India’s pension system is biased towards the organised sector

How is old age income security in India different from the systems in developed countries?

Research at Allianz has found that India’s pension system is globally the second least sustainable, with only Greece being worse off. India’s pension system is biased towards the organised sector and old age income is confined to voluntary savings in the unorganised sector. Income at retirement is far from adequate and public sector pension provisions are far behind the OECD(Organisation for Economic Co-operation and Development) benchmark. Average income earners are unable to replace preretirement earnings compared with most OECD countries. Usually, the less generous the public pension system, the better developed is the privately-funded one. So in Switzerland or the Netherlands, where the replacement rate from public pension schemes is below 40%, we find pension assets of 55,000-70,000 per capita, which is more than 50% (of per capita) GDP. In India, it’s 6.2% relative to GDP.

What can be done to improve existing structures?

The list is long. (Ensuring) strong growth of pension assets and incentives for private retirement savings, such as tax advantages, matching contributions, for mid- and higher-income earners (will work). Regulations allowing the industry to offer largescale products for private retirement savings on a cost-efficient and profitable basis would also help.

Is there a system (such as the 401k in the US) that India can replicate?

Any retirement system is based on a country’s culture and economic structure. You cannot just transfer any system. However, referring to the main models, there are three possibilities.

The World Bank’s three-pillar model, in which retirement income is from three income sources: public pensions to cover basic needs, occupational pensions for an earnings-related source and additional private savings. This model allows for risk-diversification.

If India opts a libertarian pension system, it is worth learning from the US experience—a DC(defined contribution) system that requires employee participation, either compulsory or supported by automatic enrolment. Employee contribution should be characterised by high default savings rates with auto-escalation. Each participant should have a customised ‘target date glide path’ with mid-course corrections and operational structures capable of reducing investment and administrative fees.

A more paternalistic approach, as found in Europe, would be the Dutch collective DC system.

There was a furore over insurers having to guarantee minimum returns on pension funds. How feasible is a guarantee on such a long-term product?

In some developed markets, such as in Germany, longevity coverage (beyond the age covered in a financial plan) and guaranteed life-long pension income are USPs of life insurers. The cost of these guarantees, though, has become an issue in current low-yield markets and with regard to Solvency II (European Union regulation for insurance companies).

Long-term care products are not available in India while rising healthcare cost is a major concern. So, can retirement products supplement health plans?

The primary function of a pension product is to provide life-long retirement income. Even so, from a marketing perspective, it may make sense to bundle a pension product with additional riders. This is quite common in developed pension markets.

Is there a need for more long-term savings instruments providing retirement income in India?

As mentioned, India’s pension system is biased towards the organised sector. It lacks comprehensive coverage of the whole population. Therefore, reforms to cover people below the poverty line should be the top priority. Till such time, instruments to build an individual retirement corpus should be made available.

Do you think reverse mortgage plans work well for a regular income post retirement?

In India, ownership of property has a socio-cultural value. Hence, families prefer to keep property rather than mortgage it. This could be a probable reason for reverse mortgaging not picking up in India. However, from an individual perspective, these plans serve as a regular and attractive source of income but it depends on the respective market structure and conditions.

Tax on retirement corpus is a burden. What are the most tax-efficient plans available internationally?

Tax deferral, EET (exempt, exempt, tax) schemes, has been introduced in many pension reforms. It means contributions and capital income are tax exempt and income at retirement is taxed. The advantages are, the income surplus can be used as contribution and tax on retirement income is lower. But, recently, the financial crisis and increasing fiscal debt has resulted in increased tax on capital gains, also retirement savings, and increased tax on retirement income.

What would be the best plan available currently in India for financial security post retirement?

Immediate annuity plans from life insurers seem to be the best available option. It offers a guaranteed annuity rate for life. Globally, insurers have always proved the best option for managing pension funds.