EPF is more a tax-avoidance than pension scheme, helps mostly the rich and fails its aim of creating old-age assets. As for EPS, it seems too good to be true
• What is EPFO?
EPFO is the Employees’ Provident Fund Organisation. It runs the ‘pension programmes’ which are mandatory for most firms with more than 20 employees. It has 40 million members (i.e. 4 per cent of India’s population).
• What is EPFO?
a) EPF is a personal savings scheme. Roughly 16 per cent of the person’s total cost is paid into his personal account. EPFO is a fund manager that invests this money, mostly in government bonds. People take out their money as and when they like.
b) In 2002-03, Rs 11,400 crore went into EPF, and the assets with EPF were Rs 1,03,000 crore.
•Are all contributions to provident fund managed by the EPFO?
No, there are approximately 3,000 establishments which manage their own funds. These ‘‘exempt funds’’ are mandated to equal or better the annual benefits announced by the EPFO.
•What is the controversy about the rate of return on EPF that the EPFO will declare?
EPFO does not use a modern accounting system, which can accurately calculate the value and the return of each account. So each year, a committee estimates what the return will be and this return is added into each account balance. For 2003-04, this return was 9.5 per cent. For 2004-05, their finance committee has recommended that the correct number is 8 per cent, but the board of trustees feels the correct number is higher.
•How can there be disagreement about a fact?
The accounting system is quite weak, so there can be disagreement about simple facts. And everybody operates on the working assumption that if there is any shortfall, the Government will put up the difference. Some people have the attitude of trying to force declaration of a high number, since somebody else, eventually the taxpayer, will have to bear the consequences.
•What would happen with a modern accounting system?
It would be like a mutual fund, where the value of the assets is computed and released daily, without bickering about how much is there.
•These days, government bonds pay 5.2 per cent. So how can anyone talk about 7 per cent or 8 per cent returns on government bond investments?
There are two parts to this story:
a) EPFO’s accounting system is weak. Bonds are not valued at the market price. EPFO calculates the ‘‘interest rate’’ as the annual interest flow from a bond divided by 100 (the face value of the bond). They have many old government bonds which were issued at high interest rates. So their investment performance—as they measure it—is truly higher than 5.2 per cent (which is what they earn on new money going into the scheme).
b) The second part of the story is a sum of Rs 50,000 crore, which is kept by the EPFO with the Ministry of Finance under a ‘‘special deposit scheme’’ (SDS). This scheme is a subsidy programme from the Ministry of Finance to the EPFO—GoI pays a higher interest on this compared with the rate at which it can borrow from the market. There is an effective subsidy of roughly Rs 1,000 crore per year on this money, going from the Ministry of Finance to EPFO. This subsidy helps prop up the interest earned by the EPF portfolio.
•Are there any other subsidies given by the Government to EPF?
The other subsidy lies in the tax treatment. Money that goes into EPF is tax exempt. So the government loses tax revenue on this. Roughly speaking, this is about Rs 3,000 crore per year.
Adding up the two—subsidised tax treatment and the excessive interest payment on SDS—the impact of the EPF on the Central Government’s budget is perhaps Rs 4,000 crore per year.
•If I have a small account balance, what is the subsidy that I get?
Roughly 85 per cent of the EPF accounts have less than Rs 30,000. Here, an interest subsidy of 1 per cent means a gift of Rs 300 to you from the Government.
•What subsidy do I get if I have a big account balance?
An interest subsidy of 1 per cent means a gift of Rs 10,000 to you if you have Rs 10 lakh in the balance. If a person has Rs 1 crore in his account, each 1 per cent means a gift of Rs 1 lakh.
•What is the current debate about an even higher subsidy?
The trade unions want EPF to ‘‘declare’’ 12 per cent returns (which EPF clearly did not earn). This will end up being an additional subsidy of Rs 2,000 crore to EPF. If this is done, then the total impact of EPF will go up from roughly Rs 4,000 crore to Rs 6,000 crore.
•Where does the bulk of the subsidy go?
The subsidy is proportional to the size of the EPF balance. The members with large balances garner the bulk of the subsidy. The system best suits wealthy people who do not want to take any risks. The richest 15 per cent of the accounts have 85 per cent of the assets. So 85 per cent of the subsidy is being given to the richest 15 per cent of the members.
•What is the rationale for this subsidy?
It is felt that if people build up assets for their old age pension, this is a good thing. It is felt that the payment of this subsidy encourages building up assets for old age.
•Does EPF succeed in building up assets for old age?
The EPF account balance of an average person who retired in 2002-03 works out to Rs 36,000. This would suffice to get a monthly pension of Rs 300 per month until death. This is viewed as being a failure in terms of the task of building up assets for old age.
•What is going wrong here!?The problem is withdrawals. As mentioned above, EPF participants have fairly liberal provisions to withdraw money. For this reason, EPF is not really a pension scheme, it is more of a personal saving scheme. It is highly tax advantaged, so people have an incentive to bring money into it, and people can take out money when they want to spend it. Assets are not being built up. In summary, EPF is a tax-avoidance scheme.
•Is the government Employees’ Provident Fund also managed by the EPFO?
No, that goes into a government Provident Fund. This is not really a fund.
•The provident fund seems messed up. Is the pension scheme any better?
Government employees have their own Civil Servants’ Pension Scheme. The money for this comes from government budgets. For the rest, there is EPS. EPS is the ‘Employee Pension Scheme’. It differs from EPF in that it is not a personal savings scheme. It is not easy to withdraw money from your EPS account. Upon retirement, EPS pays a good pension of roughly half the pre-retirement salary. The pension has generous provisions: after the participant dies, the spouse gains benefits also. This sounds like a good deal. But this could prove to be like US64: A deal that was too good to be true!
•Where does the money for the pension come from?
The worker pays 8.33 per cent of his wage every month. The Government pays 1.16 per cent of the worker’s wage every month (!). This adds up to an inflow of 9.5 per cent of the wage per month. EPFO invests this money and builds up assets on behalf of the worker.
•Does this money suffice for the generous pension provisions?
Nobody knows. There are some concerns about this question. In 1995, when EPS was invented, these rules were put into place. In 1995, it was believed that using 9.5 per cent of the wage every month, it was possible to afford such a generous pension. At that time, the interest rate on government bonds was roughly 12 per cent. Now, the interest rate on government bonds has dropped to 5 per cent. So even if EPS was in good health in 1995, it cannot be healthy today.
•So what is the subsidy going into EPS?
One part of the subsidy is clearly visible: This is the 1.16 per cent of the worker’s salary being paid by the Government into his EPS account. When an agricultural worker, a self-employed person or a worker in a small firm opens a bank account, the Government does not pay 1.16 per cent of his income every month into his bank account! It is a subsidy only for people working in firms with above 20 employees in certain industries.
The second part of the subsidy going into EPS is the ‘UTI effect’. If, in the future, there is any gap, the Government might have to bear the burden. In the case of US-64, the allocation of pain was roughly 50-50 per cent—the Government bore half the cost, and customers of UTI bore half the cost.
•Is there a process to check that EPS has enough money to meet future liabilities?
The law mandates that an annual valuation report should be done. From 1995 to 2004, nine reports should have been produced and released to the public. This newspaper has not been able to obtain nine reports. Recent reports have not been released either to Parliament or to the press.
•What is the best way to provide old age security without these kinds of problems?
We need a system of pension fund managers with a clear regulator such as the Pension Fund Regulatory and Development Authority (PFRDA). The existing subsidies need to be ended.
EPS might turn out to be a bigger problem than even UTI. There is an urgent need for better measurement of the liability by experts.