Monday, June 30, 2014

Review: Lottery's tax leg-up over pension!

Selling lottery has a tax leg-up over selling pension! This and some other quibbles for the FM to consider this budget:

  1. Exempt income from distribution of NPS & NPS lite from Service Tax (ST). Income from sale of lottery tickets is exempt from ST so why not income from sale of socially relevant products like NPS and NPS Lite?
  2. Make NPS and pension plan of mutual funds tax exempt on withdrawal. PPF & EPF are tax exempt on withdrawal & NPS and mutual fund’s pension plan should get the same treatment. This should be extended to all long term savings (incl. infrastructure bonds), of - 15 years & above.
  3. Extend NPS Lite Swawalamban benefit till FY 18-19. Currently available only till FY 16-17.
  4. Increase annual co-contribution limit to to  Rs 2400 pa, up from the existing Rs 1000 decided in 2010. Keep the Rs 1000 as min. savings eligible for getting the matching co-contribution.
  5. Offer Jan Shree Bima Yojana (JBY) free to NPS lite customers who have saved at-least Rs 1000 in the previous FY. Make this a scheme feature.

Thursday, June 26, 2014

Remove anomalies, update taxation of pension, insurance & savings.

Remove anomalies, update taxation of pension, insurance & savings. 
Budget time sets off a queue at the FM’s door for tax reliefs and benefits. While the FM can give tax relief to tax payers, poor perhaps need to be motivated directly as they are not in the tax bracket. 
One easy pick for the FM this year could be the NPS Swawalamban benefit - this is fast receding in its 'value' and for those joining in FY 14-15 would only be available for 3 years. 
The FM should extend this to 5 years to FY 18-19. Importantly, the annual co-contribution benefit of Rs 1000 was announced in 2010 and should now be increased.
With over 2.6 million NPS lite accounts, the FM should encourage focus on getting persistent savings outcomes. He could keep the eligibility levels at minimum Rs 1000 savings for the workers to get the Rs 1000 co-contribution but increase the matching co-contribution limit to at-least Rs 2400 pa (that’s just Rs 200 per month).  
He could consider also expanding the Jana Shree Bima Yojanan (JBY) and bundle it with NPS lite and subsidize the Rs 200 premium fully for the subscriber. JBY offers a sum assured of Rs 30,000 on natural death and higher compensation in case of disability or accidental death. The JBY cover could be made contingent on the subscriber contributing at-least Rs 1000 in the scheme in the previous financial year and should be made available to the worker for the full duration of the NPS lite scheme.  The annual insurance cover could help encourage persistent savings.
Encouraging low-income informal sector workers to save for their old age is probably the most challenging financial inclusion initiative. Promising matching contribution is a fair bet to motivate workers to save for their old age and is better than many other subsidies that may not create any lasting value. The FM should give it the required push and encourage savings by low income workers.
In this context, it might also be useful to relaunch the inflation index bonds in a retail format which are suitable for the low income workers and middle class in general. The bonds in their current form have failed to serve this purpose and failed. This will require some thinking and the usual approach of coming up with clever and complex stuff which no one might buy needs to be avoided.
Coming to the taxpayers, a person who was earning an annual income of Rs 5 lakhs nine years ago in year 2005 should today be earning Rs 9-11 lakhs pa, just assuming an 8-10% annual increment to keep up with inflation. 
However, the deduction available for investments under section 80C of income tax is stagnant at Rs 100,000 as was prescribed in 2005.  
If the FM were not to offer any real increase in the deduction but just update the limit for consumer price inflation, say at an average of 7.5%, it would need to be pegged at Rs 200,000 to represent the same value it did in 2005. 
The FM could however think of providing some real increase and peg the limit at Rs 250,000, which would make it aligned to about 10% year on year increase since 2005. 
The FM should accordingly review the list of eligible investments and make the sub sub-limits also meaningful. After all, the amount each of us can save would depend more on our income than the upper limit for availing the tax deduction. While at it, It makes sense to link this ceiling to the cost inflation index so that the FM could spare himself the task of updating this amount every year unless he wants to make a policy level intervention.
One important anomaly that the FM should set right is to bring NPS and pension plans under MF to the same footing as PPF and EPF, which are tax exempt on withdrawals. It would be worthwhile to make all long-term savings and pension scheme (and infra bonds) of 15 years and above exempt from tax at all stages. This could nudge the taxpayers to put away the much-needed sums for later. 

Well these are perhaps small tweaks here and there and the FM has many other big things to mind, perhaps there is no money to spare for increasing tax deductions and making long term savings and pension attractive. 

But then, even a housewife finds the money and method to do things which are important and required for her household. The FM surely would agree and perhaps deliver more than we expect.

Monday, June 09, 2014

Target 200-mn in NPS by 2019, club EPF into NPS & encourage reverse mortgage

I have been witnessing the pension reforms closely since 2003 and despite the mixed outcome in the last decade, there is so much that we can achieve in the next five years. I wrote an article in FE on what we should target.

