The Hindu Business Line : Pension reforms: Timely answer

IT long last, the attention of the Government has turned towards pensions. Old age security is an age-old problem. Not much attention has been devoted to this issue. Now, with pension reforms, savers have a chance to take charge of their financial planning, and can create a corpus to take care of old age through contributions from already taxed income.

Pensions, however, are a vexatious problem. Even with regular contributions, old age security is a difficult objective to achieve. Proper care needs to be taken to ensure that what goes into pension funds is adequate to take care of post-retirement needs.

Another issue is the presence of equity in pension fund portfolios. We need equities in pension fund portfolios, though they are a risky proposition. In this context, the appointment of a separate regulator is welcome.

SEBI and IRDA, the claimants, are already beleaguered with many issues. Entrusting the job to them may detract from the quality of regulation.

Old-age shortfall: Meeting many of our investment objectives solely through investments in debt has now become impossible. The return from debt investments is around 6 per cent. This means money will double only in 12 years. This is not enough to meet many of our investment objectives. That is true of old age security too.

If an employer offers guaranteed pensions, it may at most account for 40 per cent of an individual's pre-retirement income. When an employee himself has to create a corpus through contributions, pensions may be even lower if investments are made only in debt.

The numbers are quite scary. But there is no escaping them. Let us assume the following:

You have a monthly income of Rs 20,000

You invest 10 per cent of your salary in a pension fund

Your salary increases annually by 5 per cent

You have 20 years left to retire

If your investments fetch a return of 7 per cent annually, your pension fund will be worth Rs 15 lakh. That is a huge sum. However, the annual income from that Rs 15 lakh will only be 15 per cent of your last salary prior to retirement.

If you invest in equity and fetch a return of 15 per cent annually then your pension fund will be able to provide for up to 35 per cent of your pre-retirement salary.

If you want more, you will have to hope that either your salary grows at a rate higher than 5 per cent annually or your investments fetch a return of more than 15 per cent.

Both these are highly unlikely. A better alternative is to either to save more now or start saving well before you are 40. In any case, there are no easy answers.

More about equities: In a way, pension funds are more about equities than old age. Pension funds cannot do without equity. The presence of equity in their portfolios, however, requires strong regulation.

The framework for regulation needs to be similar to that for mutual funds. Elaborate disclosures, low-cost operations and ethical selling practices are a must. Regulation has to be transparent and stringent.

In addition, the exposure to equities of particular investors also need to be regulated.

A person in the 30-40 age group can invest in a fund with a 50 per cent exposure to equities. On the other hand, a person above 50 should hold as little equity as possible.

The extent of exposure to equities in a portfolio cannot be left to the preferences of the individual in a pension fund.

This has to be mandated. Investors may not know what is good for them.

And last, asset management companies need to be allowed to offer pension fund products if they fulfill specific conditions.

Specific fund managers should not be selected and appointed by the Government. That could lead to undesirable outcomes and may even undermine the confidence of investors in pension funds.

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