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Why Supreme Court ruling on higher pensions will bankrupt EPFO

The Financial Express
supreme court, sc

It is unfortunate that the Supreme Court chose to dismiss the petition against a Kerala High Court verdict on pensions that was filed by the Employees Provident Fund Organisation (EPFO). The ruling has the potential of bankrupting the EPFO that has crores of subscribers unless the government steps in to fund the largesse; it also opens the EPFO to the possibility of huge fraud. The Kerala High Court ruling essentially replicates the government s erstwhile pension scheme where employees were given half their last salary as pension for life; but since the scheme was becoming unviable as the costs were spiraling as the number of retirees kept rising, the government itself moved away from the scheme and, from 2004, no new government employee is entitled to this. What was unviable for the government is now to be implemented for the general public.

Right now, 24% of every employee s basic salary and DA is deposited with the EPFO and, of this, about a third (8.33%) is deposited with the Employees Pension Scheme (EPS) portion of the EPFO. So, if an employee has a basic salary of Rs 15,000 per month at the age of 25 and this rises by 5% every year, her salary will be Rs 75,048 at the age of 58 when she retires; this means a monthly pension of Rs 37,524 or Rs 450,288 per year is to be paid. By this time, assuming an 8.33% EPS contribution on her actual monthly basic pay, however, she has a corpus of Rs 12.8 lakh which is clearly not enough to pay for the pension. While no interest is paid on EPS today, let s assume a 7% accrual on this as well, in keeping with the returns on the rest of EPFO contributions. Based on this, the retirement corpus rises to Rs 37.9 lakh. Assuming this is able to earn the same 7% interest, that gives you a yearly sum of `2.7 lakh as opposed to the required Rs 4.5 lakh. Of course, if the interest rises to 9%, the corpus rises to Rs 55 lakh and that is more than enough to service the pension if you assume this corpus earns a 9% return as well till the day you die.

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The problem, however, is that no one can guarantee what returns will be earned, which makes the guaranteed pension a huge potential liability. While this possible gap in earnings was always an issue at every salary level, restricting the EPS payout to those who earned under Rs 6,500 this was later raised to Rs 15,000 at least kept the amount that would be needed low. What is not clear from the SC s rejection of the petition against the Kerala High Court ruling is whom it expects to make good the gap; and if this is done for one set of employees registered with the EPFO, surely it needs to be done for others as well?

The possibility of huge fraud can make the funding even more expensive. Take the case of an employee earning Rs 25,000 till a year before retirement. If she is now able to convince her employer to raise the salary to Rs 100,000 and promises to pay back the difference in cash every month she is now entitled to a pension that is double her last salary. It was to protect against this possibility that the EPFO said it would use the average of the last five years of employment to calculate the pension payable; the period was sufficiently long enough to prevent employer-employee collusion. The Kerala High Court, however, rejected this as being unfriendly to employees. With the Supreme Court now clearing the path for implementing the Kerala High Court verdict, it remains to be seen how EPFO remains solvent while, at the same time, giving pensions so generous even the government couldn t afford it.