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irement Planning Study Notes Sample


Roots Institute of Financial Markets RIFM

Study Notes Retirement Planning and Employee Benefits Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road



Welcome to RIFM Thanks for choosing RIFM as your guide to help you in CFP Certification

Roots Institute of Financial Markets is an advanced research institute Promoted by Mrs

Deep Shikha CFPCM

RIFM specializes in Financial Market Education and Services

RIFM is introducing preparatory classes and study material for Stock Market Courses of NSE ,

NISM and CFP certification

RIFM train personals like FMM Students,


Marketing personals,

Research Analysts and Managers

We are constantly engaged in providing a unique educational solution through continuous innovation

Wish you Luck……………

Faculty and content team,

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Our Team Deep Shikha Malhotra CFPCM M

AMFI Certified for Mutual Funds IRDA Certified for Life Insurance IRDA Certified for General Insurance PG Diploma in Human Resource Management CA

Ravi Malhotra B


NCFM Diploma in Capital Market (Dealers) Module AMFI Certified for Mutual Funds

IRDA Certified for Life Insurance

Neeraj Nagpal CFPCM B

AMFI Certified for Mutual Funds IRDA Certified for Life Insurance NCFM Certification in: Capital Market (Dealers) Module Derivatives Market (Dealers) Module Commodities Market Module Kavita Malhotra

Previous (10th Rank in Kurukshetra University) AMFI Certified for Mutual Funds IRDA Certified for Life Insurance Certification in all Modules of CFPCM Curriculum (FPSB India)

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Index Contents

Page No

Chapter 1 Issues in Retirement Planning

Chapter 2 Wealth Creation

Chapter 3 Types of Plans

Chapter 4 Defined Benefit Plans

Chapter 5 Defined Contribution Plans Chapter 6 Superannuation and other Retirement Plans Chapter 7 Group Life and Health Insurance Chapter 8 Retirement Need Analysis Chapter 9 Retirement Income Streams Chapter 10 Post Retirement Counseling Chapter 11 Needs for Reforms Chapter 12 Reform Proposals

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road








Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


] WEALTH ACCUMULATION Wealth accumulation is the process whereby the savings of an individual is used for the purpose of building up capital that will result in a source of revenue over the next several years

Wealth accumulation means increasing the amount of capital with the individual so that the amounts here are used more effectively and this becomes a corpus that one can expect support from in the days ahead

The wealth accumulation process is not a short term exercise where there are some fixed steps taken over in a couple of years

This is a steady process that has to be undertaken over a long period of time and it has its own characteristics as the results will be evident only over this long time frame

A large amount is required at the end of the process This cannot be generated overnight A long time span is required to arrive at this wealth Market conditions where investments are made are not smooth Things do not move in a straight line There are tumbles and shocks in between This will create problems in the wealth accumulation process Continuous efforts will pay the required dividends The ups and downs will be taken care of by the long time frame There is another reason why slow accumulation is a necessity

The wealth generation process required use of different assets

Several of these earn steady returns

Not all of them have features like equity

This means that the time required for wealth creation is also going to be long

The long period also gives a chance to use the power of compounding

A successful Wealth Creation strategy needs to have the following: Safety – Safety of the wealth is very important for wealth creation

Investor must look for safety in the first place for deciding on a investment

Liquidity- Though the liquidity requirement is needed the most 3-5 years before retirement,

to convert the assets as and when required for meeting the retirement outflow

Even in earlier period of life,

liquidity nature in an investment commands a premium in the market over liquid assets

Yield- Earning suitable return on the investment is also very important to beat inflation,

otherwise the inflationary pressure will eat up the asset and the corpus will have a shortfall

Investment vehicles for wealth Creation

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Following investment avenues can be considered and used as investment vehicles to reach the target goal

Real estate Bullion Shares Small Saving Schemes Pension Funds Mutual Funds Life insurance

[A] WEALTH EROSION The word “wealth erosion” means a “wearing off or the gradual decline of the wealth of a person

If the wealth is kept lying idle,

it is likely to be eroded over a long period of time,


prudent steps need to be taken to make an optimum use of such wealth so as to generate a regular income stream

During the pre retirement stage,

the effect is not much as the individual continues to earn income during his working life plan


after retirement with the discontinuation of a regular income,

the individual will have to solely depend upon the pension benefit or the invested corpus income,

which in many cases is a reduced amount


there is a gradual reduction in purchasing power due to inflationary conditions

As a consequence,

it leads to a steep fall in the value of money

In the spending phase individual spends his/her retirement corpus and corpus keeps reducing due to inflation and most conservative investments in this phase

Reasons of wealth Erosion a

Fall in Interest Rates In India during the period between 1980-2000,

Indians had witnessed a very high rate of interest ranging form 14% (Available on government administered schemes) to 20% (offered by corporate India)

