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OLD AGE SOCIAL & INCOME SECURITY

The contribution rates of India 's workers are already amongst the highest in the world. There is hardly any scope to transform income in old age by raising the contribution rate.

The central factor which should be at work in saving for old age is the steady compounding, at the highest possible rates of return, of contributions through a person's working life. This steady accumulation, without any withdrawal, can generate a stock of wealth at retirement which may be entirely out of line with common intuition. For example, saving Rs.5 per working day from age 25 onwards leaves the worker with Rs.6,78,307 (measured in 1999 rupees) at age 60 at a nominal return of 12%. These numbers remind us that low contribution rates are not the essence of the problem. Today, in India, a contribution rate of Rs.5 per working day is possible for everyone above the poverty line and a person at age 60 with a stock of wealth of Rs.6,78,307 would not be destitute.

The terminal wealth at age 60 is highly sensitive to the rate of return. An improvement of one percentage point in the rate of return - i.e. from 12% to 13% - yields a corpus at age 60 of Rs.8,74,065. This is an increase of 29% as compared with what is obtained at 12%. If the interest rate goes up from 12% to just 14.75%, it yields a doubling in the corpus at age 60. Improving rate of return by such percentage points, without sacrificing long-term safety of funds, is possible by appropriate modifications in investment guidelines, and by entrusting funds to professional managers.

Such accumulation requires two ingredients: (a) high rates of return and (b) steady accumulation, without either withdrawals or interruptions to savings. The challenge lies in finding institutional mechanisms where individuals actually do save steadily through their working careers, and earn the highest possible rates of return for their wealth, so that the corpus created at age 60 is able to offer income security during old age.

The weaknesses of existing schemes lie in these two directions: low rates of return and poor accumulation. The rules governing withdrawal are excessively permissive, thus generating poor accumulation of wealth and a failure to harness the benefit of compounding over decades and provide enough for old age. When workers view their contribution as an escape from tax rather than savings that they benefit from, they would have strong incentives to withdraw early.

A similar problem is faced after age 60. We are increasingly in an environment where a worker at age 60 can expect to live beyond age 75. If wealth is rapidly spent away, then individuals may be destitute late in their lives. This process could be checked by access to a competitive market for annuities.

Systemic distortions and preferential treatment to certain provisions is undesirable and we need to strive towards creating an equitable environment and simplified provisions to encourage universal coverage both for employed persons as well as self-employed persons. Presently, contributions as well as interest earned of them are not taxed both in case of pensions and provident funds. But pensions, in the hands of, receivers are taxed whereas provident funds (including PPF) are not. This is a disincentive for contributory pensions and needs to be rectified. There is also a strong justification to tax receipts of accumulated provident funds.

Once the core problems of the system, which lead to poor accumulation of wealth at age 60, are adequately addressed, the incremental expansion of the coverage of the system would help raise the number of workers who save for old age in this
fashion.

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