Moving towards a pensioned society
13 June 2016
The furor created by the Employees’ Provident Fund (EPF) taxation proposal has brought to the fore the core issue of what we are doing as a nation to address the looming problem of a large elderly population. Although there is a lot of enthusiasm around our young demographic, there also needs to be acknowledgment of the fact that with over 110 million people above the age of 60, we are home to the second-largest elderly population in the world.
The average life expectancy in India has increased by 3.5 years every decade over the past three decades. And this number is likely to go up to 300 million elderly by the year 2050, and the percentage of elderly population will increase to 15% from 8% today. There are financial issues related to the rising elderly population that will need to addressed, and soon. Further, social attitudes of life after retirement are changing leading to increasing financial outlays. A manifestation of this is the quality of medical care being sought.
A big concern is the fact that there is relatively low coverage of formal retirement solutions. While central government employees have reasonably good coverage in terms of pension schemes, private sector employees’ coverage is estimated at as low as 8%, and the coverage is non-existent in the informal sector.
It, therefore, becomes absolutely essential that the Indian population begins planning well in advance for their retirement needs to ensure a comfortable and stress-free future.
Typically retirement solutions have two parts; an accumulation phase where one regularly saves using an investment avenue to create a corpus, and the other, a de-accumulation phase where the corpus is converted into regular income for after retirement.
In the accumulation phase, one looks at investment options for regular savings over the long term (up to the expected retirement age), while balancing growth and safety considerations. The National Pension System (NPS), pension products provided by insurance companies, EPF, and the Public Provident Fund (PPF) are all accumulation products catering to retirement needs. Other wealth accumulation solutions like systematic investment plans of mutual funds, unit-linked insurance plans, bank recurring deposits can also be considered in the accumulation phase. Most of these products also offer good tax incentives.
However, when it comes to the de-accumulation phase, there are limited choices, and this is one of the key reasons for low penetration of retirement solutions. A good de-accumulation product for a retiree ideally should cover the following:
1. Regular pay-outs for life, not only for a defined period
2. Income for dependent survivors (if applicable)
3. Protection against inflation.
Annuity caters to the key dilemmas of a pensioner; it provides life-long pension at a steady, guaranteed rate. Annuity is the only solution that provides complete protection from the perspective of living longer (i.e., outliving one’s corpus) by providing a regular flow of income throughout one’s lifetime, purchased in lieu of a single lump sum amount. In its simplistic avatar, an annuity plan provides a lifetime guaranteed pay-out, irrespective of how long one survives, and will not decrease even if the interest rate falls. So, not only does it lock-in at the current interest rate, it also eliminates the risk of exhausting the retirement corpus while one is still alive.
There are many other annuity options that are designed to meet needs of different customers; one of the most popular options being the annuity with return of purchase price. As the name suggests, it provides a guaranteed pay-out during one’s lifetime and returns the premium on death—intended for those who want to leave a legacy behind, while ensuring a lifelong income. Joint-life is another option which is in demand, and provides a guarantee that the pay-out would continue as long as either of the spouses is alive, hence giving a sense of surety that one’s spouse would get a steady stream of income throughout his or her lifetime, even after one’s death.
Other annuity options include increasing pay-outs at a pre-determined rate, usually 3% or 5% annually, providing some level of protection from inflation, as well as pay-outs for certain guaranteed periods, irrespective of whether the annuitant is alive or not.
However, annuity does come with its own share of challenges. There is insufficient visibility of the product for the last mile customer coupled with the fact that annuities are taxed at the prevailing tax rate, thereby reducing the attractiveness of pay-outs.
There are challenges for the annuity providers (i.e., insurers) having access to suitable long-duration assets to match the long-tailed liability, thereby limiting the ability to guarantee attractive returns. Managing longevity risk is also a key challenge.
Hence, the government should come out with long-dated bonds for institutional investors (primarily annuity providers), which has the added benefit of helping infrastructure projects by raising enough funds. It will be imperative that the government focuses on building awareness around the de-accumulation phase, and rationalising the tax proposition vis-a-vis other instruments, including targeted tax relief on annuities.
These are larger structural concerns that needs to be addressed, but that does not detract from the need of having a well-thought out and planned retirement solution for Indian citizens.
Original article published on mint.
Interview of Deepak Mittal. Published on Mint | Date: 13-June-2016