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Friday, Nov 14, 2003

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Supreme Court ruling — Easier to make EPF a pension scheme

Jayanthi Iyengar

The Supreme Court's recent decision upholding the validity of the government pension scheme started in 1996 will pave the way for the smoother conversion of the Government's provident fund scheme into a pension scheme.

THE Supreme Court this week took a decision that will strengthen the Government's hand more effectively than anything else in converting its provident fund scheme into a pension scheme.

In the ruling passed on November 11, the apex court upheld the validity of the government pension scheme started in 1996. It is not an independent scheme but is part of the employees provident fund scheme in the sense that 4 per cent of the employer's contribution to the Employees Provident Fund (EPF) mandatorily finds its way into the Employees Pension Scheme (EPS).

Thus, to participate in the scheme, a person has to be employed, has to be in organised sector, and working with an organisation covered by the EPF. This means all organisations, excluding the government, employing 20 employees and above.

The EPF covers less than one per cent of the country's employed population, yet its importance lies in the fact that it is the only pension scheme, excluding the government pension scheme, available in the country. It is a contributory scheme, which makes it modern and sustainable. It is mandatory — ideally, it should be voluntary as planning for old age is a personal responsibility — but, still, it is a contemporary model, worthy of replication countrywide.

The EPS was challenged in the apex court by employees' associations, both public and private, whose establishments are covered under the EPF. The employees' associations have a say, not only because these are employees' savings and they represent the interests of the workers, but also because they manage EPF trusts in many organisations.

This is made possible by the EPF Act, which permits employers to participate in the government-managed scheme or trusts set up within their organisation and managed by the representatives of employees. In the EPS, the argument of the employees' association before the court was that the scheme was arbitrary and that they were better equipped to manage a pension scheme for employees. Some of the issues raised by the employees' associations are not necessarily invalid. The government's management of the EPF through its board of trustees has hardly inspired confidence among its members. When one looks at the EPS specifically, its structuring is so faulty that many of its members do not even know they hold a pension cover, as the contributions go directly from the employer to the scheme.

The Board of Trustees which manages the Employees Pension Scheme is also not famous for adopting international best practices. Nor are statements issued regularly to keep employees informed of the status of their savings. The apex court's ruling has, thus, come at the right time. For two years now, government functionaries, backed by experts, have been trying to convince the political leadership of the need to convert the existing EPF into a pension scheme. This can be done by a simple enough procedure.

At the moment, withdrawals from the EPF are permitted for specified reasons, such as marriage, mundan (tonsure ceremony), children's education and house-building. In order to convert the scheme into a pension scheme, such withdrawals would have to be stopped. They could be done directly, which would be effective but unpopular. Or it could be introduced subtly by discouraging withdrawal.

Introduction of deterrents is also easy. These schemes enjoy a tax cover. Fine-tuning tax concessions to cover only net and not gross savings would automatically make withdrawals unattractive.

The extension of tax benefits to net savings is also sound in law — yet, despite all these reasons, the political leadership has been hesitant to introduce deterrents as they could be viewed by the "vocal" segments of the voting public as being regressive at a time when interest rates are falling and people's nest-eggs have seen severe erosion in value.

The timing of the Supreme Court ruling is heaven-sent, in that sense. Many know that the corpus of the EPF is roughly Rs 56,000 crore. Yet, very few know that the corpus of the EPS is equally large, at around Rs 35,000 crore.

This corpus has been growing unfettered, as it has remained untouched since inception because, unlike the EPF, withdrawals from EPS are not possible. In order to draw a pension, an employee has to participate in the scheme for a minimum of 10 years.

Since the EPS began in 1996, the payouts from the scheme will begin only from 2007 onwards. Hence, the corpus has been growing, but what is significant is that though contributions to it are one-sixth of what gets contributed to the EPF, its corpus has grown faster than that of the provident fund scheme. This is known as the magic of the money multiplier.

The apex court's ruling has opened the route for this multiplier to demonstrate its prowess fully. Tomorrow, when the Government is able to bring more organisations under the EPS, based on the apex court's ruling, ordinary savers will be able to understand first-hand the advantages of letting their money grow.

That in itself would be a service when it comes to paving the way for the country's soon-to-be introduced privately managed pension scheme.

(The author is a freelance writer and can be contacted at

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