Employee Pension Scheme

The EPS is a savings scheme that is part of the larger EPF in India. The EPS is designed to help employees save money for their retirement with the ultimate goal of providing them with a pension once they retire.The recent EPS rules have left a lot of people confused as to whether or not to opt for higher pension. In this article, DSIJ untangles the confusion revolving around opting for a higher pension.

Retirement is a time in life when you can relax, pursue your passions, and spend time with loved ones without the pressure of work. But to ensure that you have a comfortable and financially secure retirement, it’s important to plan ahead. The Employee Pension Scheme (EPS) is a way for people to save money for when they retire from working. It’s like putting money in a piggy bank every month so you can use it later when you are not working anymore. The EPS is part of a larger savings scheme called the Employee Provident Fund (EPF). This is like a bank account where people put money aside for their retirement. Both the EPS and the EPF help people save money for when they are older and don’t work anymore.[EasyDNNnews:PaidContentStart]

When people retire, the EPS will give them money every month – like an allowance – so they can pay for things they need like food and housing. The EPF will give them a big chunk of money when they retire, so they can use it for things like travelling or buying things they want. By saving money in the EPS and the EPF, people can have a better retirement phase where they can do the things they love and not have to worry about running out of money. However, recently we have seen some changes in these schemes. Previously, the pension that EPS subscribers got upon retirement was insufficient. 

An individual who contributed the maximum of ₹1,250 to the EPS every month for 30 years would receive a monthly pension of ₹6,857. Today, the Supreme Court decision has transformed the EPS pension from a supplemental benefit to perhaps the primary source of retirement income. The Supreme Court has lifted the ceiling on EPS contributions, allowing subscribers to choose a greater pension equal to 50 per cent of their basic salary. From May 3, 2023, the Employees’ Provident Fund Organisation (EPFO) has extended the deadline for applying for a higher pension from EPS to June 26, 2023. We looked at three subscribers at different phases of life in the following article to understand the implications of choosing a larger pension.

The graph above clearly shows that the interest rate in EPF has been declining since the year 2000. Still, it offers better interest rates than most of the other government schemes. The chance to receive a secured pension equivalent to 50 per cent of your base salary for the rest of your life looks quite alluring at first glance. Someone with a monthly salary of ₹1 lakh will receive ₹50,000 for the rest of their lives. It is easily able of being the primary source of income in retirement. Of course, this improved pension will come at a cost.

If a subscriber desires a higher pension, the EPS contribution must be 9.14 per cent of the base salary. Until recently, there was a cap on EPS contributions. Up until November 2001, members were able to contribute as low as ₹5,000 a year (₹416 per month) in contributions. This was increased to ₹6,500 per year and is now at ₹15,000 per year (₹1,250 per month). To get a higher pension, a person must raise his contribution to the EPS as well as deposit the shortfall payments and interest collected since joining the EPS.

The EPS Calculation

In this section, we would be understanding how currently the EPS is calculated and how you can calculate it as per new rules.

₹689,210 crore was the corpus of the EPS as on March 31, 2022. The scheme receives inflows of roughly ₹4,200 crore every month.
 

From the Lens of Different Life Stages Nearing Retirement

Let’s assume that you are nearing retirement and your present age is 56 years.

If an individual joins EPS at the age of 28 in 1995 when his basic pay was ₹10,000 per month, he must deposit ₹20.5 lakhs in the EPS if he wants a bigger pension. His monthly payment to the EPS will also be more than fivefold, from ₹1,250 to ₹8,200, implying that the inflow into the EPF would be significantly reduced. The calculations assume that salary increases by 8.5 per cent every year. The interest shortfall was computed using the Provident Fund’s historical interest rates. Choosing a larger pension appears to be an appealing option for individuals nearing retirement.

Mid-Career

Let’s assume that you are in your mid-career and your present age is 46 years.

If a person joins EPS at the age of 28 in 2005, when his basic pay was ₹20,000 per month, he must deposit ₹12.15 lakhs in the EPS if he wants a higher pension. The monthly payment to EPS will rise from ₹1,250 to almost ₹7,200. The calculations assume that salary increases by 8.5 per cent every year. The interest shortfall was computed using the Provident Fund’s historical interest rates. Choosing a larger pension appears appealing for people in their mid-career.

