Notes

The retirement corpus has to be built over the working life of the individual from his earnings.
A portion of the earned income is set aside for accumulating the corpusthat will generate the
income required to meet expensesin retirement. In some cases, the employer may also make
a contribution to the corpus, such as, in the case of contribution made by the central and state
governments to the employees’ National Pension System (NPS) account. In most cases, the
corpus is built out of the savings of the individual. In some cases, as in the case of government
employees and employees of companies covered under the Employees Provident Fund Act, it
is mandatory to make a contribution to the retirement account, and there may also be a
minimum contribution specified. For persons in the unorganized sector not covered under a
mandatory retirement provision, such as self-employed people, retirement saving is a
voluntary exercise.
Some retirement benefit schemes, such as the Central Civil Services Pension and the Public
Sector Bank Pension, provided a defined pension to those covered under it. Such schemes
were called Defined benefit schemes. The benefits received from other retirement schemes,
such as the Employees Provident Fund, depend upon the contributions made to the scheme
through the working life of the employee and the returns earned on the corpus. Retirement
benefit schemes are broadly categorized as Defined Benefit (DB) schemes and Defined
Contribution (DC) schemes.
Employers provided Defined Benefit (DB) retirement plans earlier. In a defined benefit plan,
the pension amount or value of retirement benefit is known beforehand. In other words, the
formula based on which the pension amount would be calculated is known. The pension is
typically calculated as a percentage ofthe finalsalary. It is paid out of a corpus that is created
from contributions made by the employee, employer or both towards the corpus, which is
invested to generate returns. The individual is assured of the pension amount as defined,
irrespective of the returns that is generated by the pension fund. There are a number of
unknown variables to be managed by the provider of the pension in a DB scheme. The high
increase in salary overthe years,themortality factors which will determine the yearsfor which
pension will have to be paid, the investmentreturns over the long term period, will all impact
and determine the contributions that will have to be made by the pension provider to meet
their obligations. The biggest risk a DB plan runs is that it could become ‘under-funded’ or
unable to make the defined payments. This may happen if the contributions are not adequate
and the portfolio in which the contributions are invested does not generate the returns
required to create the corpus that is adequate to buy the annuities to make the defined
pension payments over the retirement period. The downward trend in interest rates and the
high price of annuities have affected the viability of DB schemes.1
Apart from the financial reasons that have contributed to the unviability of DB schemes, the
change in attitude of employees and employers have also contributed to the decline in the
DB schemes. Young employees are unwilling to trade-off lower current remuneration for
defined pension in the retirement period which they see to be in the distant future. With
greater employment opportunities, mobility between employers is high and the employees
no longer like to limit their options to further their career for the promise of defined benefits
in retirement. They see this as risky too, given the instances of failure of companies.
Employers are understandably disenchanted with the high costs of maintaining a DB scheme.
Given these circumstances, retirement schemes have been moving to the DC platform.
New pension products are Defined Contribution (DC) plans which are more flexible. In a
defined contribution plan, the pension amount is not known beforehand. In a DC plan, a
defined amount is contributed by employee, employer or both, towards a pension fund over
a period of time. The final corpus of the pension fund determines the retirement benefit,
which can be taken in a lump sum or as an annuity bought from the funds received, or a
combination of the two.
Since the pension depends upon the returns made on the investment, the contributing
individual usually gets some say in the way the amount is invested. This is done by providing
multiple options in the way the funds may be invested – like equity focused (high risk, high
returns), debt focused (low risk, low returns) or anything in-between (medium risk, medium
returns). The decision on allocation of funds to various options and periodic re-allocation is
usually taken by the contributing individual. The retirement corpus of the individual depends
on both the value of the contributions made and the returns generated through their
investment. There is transparency in the way the corpus is growing and allows for course
corrections at differentstagesin the accumulation stage. The DC schemes are simplerto move
from one employer to another. The National Pension System (NPS) applicable for central
government employees who joined service on or after January 1, 2004 is a defined
contribution pension plan. It has a corporate model too that has been adopted by companies
to provide retirement benefits to their employees.