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Compulsory annuitization and NPS

LiveMint logoLiveMint 27-02-2017 Deepti Baskaran

The National Pension System (NPS) mandates that subscribers must use at least 40% of the maturity corpus to buy an annuity product. We ask experts in the industry if this rule should stay or be changed

Sandeep Shrikhande, CEO, Kotak Mahindra Pension Fund Ltd

The vision statement of the Pension Fund Regulatory and Development Authority (PFRDA) states that it aspires to be an organized pension system to serve the old-age income needs of people on a sustainable basis. The basic objective of any pension plan is not only to provide an attractive return on accumulations but also to ensure that a subscriber is able to generate a decent income post retirement.

Giving an option to commute, or withdraw lump sum, defeats the very purpose of an organized pension. This increases the probability of the lump sum being en-cashed and utilised to acquire assets that may not generate a regular income.

The most important requirement of a retiree is to earn a lifelong pension. It is for this purpose that NPS has been designed to compulsorily provide an annuity on 40% accumulation. In fact, there is an option to annuitize a higher amount, up to 100%, to purchase an annuity and thereby increase the pension amount. To smoothen the tax impact, there is also an option to defer the annuity anytime up to the age of 70 years post retirement. This helps reduce the tax burden as annuity income is taxable.

Today, the average post retirement life span can be as long as 20 years (up to the age of 80 years). With inflation at around 5% it is imperative that maximum accumulation is utilised to provide for a fixed income and maintain the standard of living one is used to.

Dhirendra Swarup, former chairman, PFRDA

The objective behind compulsory annuitization is to provide a regular and steady income to the subscriber after her retirement. Some doubts are now being expressed whether buying an annuity at the end of the investment period should be made compulsory.

World over, annuity provides tax benefits whereas ‘cashing out’ involves payment of tax. Buying an annuity is, therefore, clearly advantageous.

However, there are some disadvantages too. Annuities do not come free. There are high expenses involved in the form of commissions to agents and annual fees as well as surrender charges to annuity providers. These costs reduce payouts. Moreover, the policymakers must bear in mind that annuity is a complex financial product. There are several types of annuities: immediate, deferred, fixed and variable annuities. Then there are annuities with or without survivor benefits. Will an ordinary person find it easy to select from this menu? Add to this the fact that the annuity market in India is yet to fully develop to provide optimum returns to the retired.

Some jurisdictions in Asia allow 100% payout and trust the individual to decide where and how to invest the accumulated corpus. Should we not also allow the NPS subscriber to decide where and how much to invest as she had during the accumulation phase? These are some issues which the policymakers should reflect on.

Mukul G. Asher, profess-orial fellow, National University of Singapore

The mandatory annuity requirement...is consistent with international practices. However, over the last decade there have been design and governance innovations in providing periodic payments during retirement. In the case of NPS, the challenges—which will become acute as India ages and medical technology evolves—in developing annuity markets are uncertainty in the longevity trends and limited set of products to match assets and liabilities for annuities, which is further accentuated by the conservative investment allocation required under Irdai’s (Insurance Regulatory and Development Authority of India) guidelines for annuities. These result in very cautious annuity products, resulting in relatively low benefits for a given sum.

To improve the payout phase, it’s important to relax investment guidelines of annuity products. Further, the bond markets need to be deepened and broadened.

Additional options such as systematic withdrawal or phased withdrawal should be considered. Under them, a member can withdraw the amount set aside for annuity over a 15-20 year period, in a manner that it exhausts the balance. Flexibility can be given to the member to decide the age at which such withdrawal begins. This will permit taking advantage of compound interest over a longer period, resulting in higher balances. This will also imply that members would not need to bear costs built into annuities.

Kulin Patel, head of retirement, South Asia, Willis Towers Watson

Annuities have been the default insurance-based solution for long-term old-age income. However, globally in recent years, it has been strongly said that annuities are not efficient for the investor. This debate is gaining steam in India with the NPS requiring compulsory annuitization on retirement. I believe that a minimum level of secured income is paramount and therefore, some type of assured protection through an insured solution is advisable. However, against the background that annuities essentially protect longevity risk, I believe that compulsory annuitization may be enforced at an older age, say, 75 or 80 years. This age could be changed in the future, as longevity increases.

Before this age, there should be flexibility for retirees to adapt their de-accumulation income as per their needs and lifestyle, whilst being able to still achieve reasonable returns and manage one’s tax burden. This has many advantages for the investor but a regulator needs to also ensure that there is strong awareness of the risks, some control checkpoints and a financial advisory pillar that goes hand in hand with this flexibility.

It is all too easy for investors to blow the money too early and then look to others for help.

I know that PFRDA is looking at the issue closely and as the pension system and public awareness increases, we will see the right balance come into the NPS offering for the de-accumulation phase.

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