In just last 5 years the interest rate scenario has totally reversed,

Any retirement corpus is always at risk with this kind of fall in interest rate

The fall in interest rate reduces the yield on investment,

thus creating a mismatch in income stream and expenses stream,

which in turn needs to be bridged by liquidating the capital assets

Taxation Tax has the tendency of eating away a good part of income generated

Taxation is thus an area,

which needs careful evaluation viz a viz to investment vehicle and time of withdrawal

Preference of present consumption over future consumption The tendency of the human being for current consumption over future consumption can be devastating,

as any deviation from the set goal can only reduce the surplus Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


available for saving for retirement

Individuals must be made aware of the fact that the financial discipline must be followed

Shift in Government Policies In India,

we do not have only the market risk but we also have a very high risk of wealth erosion,

considering the shift in government policies too often

What is required is a progressive and long term policies dealing investments and taxation,

while we are exposed to the changes every fiscal

Thus it becomes very difficult to take a long term view from the government legislation point of view: For eg: Long term Capital Gain on Equity Mutual Fund and on stocks traded on a recognized stock exchange,

on which Securities Transaction Tax is paid,

thus incentivizing the investor to invest in equity for long term

Any change by the government to the above,

will adversely affect the return

[B] RETIRING EARLY REDUCES THE EXPECTED BENEFIT An individual can begin receiving full pension benefits at the retirement age However,

the pension benefits or the retirement corpus will be less because of the less time given to the investments for compounding

Thus for an early retirement,

greater saving is required to fund the retirement,

as the compounding of return will not be in favor,

as also the retiree will have a longer retirement years,

which will need more corpus to sustain full term

Let us consider the following example

Person A saves Rs

If he can manage a return of 12% on his investments

His investments will grow to

At the age of 50 = Rs

Now if the retirement has been proponed to age 50,

then additional investments are required to match the projected expenses

Living longer than expected One of the most astounding success stories of the 20th century was arguably the sheer extension of human life spans

Advances in science and medical research have driven this success by increasing the likelihood that more infants will survive into adulthood and the probability that 65- years-olds will have a greater chance of living into their 80s and even 90s

But when it comes to retirement income planning,

life expectancy figures can be seriously misleading

Many people born at any given time will outlive their own “life expectancies

” This means that most people ought to think hard about “longevity risk”-the real possibility of living 20,

Without planning,

a longer than expected life could easily lead to a person,

Though it really boils down to a simple sentence,” You need to plan for the possibility that you will live longer than you think,” longevity risk is probably the least-understood variable in Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


very few people have any clear sense of the distinctions between the life expectancy of their own age group and the probability that they will live many years beyond their life expectancy once they reach age 65

Fewer still realize that if they are in good health,

even people who have reached age 80 or 85 still have quite high probabilities of living 10 or 15 more years

As a result most people underestimate the length of time they need to plan for living in retirement

A study shows,

an American man who has reached age 65 in good health,

has a 50% chance of living twenty years to age 85,

and one chance in four of living to 92

For a 65-year-old woman,

those odds rise to a 50% chance of making age 88 and one chance in four of living to 94

The odds that at least one member of a 65-year old couple will live to 92 are 50%

And there is one chance in four that one member of that couple will live to 97

As medical research and technology continue to push that lifespan envelope,

more and healthier individuals just entering retirement will have to make plans for the very real possibility of needing 30 to 40 years of post-retirement income

As it is evident from the table given hereunder,

that based on a constant outflow every month,

a person living longer will need higher corpus than a person having shorter life

The below table shows the need of retirement corpus for withdrawal of Rs

Monthly Requirement

Interest per Month 0

Present Required



Capital 1,395,807


This is just the opposite of retiring early,

under this the retirement corpus as planned earlier can get even better with the extra time allowed,

as the magic of compounding works

A corpus of Rs



A delayed retirement allows that extra year of working to give extra compounding benefit to the saving nest and builds up more capital

[C] Effect of Inflation Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Inflation means a general and progressive increase in prices

It is a proverbial saying that “in inflation everything gets more valuable except money‟

also “too much money chasing too few goods‟

The excess of money supply in the country also causes inflation

The Reserve Bank of India,

which is the Central Monetary Authority in India manages and controls the money supply by issuing directions regarding the fixation of interest rates for banks,

fixing of CRR (cash reserve ratio),

SLR ( Statutory liquidity ratio),

With the rising inflation,

the goods and services get costlier and hence,

the purchasing power per currency unit gets reduced

Inflation also affects the prices besides the forces of demand and supply

There are many other economic factors that may affect the price levels considerable

These factors are static supply or short supply despite growing demand in respect of certain commodities,

Government distribution policy,

indirect taxation level measures such as grant of subsidy,

different levels of excise duty,

protected market (custom tariff) etc

The application of Deficit Financing by the Government in its budget also adds to the cause of inflation

