Explainer: New EPS rules and why higher pension will come at a cost

Employees need to weigh the pros and cons before opting for a higher pension; EPFO also needs to clarify how the higher contribution to EPS will be funded

What happened in 2014?

In 2014, the Employees’ Provident Fund Organisation (EPFO) raised the ceiling on the Employees’ Pension Scheme (EPS) from Rs 6,500 to Rs 15,000. It said then that people could not contribute above this limit of Rs 15,000. The matter went to court.

What did the Supreme Court (SC) say in its November 4, 2022 judgment?

The SC made several points. One, it said those who were employees before September 1, 2014, and who have continued to be employees after that date, need to be given an additional four months to make the choice of whether or not to opt for higher pension.

Second, the Court said that the higher limit of Rs 15,000 is valid.

Third, it said that for those who want to contribute amounts above Rs 15,000, the EPFO should come up with a plan to fund it.

(Currently, the contribution to EPS comes only from the employer. It is 8.33 per cent of the employer’s contribution, subject to the Rs 15,000 ceiling. The entire contribution of the employee goes to EPF.)

Four, earlier the EPS was calculated according to the following formula: (Last 12 months average salary x number of years worked)/70. The Supreme Court said that you need to take the average of the last 60 months' salary (instead of 12).

What has the EPFO done in its February 20, 2023 circular?

The EPFO has opened the window for employees who were on the payroll on September 1, 2014 and who have continued thereafter, to choose a higher level of contribution to EPS if they want to.

Those who wish to contribute more, have to do so before the deadline of March 3.

EPFO has also outlined the procedure for those who want to contribute a higher amount. They need to apply online, both employer and employee need to agree to this, and then EPFO will scrutinise each application on a case-by-case basis before it gives the approval.

This circular basically offers an opportunity to those who want to contribute more than Rs 15,000 to get the permission to do so.

What is not known here?

What is not clear is how the higher contribution will be funded. EPFO has said it will issue more circulars on this.

What will the impact be if you opt for contribution on an amount above Rs 15,000?

Suppose the EPFO says that employees must also contribute to amounts higher than Rs 15,000. Today the employee’s entire contribution goes to EPF. If a part of it gets diverted to the EPS, then the contribution to EPF could decrease.

If employees have to contribute over and above their current contribution (12 per cent), their cash in hand would reduce.

Another key question is whether the higher contribution to EPS will happen from 2014. In that case, if the employee needs to contribute, then the amount could run into a few lakhs (because contribution would be for more than eight years).

The law currently says that the employer has to contribute only till the ceiling of Rs 15,000. “The facility to contribute above Rs 15,000 exists, but the employer is not bound by law to contribute,” says Arnav Pandya, founder, Moneyeduschool.

If employers have to contribute for amounts higher than Rs 15,000, they may ask for this amount to be adjusted against the contribution already made to EPF. They may ask for money to be transferred out of their contribution to EPF (to EPS). This will reduce the final EPF corpus.

Future contributions from the employer to EPF may also be reduced.

Explain the impact through an example

Suppose your salary is 50,000. Your employer contributes 12%, which comes to Rs 6,000. The Employer contributes 8.33 per cent up to Rs 15,000, which is Rs 1,250. The remaining Rs 4,750 goes to EPF.

In the future, if the employer has to contribute the entire 8.33 per cent of Rs 50,000, which is Rs 4,165, then the amount which will go to EPF will be only Rs 1,835.

So you might get a higher pension, but you will get a lower EPF amount.

Should you make a higher contribution?

Contributing more to EPS may make sense for people who want to get a higher pension, and take care of their family also. Remember that the pension goes to the spouse and children also after the death of the pensionable member. That can make it attractive for those who want additional stability.

With life spans growing longer, a higher pension can be worthwhile. Besides, in a low interest rate environment (which is likely over the long term), if you get a lump sum (from the EPF corpus) it will be difficult to generate a higher level of income.

Financial planners say the answer is not clear at present. “Clarity needs to emerge on how the higher contribution will be funded, and by whom—the employer or the employee,” says Pandya.

He adds that if your salary is not too much above Rs 15,000, then going for a higher pension may not hurt you too much, and you will be able to earn a higher pension. But if it is much higher, then you have to factor in the above-mentioned aspects.

What is the bottomline?

The bottomline is that every person will have to make a sacrifice somewhere. The higher pension will come at a cost.