Private sector employees, especially taxpayers, may not be thrilled at the rollout of the Unified Pension Scheme for government employees. But they can take away one useful lesson from it. It is that, if they aspire to a comfortable retirement, they shouldn’t be relying so much on the Employees Provident Fund (EPF).
UPS’ design shows that, to fund an inflation-adjusted pension at just 50 per cent of an employee’s salary, contributions at 28.5 per cent of her pay are necessary for 25 plus years of her working life. (The employee contribution in UPS will be at 10 per cent and government contribution at 18.5 per cent.) UPS contributions are to be invested in the NPS (National Pension System) with a default 15 per cent equity allocation.
UPS’s structure begs the question: If government calculations show that the market-driven NPS is the best way for government employees to fund their retirement, why should private sector employees be forcibly saddled with the opaque EPF?
Equity, a must-have
Recent research shows that thanks to inflation and longevity, Indians looking to fund their retirement have a Herculean task ahead of them. To be comfortably off, they will need a corpus equal to 33 times their annual expenses at 60 when they retire. (More details here
Therefore, a 35-year-old expecting monthly expenses of ₹1 lakh when he turns 60, will need to accumulate ₹3.96 crore. If he invests in a fund returning 8.5 per cent per annum, the subscriber (with his employer) will need to contribute ₹38,100 per month over the next 25 years to get to that goal. But with a 12 per cent return, the contribution will drop to ₹20,900 per month. While the EPF has declared returns of 8.15 to 8.75 per cent in the last 10 years, NPS equity managers have delivered 12-13 per cent.
This demonstrates the absolute need for employees in India to rely on equity-oriented vehicles rather than debt-oriented ones for their retirement savings.
Returns apart, the EPF suffers from many other shortcomings too as a retirement vehicle.
Employer-dependent
A primary flaw in EPF design is that it forces the employee to route her retirement savings through her employer. The employer organisation is tasked with depositing these contributions with the EPFO or managing them.
The problem with this arrangement is that, when an employer organisation lands in governance or debt trouble, it is tempted to make away with employees’ PF contributions. From Kingfisher to Byjus, there are literally hundreds of large organisations which have run into financial hot waters and left employees in the lurch not only on their pay, but also on their PF savings. EPFO’s FY23 annual report (its latest) discloses ₹13,953 crore in dues from defaulting employers.
Employer dependency is also a key reason why the EPF has an alarming number of accounts that are dormant or inactive. Organisations often make clerical errors in recording KYC details, or fail to complete transfer formalities correctly when employees switch jobs. This forces the employee to abandon his retirement savings so far, and start all over again from scratch.
Though the introduction of the Universal Account Number (UAN) and an online interface have made transfers, withdrawals and grievance redressal easier for new EPF members, monies from many legacy members remain stuck due to KYC or migration issues. Of the EPF’s 29.88 crore subscribers as of March 31, 2023, only 19.10 crore had been allotted UANs and only 6.85 crore were actively contributing to the fund. KYC issues have also led to EPF seeing a high claims rejection rate in recent years. About 24 lakh of the 73 lakh final settlement claims were rejected in FY23.
The NPS (even in its corporate version) gives the employee control over her retirement account and allows her to manage her own contributions and withdrawals, without having to route this through the employer.
Archaic accounting
When you invest in vehicles such as mutual funds or NPS, your contributions are held in a separate unit account that is directly traceable to you. Your investments are processed at the prevailing NAV to fetch you the correct number of units. On maturity, you get to withdraw the unit balance in your account at prevailing NAV.
This unit accounting system ensures there are no leakages between returns earned on the portfolio of the fund and those earned by unitholders and that these returns are fairly distributed. It also ensures that each investor gets the return due to her, based on the timing of entry into and exit from the fund.
The EPFO however is yet to transition to the unit accounting system despite this being talked about for years. It follows an archaic pool accounting method where contributions of all members are co-mingled and claims are paid as and when they crop up. EPF contributions are invested in a mix of government securities, bonds and equities (capped at 15 per cent).
Every year, the expenses of running the fund are deducted from its income which consists of dividends, interest, capital gains and administrative charges levied. The difference is used to ‘declare’ an annual ‘interest’. Individual subscribers to the EPF therefore have no way to estimate or control their returns.
In the absence of any mark-to-market portfolio disclosures, profit and loss account or a balance sheet, it is also difficult to gauge if the fund will comfortably meet future maturity claims.
Compliance costs
The EPF is not a shining advertisement for ease of doing business either. The EPF came into existence because Employees Provident Fund and Miscellaneous Provisions Act of 1952 requires all establishments with 20 or more employees to enrol with the EPFO and make contributions on their behalf to the fund.
This mandate prompts many micro and small enterprises to restrict their employee roster to below 20. Larger firms avoid taking on full-time employees and hire contract staff to side-step the EPF obligation. This acts as an impediment to formalisation. Firms that don’t avoid the enrolment obligation structure their employees’ pay so that the basic pay component, on which EPF contributions are mandatory, are kept minimal.
GenZ employees, many of whom are on the new tax regime, aren’t too fond of EPF either. Prone to short stints with employers and frequent career breaks, they would rather not route their retirement savings through their employers, or cough up 12 per cent of their pay to a black box until they turn 58. Left to themselves, many of them may prefer open-end equity funds over strait-jacketed vehicles such as the EPF.
Yes, on paper, EPF enrolment is currently voluntary for employees earning over ₹15,000 per month in basic pay. But in practise, most employers insist on EPF contributions because the EPF Act requires them to compulsorily enrol with the EPFO.
All this suggests that it is about time the government amended the EPF Act to make EPF optional for both employers and employees. Private enterprises should be permitted to offer NPS as an alternative or replacement to the EPF.