The government sometimes tries to fill in the deficit gap i

the difference between planned expenditure and total receipt (revenue plus capital) by following additional money into the economy

The inflationary trend affects the cost of living of the citizen of a nation,

as there is a fall in the value of currency

At the micro level,

inflation has an impact on an individual‟s financial planning

With a sharp rise in the cost of living there is a general demand for wages and salary to be linked to the wholesale price index and wholesale price index is considered as a direct determinant of the variation in the cost of living

To calculate the wholesale price index and consumer price index,

a base year is selected and made equal to 100 points

Dearness allowance paid to the employees working in industry,

civil service and public sector undertaking,

banks and others specified industries is marked to the wholesale price index through the cost of living index

When inflation creeps higher,

your investment money has to work even harder to retain its spending power

Instead of trying to predict where inflation is headed,

investors should focus on their portfolios,

ensuring their investments are best-positioned towards off inflation‟s effects over time

That becomes even more important given the expectation that various returns could slow down from the hectic pace witnessed in the last few years

Inflation has remained pretty high in India over the past decade and a half

The rise is particularly strong in a few years in between when the price jumps have been in double digits,

which is far more than the average figure

If you are working and you receive dearness allowance then the rise in inflation will be affected through the regular revision of the figure and thus,

you end up earning a higher sum

The same principle needs to be applied when one has retired and in this case,

the retirement fund has to earn this kind of higher sums in order to tackle inflation

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


The first place to start is asset allocation

Stocks tend to outperform bonds during inflationary periods,

so investors need to have enough exposure

risk tolerance and goals need to come into consideration,

) Many financial advisors also recommend putting 5-10% of a portfolio in commodities-even a mutual fund that invests in a broad-based basket of commodities-which also tend to work well as inflationary hedges

Gold is another classic hedge,

moving independently of stocks and other asset classes

the size of~ allocation depends on the individual

That said,

advisors caution investors against putting too much money into assets like gold and commodities because,

returns don't keep up with more traditional investments like stocks

Real estate is also considered a good inflation hedge

Other tangible assets,

like' vacation and commercial properties,

though real-estate investment trusts are probably the easiest way to enter the market

Indians do not have this option yet but as the market develops,

this kind of opportunities is likely to be present in increasing numbers in the coming days

There has also been talk about issue of inflation-linked bonds

Their interest payments tend to be levered to inflation,

so these bonds might pay interest based upon the movement of the price index selected for tracking purposes

Since these offerings are smaller than traditional corporate offerings,

Dividend-paying stocks also provide an extra cushion

Whatever you do,

This calls for careful monitoring of the overall plan but there is no need to panic every time the inflation figures rise by a bit,

What adjustments must be

? The cost of retirement will likely go up every year due to inflation

- that is,

Rs 35,000 won't buy as much in year 5 of your retirement as it will in the first year because the cost of living usually rises

Although pension benefits are adjusted for inflation,

any other estimates of how much income you need each year and how much you'll need to save to provide that income

When planning for your retirement it is always safer to assume a higher,

rate and have your money buy more than you previously thought

Retirement calculators should allow you to make your own estimate for inflation

Many financial experts feel it is important to save at least a portion of your retirement money in higher risk-but potentially higher returning-assets

These higher risk assets can help you stay ahead of inflation,

which eats away at your nest egg over time

Which assets you want to invest in,

Never invest in anything you don‟t thoroughly understand or don‟t feel comfortable about

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Exercise Ch 2 1

In post retirement period,

many investment principles and strategies that people rely on while accumulating wealth remain valid with significant differences in how they may be applied tactically A

False 2

In the process of building lifetime wealth through financial assets,

consistency factor implies investing as early in life possible

whereas time factor implies keep investing regularly

False 3

For longer investment time horizon,

volatility of the market can be a significant risk factor because the value of an investment may be down at the time when funds are withdrawn

False 4

A risk tolerance profiling of the client must be done based on certain premade_______ A

Questionnaire B

Financial Plan C

Invoice D

Draft Plan 5

Which of the following statement(s) is/are correct

Income means current stream of cash inflow from various sources

Wealth is the income invested for growth in investment vehicles A

Only I is correct B

Only II is correct C

Both I and II are correct D

Neither I nor II is correct

Without planning,

a longer than expected life could easily lead to a person,

This risk is rightly defined as_____

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Inflationary Risk B

Longevity Risk C

Deflationary Risk D

Asset Allocation Risk 7

Which of the following statements/s regarding “ultra-conservative” strategy is/are correct

An “ultra-conservative strategy is the one where retirees aim to meet lifetime income needs solely with cash and fixed-income instruments

Retirees with insufficient cash resources relative to their needs should also adopt „ultra-conservative strategy

