EPFO update: Key factors to keep in mind before switching to higher pension option under EPS
The Supreme Court recently directed EPFO to give pension to all retiring employees on the basis of their full salary. But while this means that private sector employees will see their pension shoot up, there are several factors that determine whether the new option is really an advantage or not.
Private sector employees will see their pension shoot up under Employees Pension Scheme (EPS), 1995, thanks to a recent Supreme Court ruling directing the Employees Provident Fund Organisation (EPFO) to give pension to all retiring employees on the basis of their full salary.
The impact on your EPF balance
But while this is great news in terms of building a nest egg, EPF subscribers will have to forego a significant chunk of their provident fund balance if they choose to opt for higher pension.
Here's the math to help you understand:
All employees in the organised sector currently contribute 12% of their salary (basic salary+dearness allowance) to the EPF. The employer makes a matching contribution, of which 8.33% - or Rs 1,250, whichever was higher - goes to the EPS. Till now an arbitrary cap of Rs 15,000 was put on pensionable salary but post the top court's ruling, the entire 8.33% of your monthly salary will go into the EPS, should you opt for higher pension.
Let's assume a 58-year old who is about to retire after 35 years on the job. If his salary is currently Rs 90,000 at a 7% annual salary increment, the additional contribution for the last 35 years will be to the tune of Rs 10.35 lakh, plus interest, if he wants to avail of higher pension. According to the daily, including the interest component, the additional contribution comes close to Rs 45.15 lakh. The employee will have to shift this amount from his EPF corpus to the EPS to be eligible for full pension, which now works out to Rs 45,000 per month instead of just Rs 7,500 previously (when the Rs 15,000 cap was in place).
In the same example above, while the employee was getting Rs 9,550 in his EPF account in the old regime (after deducting the employer's EPS contribution of Rs 1,250), now only Rs 3300 goes into EPF since the pension contribution has swelled to Rs 7,500. Significantly, the top court ruled that recently retired people can also opt for the higher pension option. To avail of the new rule, you have to submit an application to the EFPO via your employer requesting the body to deduct a sum equal to 8.33% of your salary (basic+DA) towards the EPS together with the accrued interest there upon till date retrospectively and shift the pending dues from your PF corpus to the EPS.
Comparison with annuity plans post retirement
The big question is whether you should opt for higher pension right now, or would it be better to continue accumulating your EPF corpus and investing it lumpsum at the time of your retirement?
"Due to the increase in life expectancy, we all need some regular monthly income. So, it will be better if people opt for higher EPS contributions," Amol Joshi, Founder, Plan Rupee Investment Services told the daily.
Besides, investing your EPF, say, in an annuity from an insurance company, may fetch a lower monthly income than the additional pension amount coming from EPS under the new regime. For instance, if you put Rs 45.15 lakh in LIC Jeevan Akshay, you would get a monthly annuity of Rs 32,054 but if you opt for higher pension you will get Rs 37,500.
Salary bracket matters
However, given that pension under EPS is fully taxable, experts say that opting for a higher pension may not be a cost advantage for people in the higher tax bracket. For such people, debt funds and systematic withdrawal plans could prove a more tax-efficient option. Also, while switching to the higher pension option works for people in the lower income brackets, they are advised to exhaust other high yielding safe instruments such as the Senior Citizens' Savings Scheme before putting additional money into EPS.
The biggest beneficiaries of the Supreme Court ruling will be people whose salaries were low for most part of their careers but have grown sharply in the past few years.
Sustainability of the EPS corpus
There's one other factor you need to keep in mind: The EPS corpus, while huge currently, is certainly not completely risk-free. Total inflows into the pension fund in 2015-16 reportedly stood at Rs 32,307 crore, and after pay-outs it was left with a net surplus of Rs 17,762 crore. Then there is the interest income of Rs 21,662 crore in the same fiscal, which continues to grow.
But as India ages and the number of pensioners multiply, the EPS corpus may not be able to meet liabilities in the future. Actuarial studies reveal that while the projected deficit has come down from Rs 10,855 crore in 2011-12 to Rs 5,027 crore in 2014-15, the latest Supreme Court ruling may compound the shortfall in the EPS.
"Current EPS corpus is not sufficient for pension payouts at the current levels in the coming years. So the long-term viability of increased pensions under existing circumstances is suspect," B.P Pant, a former EPFO member, told the daily. That's worrying news indeed for those dreaming of a golden retirement.