Why applying for higher EPS pension may be a golden opportunity

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After almost 9 years of spirited court cases since a 2014 EPS amendment, members of the Employees’ Pension Scheme (EPS) finally got their due when the Supreme Court allowed them to apply for higher pension. While most employees are convinced about the benefit of the higher pension from the scheme, EPS 95, many others are still evaluating whether they should go for it or not because of a higher contribution component. They will not only have to pay a higher share of their employers’ monthly contribution towards the EPS — which will bring down their EPF corpus — but will also need to deposit the deficit contribution of the past along with the accumulated interest under the EPF. Here are six compelling reasons why a higher EPS pension can be an advantageous choice for most employees.

1. Higher basic salary allows you to be eligible for higher pension

The way pension is calculated under the EPS 95 is that it links your pension eligibility directly to your years of eligible service and basic salary. Pension under the EPS 95, which became effective in November 1995, is backed by the government, so most employees want a higher amount of such a guaranteed pension during their retired life. However, the EPFO had put a ceiling on this basic salary — Rs 5,000 since October 1994, Rs 6,500 since June 2001 and Rs 15,000 since September 2014 — which restricts the maximum pension one can draw, especially for people getting a higher basic salary above these ceilings. Now with the Supreme Court (SC) order, there is no limit on the basic salary. The higher your basic salary during the last 5 years of service before retirement, the higher your pension amount will be. So people with a higher basic salary can get a good amount as a government-backed pension throughout their retired life.

2. There is no discretion to deploy your fund elsewhere
Some people may think that instead of contributing a higher amount to the EPS, they can allocate it to other assets and generate better returns. But the problem is that this additional amount is most likely to come from your EPF corpus, unless you have insufficient balance there. So for most people, the additional contribution amount for the EPS may not be available for deployment in other asset classes. Beneficiaries would get discretion over this fund only at the time of retirement, when a lump-sum amount is received as EPF corpus. But at retirement age, how many people would be willing to put their lifelong savings into a risky asset like equity? Most of them are likely to invest a larger part of that corpus in fixed income instruments to generate regular income.

During the accumulation phase, EPF is known to offer one of the safest and highest returns among fixed income investments. That situation is not likely to change much at the time of retirement. If the yield offered on this corpus under EPS works out to be higher than other safe options, then going for a higher EPS contribution will be a beneficial move.

3. ROI on additional contribution is a critical factor
This is the best way to know what kind of return you will get on the higher EPS pension option. In most cases, the annual yield on additional retirement corpus is in the higher double digits, or more than 10%.

Let us assume a person started his employment on April 1, 1995, with a basic salary of Rs 5,000 that grows annually at 7.5%. If this employee does not opt for higher pension, he/she will end up with a pension of Rs 7,929 after 35 years of service in 2031 under the old rule with wage ceilings. However, if the employee goes for a higher EPS contribution, he/she will get an increased pension of Rs 26,879. But for this, the employee needs to contribute an extra amount with accumulated interest, which will be equal to Rs 9.74 lakh at the time of retirement. This means that the extra contribution which grows with EPF interest rate during employment will earn an annual return of 23.4% after retirement. Therefore, unless the EPFO changes the pension calculation rule significantly, employees will benefit by going for higher EPS pension.

However, there is one factor related to additional 1.16% contribution on amount of salary above wage ceiling of Rs 15,000 which EPFO had mandated in 2014 amendment for members opting for higher EPS contribution to pay. SC had asked EPFO to find some alternative to it. This factor may have some material impact on these calculations.

4. Higher your pensionable service period, the greater the gain
The analysis of the additional corpus requirement to apply for the higher EPS pension has thrown up an interesting insight. You have to be an active EPS member for a minimum of 10 years to become eligible for pension at the retirement age. If your service period under EPS is longer, your overall gain will be higher. This can become a major factor in deciding if one should go for higher EPS or not. People with 20 years or more service under the EPS 95 will gain substantially by going for the higher pension option.

However, there is one scenario in which you gain in higher EPS 95 pension may not substantial, which is when you leave your employment early and wait for a long period like 8-10 years or more to reach to retirement age and start getting pension, your yield on higher contribution may come down significantly. This is because this fund could have grown to a bigger corpus during the gap had it been kept in EPF. So, the closer you are to your retirement with eligible EPS contribution, the more rewarding your option to go for the higher pension will be.

5. High interest rate options will not remain available for long
India is a developing country with a significant annual GDP growth rate. However, the higher growth rate may not be sustainable for a very long period. Just like China, India may also witness slower growth 10-15 years later. A higher growth phase typically pushes inflation up and so interest rates are on the higher side. However, once the growth slows, interest rates are likely to cool down, just like in developed economies the US, Europe and Japan.

Most high-yielding regular income options available now — such as the Senior Citizens Savings Scheme and the Pradhan Mantri Vaya Vandana Yojana — have a lock-in period of 5-10 years. It would be a big challenge to get such a high rate of returns 10 years down the line at the time of reinvestment. The farther we go into such a future, the greater the challenge becomes.

Pension is a very long commitment with joint life as the last surviving partner may live 25-30 years into retirement. If you do not go for a guaranteed long-term pension product, there is a good likelihood you may face reinvestment risk. Then the return will be too low, or risk will be too high. If you will retire 10-15 years from now, will there be any annuity product offering 8% or more for 25-30 years? The chances are very less.

6. No return of principal to the nominees of pensioners is not a big hindrance for many
Many people have been complaining that the provisions of the EPS do not return the corpus to the family, so this makes the scheme a not-worthwhile pension option. However, they forget that except for annuity plans, there is hardly any product that gives retail investors a lifelong guaranteed monthly income with return of principal. When you go for a joint life option with return of purchase price, the best return that you currently get is 6.87%; offered by HDFC Life. However, when you opt for without return of purchase price, where the principal is not returned to the nominees, the return becomes higher but only up to 8.6%; offered by HDFC Life ASP. This means if a product gives you a substantially higher return than this with a government guarantee, then that is a better choice. Even with the minimum EPS service of 15 years, you can very well get a better return from this pension scheme.

Higher yield and longer retirement life lessen the impact of purchase price return

Post retirement life Return (IRR) with ‘return of purchase price’ Return (IRR) without ‘return of purchase price’
15 years 9.71% 5.56%
20 years 9.84% 7.75%
25 years 9.91% 8.78%
30 years 9.94% 9.31%

Assumed annuity yield is 10%

The return of purchase price matters more if your post retirement life is not long. In case it is longer and the difference between the return (IRR) between annuity with ‘return of purchase price’ and annuity without ‘return of purchase price’ diminishes. Moreover, higher the yield on retirement corpus lesser will be impact of return of purchase price. For instance, if the yield on your additional EPS fund is 10% then even without return of purchase price the IRR is 5.56% for a 15 years of post-retirement life which goes up to 9.31% for a 30 years of post-retirement life. As we have seen in our previous example the return on additional corpus is coming out in higher double digit so return of purchase price will have much lesser impact.

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