Pension Withdrawals: Holier than Thou ???

This note comes as a reaction to the Indian Pension Regulator PFRDA’s (Pension Fund Regulatory & Development Authority) invitation of public comments on allowing partial withdrawals under the National Pension System (NPS).

As a personal opinion, the Purpose of Pension Savings Gets Defeated With Partial Withdrawals.  

Backdrop

The purpose of Pension is Purely to Provide / Receive an Income in the Old Age for self as well as spouse (family pension). An Individual Retirement Account (IRA) is ideally meant only for the concerned Individual including the Spouse and should not be treated as cheap banking source during the accumulation phase itself. In fact, one’s own pension account should not even be used to help Children for their education, setting up business or marriages, unless the children are minor or differently able as in true sense of family pension.

Pension Savings are NOT meant to be used for the purpose other than fighting the old age poverty and hence any withdrawals even partial, should Never be adhered to. Remember, the longevity is on the rise and life expectancy at 60 is more than 18 years in countries like India. So in any case one would require pension as means of livelihoods for over two decades that would be full of Inflation and warrant expenses on health. Any compromise at the accumulation phase would have a heavy impact on the de accumulation phase. It may be perfectly fine if one leaves the wealth for the successors at the end of life, but Outliving one’s resources could turn out to be the worst nightmare where one would exhausts one’s resources before joining the majority.

Current Issue

Indian Pension regulator PFRDA (Pension Fund Regulatory & Development Authority) has proposed allowing subscribers of National Pension System (NPS) to withdraw up to 25 per cent of accumulated funds for meeting medical treatment expenses, higher education and marriage of children, and even house purchase. The "partial withdrawal" is however allowed only after 10 years of contribution by the subscriber. The draft guidelines for withdrawal of 25 % of accumulated contributions by NPS subscribers are proposed and comments from the public and all concerned are invited by the PFRDA on its website.

NPS is aimed at providing income security in old age and not to meet periodic or occasional fund requirements during the working life of a person. NPS is a long-term, retirement savings product which accumulates and generates maximum pension wealth. NPS, which has more than 5 million subscribers as of now, is one of the lowest cost pension funds in the country (and also in the world) and is open to every citizen.  The current exit / withdrawal guidelines under NPS ought to be framed in such a manner that the subscriber has a long period of accumulation of corpus for providing him with a decent accumulated pension wealth when he retires or he moves out of the regular work routine due to age. PFRDA has also invited suggestions over the same.

Precedence

It is not that the partial withdrawals were not permitted earlier under the civil servants General Provident Fund (GPF) or public / private sector Employees Provident Fund (EPFO). However, experience suggests that wherever partial withdrawals are permitted, the allowance of withdrawals is used to finance insignificant events not related to retirement leading to a situation where the terminal balance in their PF accounts remains abysmally low and hence the purpose of pension / PF gets defeated. Amongst the civil servants (joined prior to 2004), besides the GPF, there were other retirement provision as well like the Gratuity, Commutation, Leave Encashment etc. and hence even if their terminal GPF balance was close to nil, it does not really matter to them as the lump-sum received at retirement serves their purpose. The civil servants are also the privileged lot which has a wage and inflation indexed handsome pension post retirement that is sufficient to keep them happy for the rest of their lives. But what about employees under the NPS and the informal sector workers under the NPS / NPS Lite??? They seldom have other retirement benefits and do not have any inflation and waged indexed pension. For them, the corpus NPS may be the only means of livelihoods over the multiple decades and if that too is shared with their children education and marriage, there is hardly any money left that they could survive the old age crises in the offing.

Alternatives and Exception

All investments are supposed to be targeted and earmarked for foreseen as well as unforeseen events and different boxes need to be created within their portfolios depending the risk and return characteristics of investment options as well as the time period for which investment is made. For purposes like children marriage, education, housing etc. that are foreseen expenditures, there are different instruments and products that are available that one can opt for. For unforeseen events such as health, accidents theft etc  again there are these products / insurance to cover the risk. Similarly, old age is also a predictable event and hence pension savings should be exclusively meant  for consumption in the old age and Never be used for those purposes. Even under the NPS, the PFRDA has allowed a Tier II account that has the facility of flexible savings and withdrawals that could be used for all such purposes and also as cheap banking, if necessary. However, pension savings should be treated as sacred and never touched upon other than the purpose of old age.

The only exception to the withdrawals of pension savings should be ‘Critical Illness’ that might lead to a terminal case. So, where the chances of the survival of the person itself is in jeopardy, the rationale of keeping the pension savings in a funded account beyond life may not hold justified. However, this provision too should not be used as sweepingly since there could be a chance where even the spouse might need this money as in case of family pension.

The Damage

Lets check with two such cases and identify what damage the withdrawals could make in the lives of the pensioners. Assuming Ms. Consistent joins at the age of 20 and contributes Rs. 1,00,000.oo per year throughout her life upto the age of 60. Simultaneously, Ms. Withdrawal  also joins at the age of 20 and contributes Rs. 1,00,000.oo per year throughout her life upto the age of 60, but owing to children’s education, marriage etc. start withdrawing from the corpus as per the proposal of PFRDA. In that case lets assume that Ms. Withdrawal  pulls out her money at regular intervals ie 25% of the available balance amount at the age of 30, 35 and 40. Let the rate of return in each case remain at 10% pa.

In the first case, while Ms. Consistent has contributed Rs. 40,00,000 (say 4 million) in her pension account, the terminal balance would be Rs. 4,86,85,181 (say 48.69 million) without any withdrawals. On the other hand Ms. Withdrawal shall have a balance limited to Rs. 2,76,70,702 (say 27.67 million) at retirement despite contributing the same amount of Rs. 4 million and growing at the same rate of 10%. However, Ms. Withdrawal during the entire tenure has withdrawn Rs.  5,09,607 at the end of age 30, Rs. 8,02,089 at aged 35 and  Rs. 11,66,078 while she completed her 40^th years of life. Thus while Ms. Withdrawal has withdrawn a total of Rs. 24,77,773 spread across three PFRDA permitted withdrawals, her total damage at the terminal value is Rs. 2,10,14,479 (Rs. 21 million) which is (4,86,85,181 – 2,76,70,702) more than five times her own contributions.  If the same amount of Rs. 21 million was annuitized for a period of 20 years at 10% (Principle + Interest) she would have received a pension which would be more by Rs. 2,02,794 per month. Thus in other words Ms. Withdrawal has met a damage where her monthly pension is being reduced by more that Rs. 2 Lakh for a period of twenty years.

To recapitulate the discussion, we must realize the Importance and Necessity of Pension for our old age that should remain as  ‘Touch Me Not’. Any type of individual based pension fund should be treated as sacrosanct where no contamination or withdrawals should be allowed for which other accounts / investment options can be taken up,