Only I B

Only II C

Both I and II D

Neither I nor II

Overly generous and optimistic withdrawals in the early retirement years can have the effect of downsizing retirees‟ budgets and lifestyle expectations,

and some may even be forced to go back to full-time jobs

False 9

Which of the following factors make health care costs a critical challenge for retirees and pre-retirees,

and can pose very real risks of throwing lifetime income plans of track if they are not provided for

Longer Life Spans


Declining retiree medical coverage


Shortfall of medical plans A

Only I and II B

Only I,II,III and V C

Only II and III D

Only I,II and III E

All of the above

Factors affecting wealth erosion includes all of the following,

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Fall in interest rate B

Taxation C

Government policies shift D

Preference of future consumption over current consumption E

Inadequate plan for contingencies and emergencies

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road



Project OASIS and its recommendations B

World Bank’s recommendations,

Chilean model C

Pension Authority D

The role of state developmental state (East

Asia),welfare state (Europe and North America),minimalist state (Europe and North America)

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


[A] PROPOSALS FOR PROJECT OASIS The Ministry of Social Justice and Empowerment,

Government of India had commissioned a national Project tilted "OASIS" (Old Age Social and Income Security) in 1999 under the chairman ship of Dr

Dave to examine policy questions connected with old age income security in India and create necessary institutional infrastructure and to make concrete recommendations for actions

The committee,

which submitted its Report in February 1999,

was entrusted with the twin task of further improving existing provisions,

to devise a new pension provision for excluded workers who are not capable of saving even modest amounts and converting this saving into an old age income security provision

Summary of Recommendation The OASIS Report recommended a structure based on individual retirement accounts (IRA)

The Individual accounts to have full portability: i

the individual would hold on to a single account across job changes across geographical locations

The pension system would constitute: 1

Points of presence (POPs): A two-tier system with POPs with good infrastructure facilities is proposed,

which would offer better services

Depository corporation: which would handle the database part of the Individual accounts namely choices of schemes and convey them to PFMs

Pension fund Managers (PFMs): which would perform the task of fund management

Annuity Providers: The pension system design proposed by the here critically relies on annuity providers who convert the lump sum of assets (attained at retirement) into a regular monthly pension (or a variable annuity) until death

Major recommendations of the Committee were: Pension System Structure To develop an institutional infrastructure,

through which individuals can prepare for old age while they are in the labour force,

in an efficient pension system

As most individuals in India are outside the organized sector and face temporary unemployment,

a pension system for India should thus be flexible and useful to the unorganized sector

Government role is not sustainable on a significant scale and old age economic security should necessarily result from sustained lifelong contributions by emphasizing self-help and thrift,

and for sound pension planning,

there should be sound fund management to achieve the highest possible rates of return

Individual Retirement Account An individual would be required to open an Individual retirement account with the POP

The IRA account will have unique 10 numbers,

which will not change in the entire life span of the individual

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Minimum Contribution and Annual Accretion The Committee recommended a simple and convenient pension system where a person opens a singIe Individual Retirement Account (IRA) as early in his life as possible with a minimum of Rs

No limit on the frequency of accretions or fixed monthly contribution

Point of Presence The pension system would work through a myriad Points of Presence (POPs),

which would be located all over India including banks branches,

with full portability across job changes and across geographical locations

It would be a two-tier system where POPs with good information technology and telecommunications facilities would offer better services than other technologically constrained POPs and in turn would reduce administrative and transactions costs

Private Pension Fund Managers The professional pension fund managers (PFMs) should be selected to manage the retirement funds under this system

The pension system would offer three styles

Balanced Income and Growth

Each of the six PFMs would run one scheme each in the three styles,

which individuals can choose from

Safety Net through Insurance An additional safety net in the pension system is that if the final pension of a participant is smaller that the sum total of all contributions then the insurance cover would reimburse this difference for individuals who have contributed for at least ten years

To a significant extent,

the Government can purchase this insurance from insurance companies

Regulatory Body The design of the pension system should also include a Self Regulatory Organization (SRO) that will be registered with the Indian Pension Authority

The pension system relies on annuity providers who convert the lump sum of assets (attained at retirement) into a regular monthly pension (or a variable annuity) until death

The Indian Pensions Authority (IPA) would oversee the entire working of the system and handle the administration

Tax Incentive The tax-free limit for accretions into the IRA should continue to be a maximum of RS

Premature withdrawals as well as the terminal accumulations withdrawn as a lump sum from Provident Funds should be taxable at the rate of longterm capital gains rate,


the amount that is used for buying annuities should be tax-free

The income earned on Funds held in trust by PFM's and annuity providers,

should be exempt from any taxes,

There is a strong case for Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


integrating a micro-credit facility into the pension system whereby individuals can have access to funds in the form of a loan against their pension savings

Role of government guarantees To reassure the people to switch to the new system government guarantees play a vital role

