Moves are afoot to make the Employees’ Provident Fund Organisation (EPFO), the institution that handles the retirement funds of over 4.5 crore Indians, more flexible and more market-oriented. Among other things, it has been reported that the EPFO may allow its subscribers to choose a higher investment in equity. There is also the possibility that a part of the payment on maturity, when a person retires, will be given in the form of units.

None of these proposals has yet been adopted by the organisation’s board of trustees, who are strongly resistant to change. However, change is inevitable in a falling interest rate regime, where both government bonds (which is where EPFO must invest most of its funds) and fixed deposits with banks are paying less. A 10-year government bond yields 6.7 per cent, and the top fixed deposit rate of the State Bank of India is 6.5-6.75 per cent (taxable), with senior citizens getting 7 per cent. In contrast, the EPFO paid out 8.65 per cent last year, lower than the 8.8 per cent given the year before. But this is far higher than market rates for long-term investments, and not sustainable.

Clearly, the EPFO cannot guarantee current payout rates, and sooner or later it must earn more from non-fixed interest avenues, including equity. To improve returns, the NDA government allowed EPFO to invest 5-15 per cent in exchange-traded funds (which are indirect stock investments that work somewhat like mutual funds by tracking indices like the Nifty or Sensex), and the results so far have been encouraging. The Economic Times reports that EPFO investments in equity over the last two years delivered cumulative returns of 13.72 per cent.

The major opposition to higher EPFO investment in equity, or giving subscribers the option to invest more of their savings in equity, will come from the trade unions, which fret that equity returns cannot be guaranteed. While this is true, the logical way to proceed would be to protect the returns of the smallest contributors – for example, those with total contributions of up to Rs 1 lakh over their lifetimes – and allowing the rest to take on more risks with higher equity allocations. Over long periods, say over 10 years, equity has always yielded higher returns than debt. This means those opting for a higher proportion of equity in their EPFO portfolios will get more handsome returns when they retire, especially since EPFO payouts on retirement are entirely tax-free.

However, two points are worth making. One, in making EPFO more flexible in terms of investment options, it is becoming more like the National Pension Scheme (NPS). And two, it does not make sense to have two similar schemes with different tax treatments. Currently, EPFO is EEE – tax-exempt at all three stages, entry, accumulation and exit. NPS is EET – contributions are exempt, and so are accumulations. At exit, the subscriber can opt for either investing 100 per cent of the accumulation in annuities, on which tax is payable annually. In the alternative, the subscriber can withdraw up to 60 per cent, of which 40 per cent is tax-free. Tax is paid only on the balance 20 per cent.

The government tried to make both EPFO and NPS similar in terms of tax treatment in the 2016 budget, but the union outcry forced it to reverse course.

The logical way forward is to “grandfather” the old tax-exempt EPFO scheme, which means making it tax-exempt (EEE) only for existing subscribers. For new entrants, it can be made like NPS.

Once this is done, subscribers should be free to migrate from the EPFO to the NPS or vice versa.

The reform EPFO needs is not only more investment in equity and taxation of a part of the end proceeds, but also competition from a rival option like NPS. Another change required is to offer a larger variety of annuity products for investment post-retirement. The LIC Jeevan Akshay VI, the most popular annuity option now taken, offers an annuity yield of 7.11 per cent at age 60. This is not bad given current interest rates, but for the last five years it has compared badly with mutual fund returns and even fixed deposits.

More options and more competition is the way to improve retirement corpuses for Indians.

(This article was first published in Dainik Bhaskar.)