Personal Finance
The one mandatory pension saving instrument, the Employee Provident Fund (EPF), has undergone several changes recently. From increasing the equity investment, to allowing employees to withdraw the entire corpus in case of a job loss and a proposal to lower the contribution to the EPF by both employer and employee. These changes offer flexibility for subscribers with regard to withdrawal and a potential for the fund to earn higher returns. But it could also mean higher variation in the fund performance. We take a detailed look at these changes and how they will impact you.
Updated : Aug 09, 2018, 06:40 AM IST
The one mandatory pension saving instrument, the Employee Provident Fund (EPF), has undergone several changes recently. From increasing the equity investment, to allowing employees to withdraw the entire corpus in case of a job loss and a proposal to lower the contribution to the EPF by both employer and employee. These changes offer flexibility for subscribers with regard to withdrawal and a potential for the fund to earn higher returns. But it could also mean higher variation in the fund performance. We take a detailed look at these changes and how they will impact you.
EPF is a product designated for creating a corpus for retirement. It is in place from year 1956. But it caters to the organised sector only. The un-organised sector is much bigger than organised sector and are largely not sensitised about retirement planning. The EPF enjoys generous tax breaks, a safe haven status, as well as, is bounded by regulations, but the real reason it exists - that it is a retirement product is a secondary knowledge.
Think there is a greater need of emphasising the requirement of retirement planning, which will require realistic retirement goal setting. It is far more important for the EPFO to focus more on defining the actual need for retirement kitty, rather than focusing on populistic measure of lower contribution.
The Board of Trustees of Employees Provident Fund Scheme invests EPF money as directed by the Central Government. Currently the Central Government permits a maximum 15% of contribution to be invested in Equity. The Trustees have been investing the money through Index ETF.
The Central Government is considering a plan to increase the 15% ceiling limit (set in 2015). However, though the limit may increase, it is for the Trustees who will decide whether they would actually use this limit or not.
So far the overall investment was routed through nifty / sensex based Exchange Traded Funds only.
If fresh allocation also starts chasing the same set of stocks through NIFTY/Sensex based ETFs, we see the valuation of few stocks in the market will increase. Again, these are blue-chip stocks which are considered to be safe haven. However, if incremental money keeps on chasing these stocks, the valuation may turn out to be unsustainable. So the investment should be routed to other indices.
Investing in equities is riskier than investing in sovereign debt. The risk is mitigated to an extent only with diversification, research and tenure of investment. The combination of these three issues can offer superior risk adjusted return.
The EPFO return was always varying. The Trustees used to declare return based on investment performance at the completion of each year. However, with incremental investment in equity, the gyration will be more in future.
The Central Board of Trustees approved a policy to credit units linked directly to exchange-traded funds into members accounts. The invested corpus may thus get bifurcated into debt and equity portion. The equity portion may be reported based on NAV. But this is not a ground reality.
As of now the subscriber can't dictate where his fund should go. It is upto the Trustee's to decide based on Government guidelines. The model is more of a 'one size fit all' model.
As per law, the exempted trust should follow the same investment pattern as dictated by the government. However, the investment may not be only restricted to ETFs when they are investing in equities.
PF will now be regarded as a Sabbatical Fund than a Retirement Fund. The more successful retirement funding models like the US 401K is successful because they made it optional for subscribers, but the design and incentive is such that once there is a buy-in, the subscriber is bound for life.
We need to appreciate that in India, we do not have a Social Security model and people will be at large when the income stops.
While EPF will thrive on the prescribed regulation and mandated, NPS is more attuned to shape as a real retirement product with unique features like long term lock-in of funds and annuities after retirement. NPS is far more transparent, operationally efficient and run by professional fund managers unlike EPFO. The real challenge in NPS is the limited distribution model incentives and lack of sentisation.
Unlike EPFO, NPS also servers the self employed, unorganised sector employees to build a reasonable retirement kitty.
The pension plans of Mutual Fund is just another variant of normal investment and can't be compared to NPS (with annuities) or EPFO (mandatory savings).
The writer is partner and consultant, at Positive Vibes Consulting & Advisory