These guarantees may depend upon the level of 'welfare' functions that the government takes upon itself to perform: Removal of subsidies The present contribution of 1


this contribution should be channeled into the National Senior Citizen‟s Fund as initial corpus for the first 3 years of incorporation of this Fund


this contribution should be discontinued

In addition,

Early withdrawals One of the main problems of the Pension Schemes in India is the problem of premature withdrawals,

which more than often results in poverty during old age

As of now there is no incentive to compel people to keep their savings till the maturity period and the tax incentives provided are the same even if withdrawals are made

The OASIS report suggests the abolition of tax on earnings of over 12 per cent in Provident Fund and levy of tax,

on early withdrawal from Provident Funds

Financing the transition cost The transition cost for a new pension system may be three-fold: a

Cost of paying the workers who chose to remain within the old system

Cost of reimbursing those who chose the new system

Cost of the 'safety net' provided by the government

This cost can be best borne in India by privatizing the State Owned Enterprises

In such a case,

Pension Fund Managers may also participate actively in buying shares of the companies being privatized

This would give workers the possibility of benefiting handsomely from the enormous increase in productivity of the privatized companies by allowing them,

through higher stock prices that increases the yield of their PSAs,

to capture a large share of the wealth created by the privatization process

Reform Suggested In Existing Schemes by Oasis Report Empowering the Employee Pension Scheme 1

The system of using competing professional fund managers,

prudently liberalized investment guidelines,

and improved governance covered in the previous chapter,

should also be applied for pension funds

This will introduce Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


specialized agencies for fund management (professional fund managers registered with SEBI) and for annuity provision (annuity providers registered with the insurance Regulatory Authority)

The presently limited,

assured returns should be replaced by marketdetermined rates of return

The Government's contribution of 1

In the interim,

this contribution should be credited to the National Senior Citizen's Fund

The vesting period for pensions should be 10 years

Breaks in contribution should be permissible provided they are made up later with the correct interest penalty

Lump sum topping-up by individuals,

in case of a shortfall in the minimum contribution period,

Empowering the Public Provident Fund 1

The "Public Provident Fund" should be renamed "Individual Retirement Account (IRA)" to focus on its objective

The provident fund system of using competing professional fund managers,

prudent liberalization of investment guidelines,

and improved governance should also be applied to the Public Provident Fund

A professional Board of Trustees should be appointed to oversee the investment and administration of the fund

The 10% tax on early and final withdrawals on provident funds should be applied to all permissible withdrawals from the PPF as well

As in the provident funds,

this tax should not be levied on the portion of accumulations retained in the IRA for purchasing an annuity at age 60,

or invested in approved instruments under Section 54E

The rate of return should be market determined and there should be no tax on it

The limit on the tax-free annual contribution should be raised to RS

This would make the PPF equitable with PF (which allows RS

In fact,

tax-free contribution from the employer could even be higher)

This would remove discrimination in tax-treatment of self-employed persons vis-a-vis employed persons

Branches of all commercial banks should be allowed to serve as PPF collection centres

A comprehensive publicity programme should be initiated to enhance awareness regarding the details and benefits of the revised scheme

PPF should provide for an optional contribution for insurance against death and permanent disability

A Public Pension Scheme (PPS) should be initiated under the Public Provident Fund

500 a year

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The first Rs

Those desirous of contributing higher percentages can contribute more

As in the case of the Employee Pension Scheme(EPS)

the vesting period should be 10 years

Breaks in contribution should e permissible and lump-sum contributions in case of short-fall in the minimum contribution period,

Those who are members of any other pension scheme,

on submission of documentary evidence,

The quantum of pension would be determined by the accumulation to the credit of the subscriber at the time of retirement,

Annuities 1


the function of accumulating wealth and selling annuities are both bundled into provident fund institutions

Annuity provision will be more efficiently achieved by a market with competing annuity providers registered with the Insurance Regulatory Authority

The Government should work towards obtaining a thriving,

competitive annuity market where private,

public and foreign firms compete in selling the cheapest annuities to India's citizens

At age 60,

the worker would accumulate a stock of wealth

On the principle of avoiding double taxation,

the part which is put into an annuity should be tax exempt

The remainder,

subject to the exemption limit,

The annual income obtained from the annuity should be a part of taxable income

National Senior Citizen's Fund There is growing awareness and concern about the case of elderly persons in society

If at all,

the problem appears to worsen in future if timely measures are not taken in present

This should be a concern of all

The government should take a lead in galvanizing all these efforts

Towards this end,

it is proposed to set up a National Senior Citizen's Fund with a view to encouraging,

and complimenting all private sector efforts for the betterment of life of senior citizens in the country

The Fund can also be utilised for educating individuals about various security schemes,

conducting research into areas concerning senior citizens and building infrastructure relevant to the social security industry

The present contribution of 1

A part of the withdrawal tax on provident funds may also be transferred to this fund annually