Millennials

Let’s assume that you are just starting your career.

If an individual joins EPS at 28 in 2020 with a monthly basic pay of ₹50,000, he has to put ₹1.75 lakhs in the EPS if he wants a greater pension. The monthly payment to EPS will rise from ₹1,250 to almost ₹6,400. The calculations imply that salary increases by 8.5 per cent every year. The interest shortfall was computed using the Provident Fund’s historical interest rates. Long-term sustainability is a big problem for those millennials who want larger pensions. Although the anticipated monthly pension appears appealing, even a 6 per cent annual inflation rate will diminish its worth to ₹51,400 per month after 27 years.

Points to Note

Subscribers should keep a few factors in mind before selecting the alternative. First, the EPS pension will be tied to the average pay over the previous 60 months rather than the last taken income. In most circumstances, this would be significantly less than the previous drawn salary. Second, there are doubts regarding the EPS’ viability. Various actuarial evaluations have already anticipated substantial losses in the system. The deficit was anticipated to reach ₹37,327 crore as of March 31, 2019. However, the annual report of the EPFO for 2021-22 states, “With the increase in the number of pensioners, the amount disbursed as pension has also shown a steady increase over the years. However, the fund has not witnessed any cash flow problems till now, in spite of there being a projected actuarial deficit in the valuation of the fund.”

The EPFO appointed actuaries in November 2022 to conduct pension scheme evaluations. Although the assessment has not yet been released, it is reasonable to believe that the higher pension option may jeopardise the scheme’s long-term viability. India’s shifting demographics exacerbate the situation. The EPS currently has more contributions than pensioners. However, as the country’s population ages and more contributors become retirees (many of whom receive a higher pension), the plan may face additional issues in the years ahead. Contributions to the system are already declining as a result of this. Contributions for 2020-21 were down to ₹50,562 crore from ₹51,953 crore the previous year, according to annual records.
 

The Right Choice?

In India, retirement planning is the most overlooked financial objective. Individuals would benefit from the option of receiving an increased pension since it would provide them with a guaranteed income in retirement. It will be especially beneficial to individuals who may not have saved enough for retirement. The lump sum payment transferred from the Provident Fund to the EPS will be returned within a few years. The return is significantly higher than that of a traditional annuity. However, we feel that people who are just starting out in their careers or in their thirties should avoid higher pension and instead invest them in a mutual fund portfolio. 
 

₹37,327 crore was the deficit projected in the EPS as on March 31, 2019. In November 2022, EPFO appointed actuaries for valuation of the scheme.
 

" If you invest in a very low-cost index fund - where you don't put the money in at one time, but average in over 10 years - you will do better than 90% of the people who started investing at the same time " 

-Warren Buffett

Because you have a lot of time before retirement, investing in a mutual fund portfolio will help you establish a significant retirement corpus. For example, if a 25-year-old with a base salary of ₹50,000 chooses a higher pension, he must deposit ₹4,165 into the EPS each month. Assuming his salary rises by 8.5 per cent per year he would invest about ₹81 lakhs in the EPS over the following 33 years and receive a monthly pension of ₹3.4 lakhs. However, if we assume he invests in a mutual fund portfolio with a 10 per cent compounded annual growth rate (CAGR), his retirement corpus would be around ₹2.96 crore in 33 years. 
 

However, this 10 per cent return is not guaranteed whereas the EPS pension is guaranteed by the government. Another significant distinction is that the EPS provides pension even if the member dies prematurely. If a member dies while serving, his widow will get his pension for the rest of her life or until she remarries. Two children will each get an additional sum of money equivalent to 25 per cent of the pension. If there is no widow, the deceased’s two children will get 75 per cent of the pension until they reach the age of 25. If there are more than two children, the benefit will be extended until the youngest is above the age of 25.
 

72.73 lakh pensioners were drawing pension from EPS as on March 31, 2022 of which 66 per cent were members while 33 per cent were spouse and children. 

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