Target 200-mn in NPS by 2019, club EPF into NPS & encourage reverse mortgage
Financial Express, June 9, 2014

It’s been a decade since the pension reforms were first dribbled out in early 2004 under the NDA regime. In 2014, as the ball shifts back to the BJP regime, it is an opportunity for the new finance minister to put the reforms back on track.
India has over 100 million elderly and this population will triple to 300 million by the time those at age 30 today turn 60. The last decade barely made a difference to the pension outcome of over 500 million workforce in the working age.

Civil servants’ pension reform has largely succeeded with 3.3 million central and state government employees now in a fully defined contribution (DC) system with pension assets (about R426 billion) invested in a mix of debt and equity. The old defined benefit (DB) and unfunded system where each retiree got a pension of about 50% of last pay has been successfully restricted to employees who joined before January 1, 2004.

But a few state governments are paying truant and the new regime at the Centre needs to focus on them. Maharashtra and Tamil Nadu joined the NPS long ago but are keeping the scheme funds in their public accounts instead of remitting the same to NPS. West Bengal and Tripura have not yet signed up. This is also an area where PFRDA, the pension regulator, has little influence.

Resting on a 1952 legislation, it is a challenging task to reform the Employee Provident Fund (EPF) but with a customer base of 50 million, it is an important cause. Measures like auctioning the fund management and moving forward on making the systems user-friendly could be counted as hits. However, well into 2014, there is still lack of assurance on maintenance of accurate data, with customer accounts even reflecting negative balances! The more important reform here is to look at integrating EPF into NPS.

The logic is evident. Private sector employees should be able to invest their mandatory provident fund in the NPS and benefits from scheme level choices and a largely glitch-free system architecture. With this, India can move closer to an integrated pension architecture with one pension account for a person irrespective whether one is in government or private service or is self-employed or switches career inter se. Here, the government should first put the NPS in order and ensure there is portability of account within NPS for the employees moving from government to private sector or vice-versa.

The Employee Pension Scheme (EPS) deficit (shortfall in scheme income as against its payout) has regrettably become a subject of debate with size estimates ranging from R500 billion to R100 billion. It would be a prudent to cap this deficit and shift the scheme to NPS for the new joiners.

Getting the NPS for private sector to scale up is an agenda that the government needs to pin up on its to-do list. With just 3,30,000 subscribers in five years after it was opened to public, it has nothing to show for. Here, the government needs to adequately invest in education and awareness and simultaneously fix the distribution.

There are other financial tools that seem to be promising solutions to strengthening the old age social security framework. Reverse mortgage, where one can loan one’s house to a bank and get a pension for life, is potentially one such solution. However, the idea of loaning one’s house is not an intuitive one and there are no clear models that India can potentially replicate. The finance ministry should take a crack at this, perhaps starting with the upcoming budget.

Finally, all of the above, even if done well, will not add up to eradicating old age poverty in India. The suggestion of a means-tested minimum pension (unfunded) or what is more commonly understood as universal pension is not necessarily a suitable one.

One could argue that our dependency ratio (percentage of number of elderly and children dependents per 100 working age population), at 53%, is expected to decline to 40% in the coming decade and our economy would presumably grow at a high rate—so we should aim for this. There is also merit in considering that the bulk of our population is poor and will not be able to save adequately on their own for their old age. The truth is that the western world with better finances is struggling with such systems and the math just does not add up over the long term. India will need to find its own solutions.

Latest data of NPS Lite, a scheme to motivate the poor to save for old age, shows that there are about 2.6 million subscribers with R8.1 billion corpus in four years. It seems to have had a decent start. The average account balance of R3,100 needs to be analysed. There is, however, a general lack of public data or discussion on how many of those who joined have continued to save in their second or third year. Driving persistent savings behaviour from a population with irregular incomes and lack of banking usage is the most important and difficult challenge here. The focus must grow beyond enrolments to outcomes, especially in socially-oriented pension schemes like the NPS Lite.

When he presents his first budget, the finance minister could look at extending the scheme co-contribution beyond 2017 and consider making the Swavalamban subsidy smarter as the present R1,000 annual co-contribution has had the unintended effect of limiting this scheme to becoming a ‘thousand rupee scheme’, where one gets R1,000 by investing R1,000 and the focus has shifted away from trying to save as much as possible.

It might also be a good time to review the product design and make it more attractive. For instance, bundling the NPS Lite with an inexpensive health insurance plan on the lines of RSBY could make it more appealing. Benefits of health cover are more immediate while pension plans take a long time to reap.

In the next five years, the government should target 100 million low-income workers in NPS Lite, 50 million informal private sector workers in NPS and give the 50 million EPF subscribers an option to migrate to NPS. Lastly, the finance minister and RBI should push for working a reverse mortgage model with at least 1 million participants to demonstrate its success.

Ashish Aggarwal

The author is co-founder and executive director at Invest India Micro Pension Services