The fund should be monitored and administered by a Board of Trustees appointed by the Ministry of Social Justice and Empowerment

[B] WORLD BANK RECOMMENDATIONS World Bank had undertaken a study on India and Its Pension Sector

The title of the study paper was INDIA The Challenge of Old Age Income Security Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Following is the executive summary extracted from the said report,

which speaks about the current pension structure,

its deficiencies and recommendation Executive Summary 1

One eighth of the world's elderly population lives in India

The vast majority is not covered by a formal pension system

Relying instead on their own earnings and transfers,

But informal systems are imperfect and increasingly strained

As the population ages,

the challenge of providing old age income security mounts

This report is about reforms that can help India address this challenge

The first step is to assess current public policy in this area

The starting point is a review of the main formal schemes sponsored by Government This includes the mandatory pension schemes that cover formal sector workers in the public and private sector as well as tax incentives that are designed to encourage retirement savings on a voluntary basis

It also includes public transfer schemes directed at the poor elderly that operate at both the state and national level

The analysis presented in this report is preliminary,

but the findings underline serious deficiencies in these programs

Having recognized many of these problems already,

the Government of India has recently assigned a high priority to pen 'on reform

In fact,

while this report was being drafted,

several key initiatives were under way

An ambitious proposal for reform was submitted by an expert committee known as the Old Age Social and Income Security (OASIS) project under the guidance of the Ministry of Social Justice and Empowerment and is now to be implemented by the Insurance Regulatory Development Authority (IRDA)

The 2001 budget includes a major reform of the civil service pension scheme

These steps signal the willingness to tackle the pension problem in lndia

Pension reform is a complex undertaking,

especially in the Indian context

This report contributes to the policy discussion that is unfolding by taking a holistic view to see how the seemingly separate elements of the system are actually interdependent

The report recognizes the current tendency,

to undertake fundamental reforms,

rather than making marginal changes to existing schemes

In this spirit,

several systemic reform scenarios are illustrated and relevant international experiences are cited


the subtle but important interactions between pension reform and other parts of the economy are highlighted


the report discusses the potential synergies between pension reform and reforms in the enterprise and financial sectors as well as emphasizing the need to provide a conducive environment for a new pension system,

especially in the fiscal arena

World Bank Report on The Old Age Social and Income Security (OASIS) project

The OASIS project is the most important recent pension reform initiative in India

While the primary goal of the initiative was to promote voluntary participation of the vast informal sector in a cost effective private pension system,

Surendra Dave and the team working under the auspices of the Ministry of Social Justice and Empowerment necessarily touched upon broader polity issues

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A series of conferences and consultations led to the publication of the first OASIS report in 1998 and a subsequent report in January 2000

The commission consulted closely with relevant government agencies such as the Ministry of Labor,

multilateral Institutions like the World Bank and the domestic firms involved in financial services and insurance

Their report has raised awareness of the failings of the existing system for old age income security and the need for reform

The crux of the OASIS proposal is to establish a system based on privately managed,

individual accounts with low costs and widespread accessibility

The new system

Would rely on a limited number of private asset managers each offering three investment portfolio options to individual savers

The three options would range from a more conservative portfolio with a greater weighting in government bonds,

to a more aggressive equity-based portfolio

The managers would be selected through a competitive bidding process that used,

a criterion of low administrative costs

Government would facilitate access to the system through a network of 'points of presence‟ (POPs) that would take advantage of the postal and banking systems throughout India and keep costs low

A new entity,

the Indian Pensions Authority would be created and would select the asset managers

While OASIS focused on extending coverage to new groups in the informal sector,

the reports also included an important diagnosis of the problems with the mandatory schemes and proposed changes that would affect the EPF/EPS

These included: Encouraging larger accumulations and annuitization through tax incentives and limiting withdrawal options before retirement age

allowing accumulation to continue after the normal retirement age and educating workers as to the need for long term savings

Increasing rates of return by (a) Liberalizing investment rules including allowance of 10 percent of new accretions to be invested in equity index funds (b) hiring professional asset managers for exempt funds and changing EPF governance structure (c) moving to market-based returns and eliminating the tax on returns higher than 12 percent

Increasing coverage by (a) removing industry type distinctions for mandatory membership (b) reducing the number of employees a firm must employ before being obliged to join the EPF from 20 to 10 (and eventually 5) and (c) eliminating the 5000 rupee per month ceiling on' covered earnings

Allowing private insurance firms to eventually participate in the provision of annuities promised by the scheme

Phasing out the government subsidy of 1

Setting the minimum vesting period at 10 years and allowing for broken contribution history and lump sum contributions to the scheme for missed years

OASIS also proposed similar reforms to the Public Provident Fund (PPF) to convert it into a modern,

funded system of individual retirement accounts or IRAs

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OASIS proposed allowing workers covered by the EPF Act voluntarily switch to the new,

privately managed defined contribution scheme

the proposal provides a foundation for the eventual convergence of pension provision within a single framework and including a significant role for the private sector

