawals. Unlike EPFO, NPS was started in the digital age and has a robust digital infrastructure. Individual accounting infrastructure for bringing flexibility in withdrawal options is in place, and the same could be leveraged for an innovative approach to serve the subscribers. In fact, PFRDA is uniquely placed to offer flexibility in withdrawal options as per the choice exercised by subscribers.
It’s time to change the NPS. PFRDA could emulate TSP by liberalising the withdrawal options and individual choice for retirees by providing alternatives and flexibility in the delivery of benefits. In particular, life annuity should 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 as larger pools of assets would be less expensive to manage on a per-unit basis as the economies of scale would lower administrative costs, increasing the retiral benefits.
PFRDA, the regulator, and the government will find it difficult to resist the idea for a much-improved retirement option that could act as a “crown” for its subscribers in tumultuous times such as the coronavirus pandemic.
Anuja Choudhary is a research associate at IMI New Delhi
The views expressed are personal