You May Be Allowed To Opt For Higher Pension, But Is It Worth It?
Pension contributed by an employer may increase substantially after the Supreme Court rejected Employee Provident Fund Organisation’s special leave petition to cap the amount.
BloombergQuint spoke to tax experts to find out the implications of the order. Here’s all you need to know after the Supreme Court verdict:
What’s Employees’ Pension Scheme?
The Employees’ Pension Scheme is managed by the EPFO, which is also in charge of the Employees’ Provident Fund. The contribution is mandatory, and it’s different from the National Pension Scheme that is voluntary.
Every employee contributes 12 percent of basic salary and dearness allowance to the provident fund—the saving is tax-free. The employer contributes an equal amount, but all of it doesn’t go into the provident fund.
The rules stipulate that the employer will contribute 8.33 percent to the pension fund, and the remaining 3.67 percent to the provident fund. But there’s a cap on how much can go into pension.
That’s what changes after the top court’s order.
If you received your first salary in September 2014 or after, and if your basic salary plus dearness allowance was more than Rs 15,000, you will not be a part of the pension scheme.
But if you were earning less and your salary subsequently crossed the threshold, you will be eligible for the scheme.
How Much Does Your Employer Contribute To Pension Fund?
Between July 2001 and September 2014, basic salary and dearness allowance was capped at Rs 6,500 for the purpose of determining an employer’s contribution to pension. Even if an employee’s salary was higher, only 8.33 percent of Rs 6,500, or Rs 541 a month, went to pension.
That limit increased in September 2014 to Rs 15,000. The employer’s contribution rose to a maximum of Rs 1,250 a month (8.33 percent of Rs 15,000). The rest was diverted to the provident fund.
How Can You Get A Higher Pension?
The Supreme Court order opens the doors for employees to opt for a higher contribution to the pension fund every month and get more pension at retirement.
To be sure, the EPFO is yet to clarify the procedure for it. Assuming that it’s made possible, an employee would be able to notify the EPFO that she would want to increase the amount that goes into EPFO pension.
So, the employer would contribute 8.33 percent of the actual basic salary and dearness allowance to the pension fund every month—even if it adds up to more than Rs 15,000 a year.
But there’s a bigger implication of choosing higher contribution to pension—it’s retrospective. What that means is the amount the employer moved to the provident fund from the share allocated to pension after exhausting the limits will have to be transferred back to the pension fund for previous years as well, including the interest earned.
Complicated? This illustration should help.
How Is Pension Calculated?
The amount you get as pension depends on your pensionable salary and the number of years of service. An individual must have worked for at least 10 years to receive a pension at retirement—EPFO has set the age of superannuation at 58 years.
After the Supreme Court’s order, pension will be the average of your basic pay and dearness allowance received in the last 12 months of service. Also, according to the EPFO rules, an individual who has worked for over 20 years and is retiring at 58 can add two more years to service for calculating pension.
Prior to the Supreme Court’s order, salary in the last 12 months of service was capped at Rs 15,000. Assuming that an employee worked for 33 years, the maximum pension she could receive would be Rs 7,500 a month.
If the person opts for higher contribution to the pension fund, that amount would increase dramatically. For example, if the individual’s monthly basic pay and dearness allowance in the last year of service is Rs 1 lakh, pension would be set at Rs 50,000 a month.
Should You Opt For This?
To be sure, a clarification from the EPFO is awaited. In fact, there is a possibility that the EPFO will approach the Supreme Court with a review petition. Experts also have doubts if the higher payouts that the Supreme Court order could entail would make the pension scheme unviable.
Let’s assume, however, that employees are given the option to increase contribution to the pension fund.
According to Saraswathi Kasturirangan, partner at Deloitte India, it can’t be a one-size-fits-all solution. It depends on whether you’d like to receive money at retirement as a lump sum, or in the form of a monthly pension, he said.
“I think it makes sense for people who have very good clarity about how much pension they would get. For example, someone who is very close to retirement, or who has already retired. Even retired individuals can make the switch. Pension is a little uncertain to calculate because it’s hard to predict one’s lifespan,” said Kasturirangan.
Pension is paid as long as a retired employee is alive. After he or she dies, the nominee gets 50 percent of the monthly pension. But an individual receives a lump sum from the provident fund. Even nominees would receive the entire amount in the event of their death.
Amol Joshi, founder of PlanRupee Investment, said provident fund is a good idea for someone who knows how to deal with money, taxation and asset allocation, or has access to a trusted advisor. For others, he said, higher pension makes more sense.
But Arvind Rao, founder of Arvind Rao & Associates, considers provident fund as the better option, pointing out that annuity payments attract income tax. “Instead, the lump-sum payout from the provident fund can be structured by individuals to earn better returns over a longer period, and they can also structure monthly payouts in a tax-efficient manner,” he said,
Agrees Kartik Jhaveri, director at Transcend Consulting. “I would definitely recommend everyone to go with the provident fund option. That way, you get interest accumulation, you get tax-free money, and you can use the money the way you like. You have all your options open.”