In today’s Finshots, we explain why there’s a furore over the pension system in India

The Story

Look, there are only 3 sources of pension in this world.

Firstly — You.

Every month of your working life, you contribute diligently to a corpus. It’s cut from your salary and deposited into a retirement fund. It’s a ‘defined contribution’ plan. You’re the only one responsible for building your security net.

Then — Your employer.

In some cases, your employer could help you out too. They’ll contribute to your retirement pot every month. Sure, it’s a bite out of their revenues but that’s the cost they pay for having employees. And it’s usually the law that forces their hand.

Finally — Current and future generations of taxpayers.

Now, this is the interesting bit. See, back in the day, all retired government employees used to get a lifelong pension from the government. The pension would even be frequently adjusted for inflation. And the best part — unlike ‘you’, they didn’t even have to contribute towards it during their working life. It was a ‘defined benefit’ pension. Only the employer (the government) would contribute.

But all this money had to come from somewhere, right?

So when people say that it came from the government, what they actually mean is that it came from taxpayers. We were all bearing the cost of extending pensions to government workers.

But things changed in 1998. The government realized that it simply couldn’t keep asking the rest of India to pay for pensions.

For starters, some estimates say that only 1.6% of Indians are employed in the government sector. And nearly 80% of India’s workforce is in the unorganized sector. These are people who don’t have a social security safety net of their own. Yet, their taxes also contribute to the pensions of government employees. It’s not a good look.

The other “problem” was that Indians were living longer lives. While the average life expectancy was just 35 years in 1950, it had jumped to 62 years by 2000. And it was only going to increase from there. In fact, the UN thinks that it’ll be closer to 82 years by the year 2100. This meant that the government would have to pay out pensions for longer. And this increased liability would complicate things further.

So the government set up a committee in 1998 to find a solution. They called it the OASIS Project — an acronym for Old Age Social and Income Security.

Now OASIS knew the answer was simple. The government would have to kill this decades-old defined benefit plan. Employees would have no choice but to contribute towards their retirement as well. Adapt to the times. As the report put it, that really was the only way to “eliminate the free-rider problem of collectivist programs.”

And though it took a while for the government to act on it, the National Pension System or the NPS finally emerged in 2004.

The scheme would work almost like the Employee Provident Fund (EPF) that we’re familiar with. The employees would put in a share of their salary. And the government would put in a bit too. On retirement, a part of this corpus can be withdrawn in a single shot. The rest of it goes towards buying an annuity. And the annuity then pays out a monthly pension.

It was a hybrid model of pension. And it would protect a chunk of taxpayer money from being used for pensions. Sounds perfect, no?

Well…only on paper.

You see, some employees who were enrolled in the NPS many years ago are now retiring. And they think the pension payouts are quite horrendous. In fact, last year, an employee union gave an example of a defence employee who retired with a basic pay of ₹30,500. They said that under the old system, he would’ve been entitled to a monthly pension of ₹15,250. But because he was stuck with the NPS, his pension amount was a meagre ₹2,400!

The unions called it an atrocity. They started demanding that States revert to the Old Pension System and give them a defined benefit. So some states like Rajasthan obliged. And others like Karnataka are mulling the proposal quite seriously.

But there’s a problem. A pretty big one.

See, States are already burdened by pensions. When the Economic Times crunched the numbers, they found that pension already eats over 25% of state tax revenues. And if every state decides to go back to a defined benefit pension, it would be mayhem. By 2047, 40.5% of the tax revenues would be spent on pensions alone.

Now you don’t need an economist to tell you going back to the OPS sounds like a massive commitment.

If you’re spending almost everything you earn on pensions, there’s no money left for building crucial infrastructure — Roads, hospitals, and educational institutes. States will have no option but to keep borrowing money. It’s a debt trap.

But wait…States aren’t stupid. We’re sure they’ve seen the reports advising them against making the shift. So, why are they still considering it, you ask?

Well, its complicated.

See, under the Old Pension Scheme, the state governments don’t really have to set aside money every month into a fund. They can postpone these expenses till the time it actually becomes due. Maybe borrow money 10 years from now to meet pensions.

In the NPS, however, states have to set aside funds immediately as part of their contribution. The money flows out of the account today. It’s an expense.

So, if they make the switch and go back to the OPS, their finances immediately look better. They might even save 7–10% of their pension expenditure on pensions. Their financial statements look better. They can claim they’re fiscally responsible with money.

But you and I know that they’re simply delaying the inevitable. It’s a tradeoff — Short-term gain for serious long-term pain. And no one put it better than Montek Singh Ahluwalia, an economist and former Deputy Chairman of the erstwhile Planning Commission. He said and we quote, “The big advantage for those who push this move is that the bankruptcy would come 10 years later.” It becomes someone else’s headache.

And finally, you could also argue that it’s all about politics. That they’re doing it for the optics when elections are near. To show that they care about the people. But will this come back to bite future generations?

Well, we will let you decide that.

Until then…

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Ditto Insights: Why Millennials should buy a term plan

According to a survey, only 17% of Indian millennials (25–35 yrs) have bought term insurance. The actual numbers are likely even lower.

And the more worrying fact is that 55% hadn’t even heard of term insurance!

So why is this happening?

One common misconception is the dependent conundrum. Most millennials we spoke to want to buy a term policy because they want to cover their spouse and kids. And this makes perfect sense. After all, in your absence you want your term policy to pay out a large sum of money to cover your family’s needs for the future. But these very same people don’t think of their parents as dependents even though they support them extensively. I remember the moment it hit me. I routinely send money back home, but I had never considered my parents as my dependents. And when a colleague spoke about his experience, I immediately put two and two together. They were dependent on my income and my absence would most certainly affect them financially. So a term plan was a no-brainer for me.

There’s another reason why millennials should probably consider looking at a term plan — Debt. Most people we spoke to have home loans, education loans and other personal loans with a considerable interest burden. In their absence, this burden would shift to their dependents. It’s not something most people think of, but it happens all the time.

Finally, you actually get a pretty good bargain on term insurance prices when you’re younger. The idea is to pay a nominal sum every year (something that won’t burn your pocket) to protect your dependents in the event of your untimely demise. And this fee is lowest when you’re young.

So if you’re a millennial and you’re reading this, maybe you should reconsider buying a term plan. And don’t forget to talk to us at Ditto while you’re at it.

1. Just head to our website by clicking on the link here

2. Click on “Book a FREE call”

3. Select Term Insurance

4. Choose the date & time as per your convenience and RELAX!