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Worried about retirement planning? Subscribe to your employer provided retirement benefits

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With a host of long-term retirement products available across asset classes, employees in current times are spoilt for choice. However, benefits of employer sponsored Retirement plans like Provident Fund (PF) and National Pension System (NPS) are often overlooked by employees.

Worried about retirement planning? Subscribe to your employer provided retirement benefits
With a host of long-term retirement products available across asset classes, employees in current times are spoilt for choice. However, benefits of employer sponsored Retirement plans like Provident Fund (PF) and National Pension System (NPS) are often overlooked by employees.
Both Provident Fund (PF) and National Pension scheme (NPS) are contributory schemes and easier to understand.
Under the statutory Provident Fund scheme both Employer and Employee Contribute 12 percent of Basic Pay and allowances. While the PF plan becomes voluntary if the applicable pay is above Rs 15,000 per month, Aon Benefits surveys indicate that more than 75 percent of organisations contribute PF on the full Basic Pay and not cap the same at the statutory wage.
The contributions are invested and credited with interest every year by the government body – EPFO. On retirement, the employee gets the accumulations as a lump sum.
The NPS scheme is managed by the regulatory body – PFRDA.
The employer may contribute up to a tax-deductible limit of 10 percent of Basic Pay towards an employee’s NPS account. Aon surveys indicate that more than 50 percent of large organisations have already set up NPS as a flexible benefit option within the Compensation Structure.
The contributions are invested across asset classes and the returns are market linked without any guarantees. On retirement, the employee can receive back up to 60 percent of the accumulated corpus as lump sum and the balance gets converted into a pension. Unlike Provident Fund, employee may choose the fund manager and asset allocation as per their risk appetite.
Tax Benefits
The Government has ensured that sufficient tax benefits are available to make both the schemes attractive, as set out below:
Tax BenefitsProvident FundNational Pension System (NPS)
Employer Contributions12% of Basic Pay tax free10% of Basic Pay tax free
Employee Contribution12% of Basic Pay tax deductible upto Rs 150,000 p.a. as part of 80C limitINR 50,000 p.a. tax deductible under section 80 CCD (1B)
Interest Accruals p.a.Tax freeTax free
Withdrawal at retirement100% Lump Sum Tax free60% of Lump Sum Tax free butPensions on balance 40% taxable
However recent tax amendments have placed a cap on the total employer contributions for all retirement plans like PF and NPS at INR 7.5 lakhs per annum above which the contributions and interest accrual would be taxable in the hands of the employee.
Similarly, interest earnings on voluntary employee contributions to Provident Fund above Rs 2.50 lakh per annum will attract tax. These measures have been introduced to ensure parity in tax saving between all categories of employees and ensure senior executives with large salary savings do not contribute excessive amounts on an unlimited basis to save taxes
Diversification Strategy
NPS offers a great diversification option for those fully who have risk appetite to invest in equities. NPS offers employees choice to invest up to 75 percent of contributions into equities whereas this is limited at 5 percent to 15 percent only under Provident Fund. Therefore, a recommended diversification strategy for an employee would be to invest a greater share of NPS contributions into equities and corporate bonds whereas Provident Funds continue to be invested in safer assets like government and state bonds.
Returns
Provident Fund is invested by the government body – EPFO primarily into bonds and has provided an average interest return of 8.50 percent to 8.75 percent over the last few years. This is commendable as this has been achieved even during low interest rate cycles like the one we are currently experiencing.
The returns from NPS on the other hand would differ from individual to individual depending on the asset allocation and fund manager performance, however if we assume an employee had invested equally across equities, government bonds and corporate bonds under the NPS Tier 1 plan, the returns achieved over a longer timeframe even outperforms the Provident Fund returns by a comfortable margin.
Returns HistoryAverage Provident Fund interest creditsNPS Tier 1 scheme average of returns achieved by fund managers assuming equal investment into all asset classes
3 Year average return8.55% p.a.11.56% p.a.
5 Year average return8.57% p.a.10.37% p.a.
10-year average return8.59% p.a.11.22% p.a.
The returns under NPS would be even higher for some fund managers with heavier equity investments since inception.
The above returns from both plans are tax-free and outperform other popular products such as Public Provident Fund, National Saving Schemes and Fixed Deposits.
Projections
High level calculations suggest that if an employee starts early and contributes towards both Provident Fund and NPS throughout their active service life, under certain assumptions, he/she would be able to replace a large part of their last drawn salary at retirement by the pension income received from the accumulations of both the plans.
For example, a fresh graduate who enters employment at age 23 and contributes to both PF and NPS plans at 24 percent and 10 percent of full Basic Pay monthly throughout his active service without withdrawals, could get a pension income at retirement which could be as high as 40 percent of last drawn salary. This projection assumes salary grows at an average of 7 percent p.a. and PF and NPS contributions earn 7 percent and 8 percent returns per annum through the service duration of 37 years.
This indicates the power of compounding therefore employees should be discouraged to make in-service withdrawals from their Retirement plans.
Conclusion
While there are several long-term financial products available in the market which may cause confusion, employees could choose a simpler strategy of maximizing their investments into employer sponsored plans such as Provident Fund and NPS which are well diversified and also provide tax incentives.
While financial planning involves decision making at an individual level, employers too can play a part by setting up the supplementary NPS plan at the Corporate level and facilitating the required financial education for employees to save towards a comfortable retirement.
The author, Vishal Grover, is practice leader, Retirement and Investment Solutions at Aon India. The views expressed are personal
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