PENSION SCHEMES (ALL ABOUT PENSION SCHEMES - WHICH YOU MUST WANT TO KNOW)

Pension is a regular monthly payment to a retired employee throughout his life after retirement. Unlike Gratuity, it is not compulsory on the part of the employers to provide pension to their employees, except under the Provident Fund Act, where 8 and 1/3 % of the employer’s contribution to the provident fund is diverted to a pension fund and the employees are eligible to get a certain amount of pension.

After the retirement, the salary stops, but the needs of the person continue. Under the joint family system, the responsibility of taking care of the elderly was with the joint family and hence the difficulties were not felt so much. But with the breaking up of the Joint Family System, it is necessary for everyone to think of his old age and provide for a steady income throughout his life. The pension available under the PF Scheme as above is very meagre.

Also the longevity of the people is steadily going up. The average age of an Indian was about 35 in 1947, whereas it is now about 60. Because of medical improvements, people are living longer, but the number of people coming into the world is reduced by family planning methods. So the people of above age 60 as a percentage of population which is about 6-7% now, is expected to increase to 25% in about 20-25 years time.

As it is not a statutory benefit, the pension benefits as a retirement benefit are available with only a few employers in the private sector. The Central Government
Employees and many public sector employees get pension benefits.

In this article, we will see how the pension benefits can be arranged, how they can be funded, what benefits are to be provided and the allied legal, technical, taxation and administration aspects.

The employee pension schemes are called Superannuation schemes and they are generally of two types.
1. Defined Contribution or Money purchase and
2. Defined Benefit or Benefit purchase.

1. Defined Contribution or Money Purchase: In this type of scheme the employer and/or the employees contribute a percentage of salary towards a pension scheme. This is accumulated with interest up to the date of retirement. On the date of retirement, the accumulated amount is used to buy an annuity from an insurance company. No actuarial valuation is needed for Defined contribution schemes.

2.Defined Benefit or Benefit Purchase: In this type of scheme the pension is fixed normally as a percentage of final salary per year of service subject to certain maximum limit. For example, for Central Government and State Government employees, the pension is fixed at 1/66 of final salary per year of service subject to a maximum of 50% of final salary. That means an employee will have to put in at least 33 years of service to get the maximum pension of 50% of final salary. If the service is less he will get a proportionately lower pension.

Administration.
If the company decides to give pension benefits to its employees, what are the steps to be taken? First the company has to decide what type of pension, whether defined contribution or defined benefit scheme is to be determined. Once this is determined the company should create an irrevocable trust and appoint 2 or more trustees to administer the scheme. The Trust Deed and rules are to be framed. This will mainly deal with the conditions for eligibility of pension, how the employer will make the contributions and how the benefits will be paid to the employees. The trust will be for the purpose of the pension scheme only and trustees will administer the scheme

For the pension scheme, the employer will have to decide whether all categories of employees will get pension or only certain categories of employees will get pension. Then the rate of contribution is to be fixed. Under the Income Tax Act, employers can make a contribution to a superannuation scheme not exceeding 27% of salary inclusive of his contribution to Provident Fund. As the PF contribution now is 12%, the employer can contribute a maximum of 15% of the employee’s salary towards the superannuation scheme.

For a defined benefit scheme, the formula for fixing the quantum of pension is to be decided. It can be let us say 1.5% of salary for each year of service subject to a maximum of 50% of final salary or any other formula. But as the contribution required to get this pension is not easily determinable, an actuarial valuation is to be done by an actuary, and the company will have to contribute the amount required as per the actuarial valuation.

Because of the difficulties of determining the contribution, which will be uncertain depending upon many factors like future salary increases; the probabilities of death, resignation etc., many companies prefer a defined contribution scheme. Even the Central Government, which was giving a defined benefit scheme to its employees till
31-12-2003, has decided to change to a defined contribution scheme with effect from
01-01-2004.

The Trust Deed and Rules are to be approved by the Commissioner of Income – Tax as per the provisions contained in the part ‘B’ of the fourth Schedule of the Income Tax act 1961, so that they will qualify for approval. The following income-tax benefits will accrue to the employer and the employees:

(1) The employer’s ordinary contributions within the prescribed limits (which is 27% including the contribution to PF at present) will be allowed as deduction for the purpose of computation of profits and gains of business .
(2) The employer’s contributions will not be treated as perquisites in the hands of the employees.
(3) The employee’s contributions will qualify for income tax relief under sec 80-C of the Income- tax act 1961.
(4) The interest income from the investments will not be taxable.

The pension schemes can be contributory or non-contributory. In the first one only the employer contributes and the benefits accrue to the employees. In the second scheme, both the employer and the employee contribute for the scheme.

The trustees can manage the funds in two ways.
1. They can invest the fund moneys as per the pattern given by the Government and purchase annuities from an Insurance Company,
2. They can enter into a scheme with any Insurance Company offering a pension scheme.

The benefits payable:

At the time of retirement, death or resignation, the trustees will have to arrange for pension payments to the depending upon the eligibility conditions. If it is a trust managed scheme, they have to withdraw the money from the trust and purchase annuities from an Insurance Company. In case of Insured schemes they have to advise the Insurer to commence the pension.

Commutation : A part of pension within the prescribed limits can be commuted for a single lump sum payment. Under Section 10(13) of the Income Tax Act, the commuted value is not taxable if one third of the pension is commuted and the employee is eligible for gratuity. The family pension payable on the death of a member is not taxable. However the pension payable to an employee will be treated as salary and is taxable under section 17 (1) (ii) of the Income tax Act.

The various options available to the pensioner are given below.

1. Life annuity : payable throughout life of the annuitant, on death nothing is payable.
2. Life annuity guaranteed or certain for 5,10,15 or 20 years: payable throughout the life of the annuitant or the certain period, whichever is later.
3. Life annuity with return of capital: payable throughout the life of the annuitant and on his death the capital amount or purchase price is returned to the nominee.
4. Joint Life annuity: payable throughout the life of the annuitant and continued to the spouse throughout his\her life.

The pensioner can choose one of the options and the Insurance Company will start paying the pensions.