Ask any individual who retired in India a decade ago what they did for financial planning and the answers are likely to be similar. Thanks to benevolent interest rates and a regulatory restricted investment universe, pension and retirement planning then amounted to allocating savings between a few standard instruments.
The options were bank fixed or term deposits, a public provident fund (PPF), or bonds and debentures issued by financial institutions. Some annuity products offered by the government owned Life Insurance Corporation of India were also available. The underlying theme was that these instruments were issued by trusted institutions and carried no risk of loss of capital. The most sophisticated investment strategy was to diversify investments between two or three instruments as a means.
Those days are well gone. The retirement planning landscape in India has undergone amazing changes. Instead of a limited universe of instruments plus a high fixed rate of return combined with safety of capital, individuals have to pick their way through a staggering diversity of products that in many cases provide no certainty about the final outcome of planning efforts.
Today the choices stretch from plans offered by multiple insurance companies to the New Pension System (NPS). The NPS is a retirement savings plan introduced by the government that is managed by professional fund managers and is now open for investment for everyone, including un-organized labor, the vast majority of India’s workers.
It is not only a question of multiple investment fields and issuers, but even within each field there is incredible choice. For example, it is not uncommon for insurance companies to offer more than one option in terms of pension plans as these differ by conditions and features.
Similarly the NPS has six fund managers offering three investment options each, so a choice has to be made in terms of allocation of amounts between 18 potential options within the NPS alone. Each of these options has a further subdivision of Tier 1 and Tier 2 accounts. This, along with their varying features, creates a complexity not previously witnessed in Indian pension planning.
FIXED RATE OF RETURN
A major change in the developing Indian market for pension products is the movement of risk towards the individual and away from the institution issuing the retirement or pension option. Earlier the nature of the instruments was such that all of them were fixed income where the rate of return was known at the time of investment.
There was also the option to lock in rates for a longer time. For example, bank deposits could be used for investments for a period of seven to 10 years with a fixed rate of return. Similarly bonds and debentures were available for 15 to 25 years with a high fixed rate of return. Today, returns on many instruments are market linked. The final amount received by an individual will be based on the performance witnessed over the life of the instrument.
Take the case of the NPS where an individual can choose between three different asset allocation options consisting of investment in equity, investment in fixed income instruments, and investment in government securities. In all areas the amount accumulated as retirement savings depends upon market conditions, so this brings an element of uncertainty into the planning process. In other instruments, like the PPF, the interest rate is now decided on an annual basis and can move up or down based on the state of the economy. Against this, the rate remained static between March 2003 and November 2011 at 8%.
The most dramatic change has been in returns generated by retirement instruments. In absolute terms, returns have actually been quite high, which also meant planning for retirement looked an easy task. Many individuals, especially those in the banking sector, took voluntary retirements at the turn of the century based on generous offers and the then available high returns. The PPF was providing interest earnings of 12% in 1999-2000. It was not uncommon for bond issues in the late 1990s to give interest rates of 14-15%.
Returns have now dropped significantly impacting retirement planning.
Returns have now dropped significantly impacting retirement planning. Long term bonds yield return around 8-8.25%. PPF returns dropped to 8%, but following a recent burst of inflation over the past couple of years have climbed again to 8.8%. High rates are increasingly looking unsustainable over the longer term considering the changing Indian economy. This will require a different approach by individuals planning for retirement as there will have to be either a larger savings amount available or individuals will have to take higher risk taken in the form of additional exposure to equities.
LONGER LIFE EXPECTANCY
The process of retiring and living a comfortable life afterwards was traditionally built upon two aspects of life in India. One was the joint family system where younger generation would take the responsibility of looking after the older parents. The other was that life expectancy was not particularly long after retirement. Both these have slowly changed, leading to the need for a rethink in the approach to pension planning in India.
In particular, the emergence of a nuclear family system echoes trends found in other countries that have gone through a period of rapid urbanization, such as South Korea and Taiwan. This is having an effect on the joint family system, which will be acerbated if the transition of Indian society continues to gather pace.
Dual working members in the family, jobs in a different city as well as migration both within the country and overseas have all contributed to the situation where parents are often living separately from their married children. In 2001, there were 15.7 million households with two family members and 21.2 million households with three family members.
The comparable figures in 2011 had risen to 23.9 million and 33.6 million households respectively. At the same time, households with nine members and more actually fell from 21.7 million to 16.3 million. This means the elderly can no longer automatically assume that retirement will involve a significant contribution from their children, but rather planning will need to be undertaken by the individual themself.
Rising life expectancies also complicate the planning of retirement. According to the latest data released in October 2012, life expectancy for an average Indian has gone up at birth by 4.6 years in 2008 compared to a decade earlier. The life expectancy has been growing steadily and like other developed countries there is a widening gap between Indian females and males. This creates a situation where the retirement planning has to be crafted for a longer time than has been traditionally catered for. Achieving this will require a different mindset compared to what has proved successful in the past.