The government role would concentrate on education,

and accessibility) and supervision

Aside from the reform proposal itself,

the OASIS project was important for two reasons

it raised awareness regarding the need for reform at a critical juncture in the evolution of India's pension system


it framed the debate over pension reform in broad terms that brought together all elements of the system

This was,

the first time that many of the government agencies connected to public policy in this area interacted

It brought together diverse experts ranging from finance to social assistance

They have provided an important forum for discussion of pension policy,

an area that requires a broad interdisciplinary approach

[B] MULTI-PILLAR REFORMS: WORLD BANK (REFORMING THE FORMAL PENSION SYSTEM) Multi Pillar Reform Pension schemes across countries can be categorized into three pillars based on the need they address and the funding nature

Each of these pillars has some combination of the five features (viz

Voluntary vs

DC and NDC

publicly managed) The first pillar schemes,

which are mandatory and redistributive,

offer defined benefits that are largely financed on a PAYG (Pay As You Go) basis and are publicly managed

Basic pension (Old Age Pension)

defined benefit and collective risk

The second pillar schemes or defined contribution schemes,

in which contributions are placed in individual or group funds,

could be managed either by private sector pension companies or by the public sector

Compulsory Superannuation (Forced/contractual savings)

defined contribution and individual risk- e

The third pillar schemes comprise voluntary personal pensions

The three pillars can be complementary to each other

While some countries avail of only one or two of the pillars,

there are several advantages in adopting multi-pillar system

Voluntary Superannuation (voluntary savings)

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The three pillars can be complementary to each other

While some countries avail of only one or two of the pillars (either Pillars I and III or Pillars II and III),

there are several advantages of adopting multi pillar system

The pension reform and related developments during the nineties in both the developed and developing countries observed that,

although there is a definite tendency towards schemes incorporatingfunded component,

State managed first pillar schemes augmented by contribution related components would continue to stay

Multi Pillar Reform is advantageous for the following reason: Affordability of PAYG systems given population aging Better rates of return through private sector investment Need for increased savings to bolster economic growth Need for capital market development Need to reduce the impact of inefficient management

Pension Fund Regulatory and Development Authority (PFRDA) Pension Fund Regulatory and Development Authority was established by the Government of India on 23rd August 2003 to promote old age income security by establishing ,developing and regulating pension funds,

to protect the interests of subscribers to schemes of pension funds and for matters connected therewith or incidental thereto

Composition of Authority The Authority shall consist of a Chairperson and not more than five members,

of whom at least three shall be whole-time members,

to be appointed by the Central Government

[C] PENSIONS AUTHORITY An interim regulator,

the Pension Fund Regulatory and Development Authority (PFRDA) was constituted through a Government resolution dated October10,

Till the architecture is fully in place,

the Central Pension Accounting Office (CPAO) under the Controller General of Accounts is acting as the interim Central RecordKeeping Agency(CRA)

Contributions are currently being credited into the public account earning a return equal to the GPF rate

As per data available,

about 137,952 employees are covered under the NPS

Approximately Rs

200 crore,

including Government contribution,

has been credited into the pension account

The Pension Fund Regulatory and Development Authority Bill,2005 was introduced in Parliament on March 21,2005

The Bill proposes that the main mandate of PFRDA is to regulate the NPS,

as amended from time to time by the Central Government

Pension schemes already covered under the Employees‟ Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Provident Fund & Miscellaneous Provisions Act,


individuals covered under such mandatory programmers under other Acts can voluntarily choose to additionally participate in the NPS

Approximately Rs

200 crore,

including Government contribution,

has been credited into the pension account

The Pension Fund Regulatory and Development Authority Bill,2005 was introduced in Parliament on March 21,2005

The Bill proposes that the main mandate of PFRDA is to regulate the NPS,

as amended from time to time by the Central Government

Pension schemes already covered under the Employee‟ Provident Fund & Miscellaneous Provision Act,


individuals covered under such mandatory programmes under other Acts can voluntarily choose to additionally participate in the NPS

PFRDA will establish the institutional architecture of the NPS including the CRA and pension funds

It will also frame investment guidelines for pension funds

PFRDA is empowered to impose stringent penalties for any violation of the law

The regulator will also create a special fund,

which will be used for educating and protecting the interests of subscribers to schemes of pension funds

The Bill was referred to the Standing Committee on Finance

The Committee presented their report in Parliament on July 26,

Allowing withdrawal from Tier I account also

Specifying in clear terms in the Bill that one of the pension funds would be from the public sector

Giving preference in selection to such pension fund managers that gurantee returns and spelling out the pre-requisites relating to capital structure and experience criteria for selection of pension funds and other intermediaries in the Bill

