Background

The Employees’ Pension Scheme, 1995 (EPS95) scheme is designed to provide a pension in retirement in exchange for contributions that have been made to the Employees Provident Fund Organisation (EPFO) over the working lifetime of an employee. Monthly contributions calculated at a rate of 8.33% of PF Wages and are currently allocated by the EPFO from the EPF employer contribution of 12% of PF Wages. The EPS95 is a defined benefit with its own formula which, at its maximum is currently capped at 50% of the final drawn PF Wages.

With effect from September 2014, the EPS95 contributions, as well as the final pension were calculated using a maximum eligible salary of INR 6,500 per month which was revised to INR 15,000 per month.

Interestingly, a provision has existed since 1996 within the EPS95 architecture for interested employees (with employer consent) to increase the contribution allocation to 8.33% on uncapped / actual PF Wages (i.e. even if it exceeded the capped salary mentioned above). This could be done either from the date of starting membership or at a time the actual salary breached the maximum threshold. The EPS95 scheme would then be obliged to pay a pension pegged to 50% of the actual final uncapped PF Wages as opposed to the maximum amount. 

Back in August 2014, along with the revision to the maximum permissible PF Wage, the EPFO introduced further amendments with effect from September 1, 2014, to the EPS95. These included:

  • Only those employees who had been contributing on a higher (than statutory ceiling) PF Wages base could continue to contribute on such higher salary subject to re-electing this option.
  • Those potentially eligible to continue the option had to notify the EPFO within a 6 month period from September 2014 to be able to continue on such a higher base of PF Wages.
  • New members joining after September 2014 would compulsorily not be admitted to EPS95.
  • EPS95 salary base would consider the average of last 60 months’ salary as against the earlier definition of average of last 12 month’s salary.

The above has not been extensively implemented since due to several legal proceedings in parts of the country against some of these changes.

A landmark judgement was made in response to several petitions in October 2018, when the Kerala High Court ruled that the notification issued by the EPFO in August 2014 was ‘arbitrary’ and therefore was to be set aside.

A recent Supreme Court judgement on 1 April 2019, upheld the above verdict in response to a special leave petition filed by the EPFO. A formal response to this verdict is currently awaited from the EPFO.

The implications

There are far reaching consequences of the above verdict for the EPFO and potential gain for employees:

  • Those employees who had previously chosen to contribute on their uncapped PF Wages would automatically continue to do so. Existing employees in the EPFO as on 1 September 2014, could choose to contribute to the EPS95 at the higher salary going forward and also make good any additional cash requirements for past contribution difference by moving a certain amount of corpus from their existing PF balance to the EPS95 account.
  • Employees who have joined the EPF after 1 September 2014 can also now be admitted to EPS95 and contribute at a higher rate. This benefit would be extended to any individuals who may also join the EPF in the future.

The position of employees already contributing at a higher salary was not impacted by the recent developments as they can continue to do so, as long as administrative or inspection charges as the case may be, were paid on higher PF Wages. The above verdict is likely to have significant consequences on the financial position of the EPS95 scheme. If a significant proportion of members of the EPF exercise their right to opt for a higher EPS95 pension, the liability on EPFO could be significantly high. We are not sure if an impact analysis of actuarial valuation of the liability has been done, but the differential cost will be more than what EPFO will get by means of a higher contribution to the EPS.

It is not out of the realm of possibility that the EPFO takes the matter up with the Supreme Court further for judicial review, even if it is for some parts of the Kerala High Court Order. During this time, employees and PF Trusts are likely going to have to wait for administrative implementation guidance from the EPFO.

In a note we published in June 2018, we had examined the potential extent to which the above changes could impact the financial position of the EPFO.

Conclusion

While the verdict may come as positive news for employees, particularly for those who are earning in excess of INR 15,000 and are looking for a higher guaranteed income in retirement (as opposed to a lump sum), we must not underestimate the financial burden it would place on the EPFO.

Employers would not likely be directly affected financially at this stage, but they will receive many queries from employees and those employers with exempt PF Trusts, will need to think about potential administrative implications.

We would expect employees to look to their employers for guidance on whether or not they should choose a higher EPS pension or retain the lump sum option. With corporate registration of the National Pension System (NPS) also on the rise (especially after recent announcements on further tax incentives), it is important that all possible retirement options are communicated to employees appropriately so that they are able to make informed decisions on their retirement savings.

Disclaimer: Nothing set out above should be taken to be formal legal or tax advice.