Mumbai: Pension Fund Regulator (PFRDA), is considering a fifth option for investments of contribution made by government employees under the new pension scheme.
Called Default Option, it is a life—cycle fund under which the amount of money invested in equity would be more in the initial stages while in the later stages, more money would be invested in debt instruments.
“We are considering the Default Option which is a life—cycle fund. The Deepak Parekh committee which is looking at various investment plans for pension scheme is also considering this option. The committee is expected to submit the report by 30 November,” PFRDA Chairman, D Swarup said.
“Once recommended PFRDA will take a view on it. It could be one of the options,” he said.
The Default Option, which is more balanced, provides a return which is much more than the option where money is invested wholly in debt instruments but certainly gives less returns than high—risk fully equity—based investments.
“Default Option has become a global trend. It is a future pension plan. In a country like India where financial literacy is very low and there is an inability to sense future risks, Default Option will be an appropriate option,” LIC Pension Fund Chief Executive Officer, H Sadhak, said.
“The Default Option also provides for portabilty which means an employee’s pension would be protected if he switches job from the government to private sector,“ Sadhak said.
“Presently, the option of portabilty is not available in India,” he said.
“Wherever the pension system has been reformed, the default scheme has been introduced. There is a strong case for its introduction in view of the low—level of financial literacy and high-risk involvement in retirement,” Sadhak said.
Under the new pension scheme which is mandatory for all central government employees who have joined service after January 2004, there are four options available.
These include a totally risk—free option wherein the entire money is invested in debt instruments. The other three options vary the risk factor by blending debt and equity instruments in different proportions.
The New Pension Scheme is now managed by three companies, LIC Pension Fund, SBI Pension Fund and UTI Pension Fund.
The three companies are completing one year in March next.
Elaborating further on the Default Option, Sadhak said: “Default Option is somewhere between an equity scheme, equity plan and bond plan.”
Default Option is age—based investing as against mutual funds which is risk—based investing. “Here, as your age increases, more investment would be allotted to debt instruments and hence it is more secure,” Sadhak said.
“At the early stage of Default Option, the return is expected to be very high because more money is invested in equity and at the later stage equity investment will be reduced and hence risk level will also come down and probably the return will also be less,” Sadhak said.
“I have also designed some simulation studies,” he said, adding: “Ultimately there are two considerations for retirement income — its safety and the returns — and the Default Option provides both of them”.
Default Option is widely accepted in various countries. In the US, 80% of new entrants opt for the default scheme. In the UK and Sweden, around 82% and 92% of employees go for the Default Option, respectively.
“Keeping in view the wide acceptance of Default Option in other countries, there is a need for having such an option in India too,” Sadhak said, adding: “Default Option is a must for our country.”
“An employee under this option can also switch from one fund manager to another or from one scheme to another,” he said.
Default Option would be a boon for those employees who cannot assess risk due to low financial literacy and inability to take investment decisions.
“If an investor cannot exercise his active investment choice (informed investment decision), then he can go in for the default option where the amount of investment to be done in equity, debt or any other instruments is pre-determined,” he said.
“By selecting the Default Option, a person can leave risk for the fund manager,” he added.
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