The Pension Fund Regulatory and Development Authority of India (PFRDA) is considering a proposal that would allow subscribers to the National Pension Scheme (NPS) to go in for a systematic withdrawal plan (SWP) or a lump-sum withdrawal option at the time of exit (pay-out).
An SWP option would allow NPS members to draw down the balance accumulated at retirement every quarter, six months or year until the subscribers’ funds are exhausted.
However, the specific design of the SWP option would need to be based on a rigorous analysis of financial data for members, and probable future demographic trends of subscribers who would be exiting the NPS. The aim should be to also address the longevity risk (the risk that funds may get exhausted before a member dies).
As of September 30, 2022, the total subscribers and total assets under management (AUM) of the NPS were 16.4 million and Rs 7.7 lakh crore (3.26 per cent of 2021-22 nominal GDP), respectively. This data was as on October 23, 2022.While the respective shares of central and state government employees in total subscribers were 14.0 and 34.1 percent, respectively, their share in AUM was much higher at 30.0 percent and 49.2 percent, respectively.
The mean balance, which hides wide variations, was Rs 10.1 lakh for central and Rs 6.8 lakh for state government employees. For corporate members, the mean balance was Rs 6.8 lakh, with 1.7 million members.
What do the current norms say?
According to the rules spelt out in a September 2021 circular (PFRDA/2021/41/SUP-ASP/06), government as well as non-government sector subscribers can make lump-sum withdrawals if the pension wealth is up to Rs 5 lakh. If it is above this, at least 40 percent of the accumulated pension wealth has to be utilised to buy an annuity providing for monthly pension. The balance 60 percent is paid as a lump-sum.
The above division between an annuity and a lump-sum was established when the NPS was set up in 2004 when the focus of the policymakers was on the accumulation phase of the NPS and not on the exit or pay-out phase.
Among the positive features of the regulations revised since the inception of the NPS are that a subscriber attaining 60 years of age or superannuation can defer availing annuity or withdrawing the lump sum or any combination till 75 years.
Also, a subscriber can continue to contribute to the NPS account beyond 60 years/superannuation (up to 75 years). This contribution beyond 60 is also eligible for exclusive tax benefits under NPS.
In both cases, the main advantage is that it lets a member benefit from compounding of returns even after the age of 60, positively contributing to retirement income security. Also, it permits a subscriber to choose an appropriate time to exercise retirement financing options.
Why SWP?
Globally, SWP is recognised as providing several benefits, but it also has disadvantages, mainly relating to longevity risk, so there is a need to strike a between SWP and an annuity, immediate or deferred.
The key advantage of SWP is that it does not require using the annuity market. The annuity markets are designed to provide financial products that convert accumulated retirement savings into a regular income stream, and thereby manage investment and longevity risks.
Deloitte has argued that historically low returns on investment, legacy technology and stringent regulations contribute to increasing buyer reluctance to participate in the annuity markets in many countries.
Domestically, the monopoly accorded to the Life insurance Corporation of India (LIC) by the Insurance Regulatory and Development Authority of India (IRDAI) to engage in the annuity markets and limitations of demographic data needed to make sound actuarial estimates have made the above limitations even more acute.
SWPs thus could provide a lower-cost alternative to receive regular income during retirement, while benefiting from participating in the well-designed NPS architecture, PFRDA’s confidence-inducing governance structure and low-cost investment options.
SWPs should therefore be an alternative option to a mandatory annuity. If any rules and regulations and the respective roles of PFRDA and IRDAI need to be changed, that task should be undertaken on a priority basis.
Thus, if the PFRDA Act needs to be changed to recognise SWP as an alternative option to annuity, which is currently under the purview of IRDAI, this should be done.
Another option would be to make PFRDA regulate both the accumulation phase of the NPS as well as the exit (pay-out phase), making it fully accountable for pension outcomes of its subscribers.
It will fall upon the finance ministry to take the lead in making these changes.
While SWP is usually regarded as an alternative to the annuity option, in an exposure draft note dated September 29, 2022, the PFRDA proposed SWP for the 60 percent lump- sum portion of the subscriber. This step should be welcomed provided rigorous research has been done to satisfactorily address longevity risk. Investment risk would be managed through well designed investments options of the NPS.
This step, however, does not address the need to provide an alternative to a mandatory annuity option of 40 percent of the corpus of a subscriber. It is this step that the PFRDA, with leadership from the finance ministry, is urged to consider as this will have large benefits to the subscribers.
0 Comments