Making available to subscribers an option of 100 per cent investment in Government securities and indicating this in the Bill

Implementing any decision relating to permitting FDI in the pension sector only by way of suitable amendments in the legislation

and not allowing such decisions and decisions relating to deployment of pension funds outside the country to be at variance with related provisions applicable to the insurance sector

Setting up a Pension Advisory Committee similar to the Insurance Advisory Committee of IRDA

Rephrasing clause 4 of the Bill to clearly depict the composition of the Authority

selecting members of the Authority only from amongst professionals having experience in economics or finance or law

and having a Central Government nominee as one of the part-time members

Including the differentiation between Tier-I and Tier II accounts as a part of the basic or essential features of the New Pension System in clause 20 of the Bill

Bringing forward a comprehensive legislation in order to cater to the social security of the unorganized sector,

inclusive of pension coverage of the workforce,

simultaneously with the setting up of PFRDA as a statutory body

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Pension Reforms in Chile

[B] THE CHILEAN MODEL The Chilean pension system has been a role model for the countries of the world after its successful implementation

World Bank has been an avid advocator of Chilean Model for other countries

The pension reforms in Chile (called as Chilean Model) have attracted other countries attention

The model was successful in a

Transferring from a pay-as-you-go system to one based on individual capitalization,

which is sustainable in time and consistent with the rapid,

irreversible aging process in the population

Generating positive performance of the pension funds' yield during more than two decades of operation of the reforms

Reducing the contribution rates,

which were reduced to half than the level,

Resulted in increase in the net salary and productivity of the workforce

Making significant impact of the pension funds on the development of the Chilean capital market and on the country's levels of savings,

The Chilean pension system is based a

On the capitalization of social security savings in individual accounts,

On professional management of the resources by private Pension Fund Administrators devoted exclusively to that end,

On individual ownership of the contributions,

On a system whereby the processes of collection,

investment and payment are strictly regulated and supervised

The principles outlined above have been included in social security reforms passed in dozens of countries in the past two decades and have given rise to what is increasingly known as the “Chilean model" of social security in pensions

The Change in 1981 During the late 1970s,

it was clear that the pay-as-you-go system had to be reformed

The military government finally decided to switch to a totally new system

The opposition to abolishing the old system was not strong because 93 percent of the pensioners could receive only the minimum benefits set by the government

The new system to be introduced was the Administradora de Fondos de Pensiones (AFP),

or Privately Managed Pension Fund

Finally the Chilean mode was introduced in the year 198

The Main Aspect of the model: Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Chile's legislative Decree No

which became operative in May of the following year

Participants in an AFP are required to pay 10 percent of their earnings into a privately managed pension fund

An additional contribution from the employee is needed for providing the disability and survivors‟ benefits

The contribution is invested by AFP on behalf of the participants

Old age benefits depend on the amount accumulated in his account plus interests accrued

Money in the AFP is both portable and transparent

Workers can move freely from one AFP to another

They can find out at any time the current valuation of their account and the commission charges

The private sector AFPs are regulated by the Superintendencia de Administradoras de Fondos Pensiones (SAFP),

According to current regulations,

workers who have a reasonable history of contributions are guaranteed a minimum pension when they reach the age of 65 for men and 60 for women

In case a worker's accumulated fund in the AFP is not big enough for this minimum,

the State will make up the difference

To prevent the State from being struck by the shortfall,

the AFPs are required to generate for each month a return averaged to market based on a formula Achievement of the Chilean Model a

Total funds accumulated in the individual accounts have been growing at an average rate of 40 percent per year

By July 1994,

3 billion,

It has also become a major source of private savings

By July 1994,

it accounted for 35 percent of national savings (World Bank,

By September 1993,

were already members of the AFPs (International Labor Office,

The attractiveness of the Chilean system has probably been due mainly to the high rate of returns

Rate of Return for Chilean Pension Funds Year ROR (%) h

1981 12

1983 22

1985 13

1991 28

1993 16

Average 14

Year 1982 1984 1986 1988 1990 1992 1994

ROR% 26

Roots Institute of Financial Markets 1197 NHBC Mahavir Dal Road


Real Rate of Return for Private Pension Funds in Several Countries (1970-90)0 Country Canada Denmark Germany Japan Netherlands Switzerland UK USA Average

ROR (%) 2

The success of Chile's pension reform has made it a role model for many other countries to follow

There seem to be several factors accounting for the success

Large pool of pension funds were created with small contributions from private savings,

which can take advantage of other investment opportunities,

which otherwise were not available to individuals

Appointment of AFP opened new investment opportunities,

which were previously not available to small investors

A number of investment strategies,

such as hedging for currency risks,

diversification and taking advantage of economy of scale,

The pension reforms were complimented by the economic reform in Chile

In particular,

economic efficiency appears to have been significantly enhanced since the reform started

The PAYG system was obviousl