The deadline to opt for higher pension under the Employees’ Pension Scheme (EPS) is June 26. The fact that the Employees’ Provident Fund Organization (EPFO) is making it difficult for people to opt for a higher pension is an indication that it is probably a good option. The maths confirms it – higher pension under EPS looks very attractive. However, you should base your decision not on math, but on factors that are personal to you.
EPFO was established in 1952 to administer the Employees’ Provident Fund (EPF) scheme. Both the employer and the employee contribute 12% of the employee’s basic salary to the EPF. Initially there was no provision for pension in EPF. In 1995, EPFO introduced EPS to provide lifetime pension to the members. Out of the 12% employer contribution, it was mandated that 8.33% would go to EPS and the remaining 3.67% to EPF.
When EPS was introduced in November 1995, it fixed the maximum pensionable salary 5,000 per month. 8.33% of the employer’s contribution to your EPS is calculated on this pensionable salary. Even though your actual salary was higher, your EPS contribution was calculated based on the lower statutory limit. In March 1996, EPFO included an option to contribute to EPS on the basis of actual salary. Thus, if your salary is stated 10,000, you had the option of asking your employer to contribute 8.33% to your EPS on this higher salary. In this option, your actual last drawn pay will be considered for deciding your pension and not the lower statutory limit 5,000 per month.
Later, EPFO might have regretted making this change as it allowed members to opt for significantly higher pension, thereby increasing the pension liability of EPS. When members started opting for higher pension by contributing to EPS on the basis of actual salary, EPFO rejected several applications on procedural grounds. Aggrieved members approached the courts, leading to a huge litigation for the EPFO.
Due to this, EPFO made significant amendments in the functioning of EPS in 2014. Firstly, the ceiling of pensionable salary was fixed. 15,000 and higher pay post the option to contribute to EPS was removed from the amendment. Second, the formula for calculating pension was changed from last 12 months’ salary to last 60 months’ salary. Third, an additional contribution of 1.16% was specified for the members who opted for higher pension. Fourth, members opting for higher pension need to choose a new option for the same.
The motive behind the above amendments is simple. The First Amendment curtails pensions, by reducing pensionable wages. The second amendment also reduces the pension amount. The third amendment imposes additional financial burden on the members who opted for higher pension and the fourth amendment introduces more red tape. The matter finally reached the Supreme Court, which in November 2022 upheld the amendments made by the EPFO in 2014 with certain limitations. The court has kept in abeyance the requirement of 1.16% additional contribution to EPS and given an extended deadline for members to apply to EPFO for higher pension.
Based on the Supreme Court order, you now have the option of applying to EPFO for higher pension. The math suggests that this is probably a good idea. Let us take the case of a 25 year old man who earns 5 lakhs each year (with an annual increase of 8%) and works till the age of 58 years. If this person contributes to his EPS on the basis of actual salary, he will get annual pension 26 lakhs, which would be a respectable 40% of his last drawn pay. If she does not opt for higher pension, the annual pension received will be negligible 82,000.
Opting for higher pension will reduce the amount deposited in your EPF and increase your pension. This eases the burden of comprehensive retirement planning on you. However, if you do not opt for a higher pension, you are left with a huge EPF corpus and the onus is on you to create an effective retirement plan. For individuals who are either financially savvy, or work with an able advisor, it is advisable not to opt for a higher pension. This will give you the flexibility to design your personalized retirement plan. However, if retirement planning sounds like a daunting task for you, then it is better to lock in the higher pension offered by EPS.
The more you think about this complex problem, the more it becomes clear. It’s not about math. It’s about you.
Ravi Saraogi is a SEBI Registered Investment Advisor (RIA) and Co-founder of www.samasthiti.in
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