On January 29, the Pension Fund Regulatory and Development Authority, or PFRDA, organised a conference on the National Pension System, or NPS. Speaking there, Minister of State for Finance Jayant Sinha emphasised “the need for innovative product development in an ever expanding capital market”. He urged the PFRDA “to consider alternative investment funds like venture capital funds, which are important to encourage entrepreneurship in our country”. Surprisingly, Mr Sinha’s argument for directing pension money into such high-risk products is to encourage entrepreneurship; he seemed to forget that higher returns for pensioners was supposed to be the main objective.
Even if such risky investments by pension funds are desirable to “encourage entrepreneurship”, this should come way down the priority list. Mr Sinha’s main job should be to clean up the messy patchwork of retirement savings options for the average Indian that successive governments have created.
The mess comes from four sources – incentives, product design, taxation and regulation – that leave Indian savers confused, and often lead them to make the wrong choices. (In this article I have loosely used the word “pension”, often interchanging it with retirement products.)
Currently, retirement products are pushed by six different sellers: the government (provident fund), banks (senior citizens savings’ scheme, or SCSS) insurance companies (annuities from pension plans), mutual funds (retirement funds), pension funds (under the NPS) and the post office. The incentive for sellers is different. Insurance companies enjoy the highest incentive to sell their products, thanks to fat commissions and fees that agents and the insurers are able to skim off the savers. No wonder, the highest advertised retirement products are the pension plans of insurance companies. As it happens, they are also one of the worst in terms of returns. Either you need to save a lot to get a comfortable pension as advertised in those touchy-feely ads, or you are going to run out of money given the increasing longevity of people.
The Public Provident Fund is popular among urban savers; but even then, the experience from Moneylife helplines shows that savers are often lured by misleading advertisements into choosing insurance products rather than the far superior PPF.
Companies selling the NPS have no incentives to push their products because they make no money. Only four mutual funds have retirement products on offer and they, too, have very little incentive to advertise them. Banks don’t want to push the SCSS because interest rates are higher.
So the main retirement products pushed to the savers are pension plans of insurance companies, even though these are among the worst, especially if you are in the highest tax bracket. We can say that savers should analyse product features and choose wisely, but in real life it doesn’t work that way; differing incentives induce adverse selections.
Savers have a plethora of choices. Except that the products have been approved for sale by the respective regulators without any coordination among themselves. For instance, the SCSS interest is taxed but not the PPF one. The return on the PPF is guaranteed but not that of pension plans, which fetch even lower returns. Just four retirement products from mutual funds have been approved by the income tax department as qualifying for deduction under 80C of the Income Tax Act. These are all different from one another. You can borrow from the PPF but not from most other products.
The NPS has two versions: Tier-I and Tier-II. Money cannot be withdrawn from a Tier-I account. Once you are 60 and its time to get your NPS corpus, you are forced to buy an annuity from an insurance company to the extent of 40 per cent of the corpus. But the annuity is taxable. This makes the NPS one of the most peculiar products to invest in. It is also among the newest!
As part of sound public policy, the government offers tax incentives to attract saving in financial products. Three kinds of tax benefits are possible: for investment, income and on corpus. This is called “E-E-E” (that is, “exempt-exempt-exempt” for all three). There is absolutely no logic why product A offers all three features and product B only two. Something like PPF is an “E-E-E” product, but not the pension plans of insurance companies. Taxation of the SCSS, the NPS and other insurance products are all different. For some strange reason, investing for three years in certain kinds of equity mutual funds called equity-linked savings scheme gets you tax benefits. Why only three years is not clear.
India has created product-centric regulations, and so retirement products are principally regulated by the PFRDA, the Securities and Exchange Board of India (Sebi), and the Insurance Regulatory and Development Authority of India (Irdai). Some, like provident funds, are overseen by the government. Through all this, the Central Board of Direct Taxes plays its own role in influencing savers’ behaviour, by decreeing which product should get what kind of tax treatment. There is a need to have a more logical regulatory framework, led by the finance ministry.
India has a long history of retirement savings products. Unfortunately, this history is one of allowing continuous fitful additions by different players. The PFRDA, Sebi and the income tax department are all under the same ministry. But there is no effort to make them coordinate and streamline the product designs, incentives and taxation, so that savers don’t have to be financial and taxation experts. Will Mr Sinha step in and simplify things, ensuring that savers are able to make like and like comparisons?
The writer is the editor of www.moneylife.in