The Atal Pension Yojana (APY), which the finance minister announced in the recent Budget, will be focussed on all citizens in the unorganised sector and who are not members of any social security scheme. Under the APY, the subscribers could choose to receive a fixed pension of Rs1,000 per month, Rs2,000 per month, Rs3,000 per month, Rs4,000 per month, Rs5,000 per month, at the age of 60 years, depending on their contributions, which itself would vary on the age of joining the APY. Will this take off? The Government had started what is called the Swavalamban Scheme in 2010-11. However, coverage under Swavalamban Scheme is poor because there is no incentive to push them and nobody takes ownership.

This scheme will benefit non-tax payers and those who are not yet covered under a social security scheme. But for most of those living in urban areas, a pension of Rs5,000 per month will be insufficient. For example, for a 40-year old who will have 20 years till retirement, a pension of Rs5,000 will be worth just Rs1,292 i.e. Rs40 per day. This is assuming a rate of inflation of 7%. We all know that the rate of inflation will be much higher in urban areas. For a younger person of 25 years and assuming an inflation rate of 9%, the pension of Rs5,000 per month at the time of retirement will work out to just Rs245 per month.

As you can see, there is a high inflation risk.

How much is the effective interest you can earn on the savings? Unfortunately, it will not even earn recurring interest rates that banks give. Here is a reverse calculation we did to work out the interest amount both during the accumulation phase.

For a monthly pension or Rs5,000 you would need a corpus of approximately Rs7.50 lakh assuming an interest rate of 8% post-retirement, using the formula for perpetuity. A 30-year old, who contributes Rs577 monthly, will earn an interest of 7.32% annually to reach the corpus of Rs7.50 lakh in 30 years. Therefore, the effective interest earned on contributions is just about 7.32%. Below we have worked out the effective interest rate for different entry ages and contribution amount.

Monthly contribution for a pension of Rs5,000 per month

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Update:

On digging through additional documentation on the APY scheme, we learned that the scheme will return the corpus to the nominee after the death of the beneficiary. For the pension of Rs5,000 per month, the indicative corpus is Rs8.50 lakh. This corpus will remain intact while the beneficiary gets a pension of Rs60,000 per year. Which means post-retirement, the corpus will earn a very moderate rate of interest of 7.06% p.a. to get an interest income of Rs60,000 per year.

To reach this corpus of Rs8.50 lakh at the time of retirement, the subscriber will need to earn an interest rate of 7.94% p.a. on his contributions. If we include the government contribution which will be capped at 50% of the contribution or Rs1,000 p.a., whichever is lower, the effective interest rate works out to 7.96% p.a.

Therefore, the growth rate of the corpus is still lower than the one-year bank FD rate which is around 8%-8.50% p.a.

It may look like a difference of a few basis points, but over a period of 30 years, the difference can mean as much as 10% on the higher side. For example, a monthly contribution of Rs500 per month at the rate of 7.94% p.a. will lead to a corpus of Rs7.36 lakh. In the same case, if the rate earned is 8.50% p.a., the corpus accumulated would be Rs8.25 lakh, nearly 12% higher.

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As for those who are not income tax payers, the Central Government would also co-contribute 50% of the subscriber’s contribution or Rs1,000 per annum, whichever is lower, to each eligible subscriber account, for a period of five years, i.e., from 2015-16 to 2019-20, who join the NPS before 31st December, 2015. The APY would be launched from 1 June 2015. The existing Swavalamban subscribers between 18-40 years will be automatically migrated to APY.

Below are the details of the scheme:

Age: The minimum age of joining APY is 18 years and maximum age is 40 years. Therefore, minimum period of contribution by the subscriber under APY would be 20 years or more.

Eligibility: APY is open to all bank account holders who are not members of any statutory social security scheme. An income tax payer or who is covered under statutory social security schemes can also join APY but those subscribers will not be eligible for government contribution (See-Additional Benefits).

Benefit of APY: Fixed pension for the subscribers ranging between Rs1,000 to Rs5,000.

Contribution amount: Subscribers are required to opt for a pension from Rs1,000- Rs5,000 as per a chart (detailed below) and ensure payment of stipulated monthly contribution regularly. Subscribers can opt to decrease or increase pension amount during the course of accumulation phase. However, the switching option shall be provided once in year during the month of April. A detailed APY contribution chart for different age level shall be supplied by PFRDA to all the banks for reference.

Payment option: Monthly. All bank account holders under the eligible category may join APY with auto-debit facility to accounts. The subscribers should keep the required balance in their bank accounts on the stipulated due dates to avoid any late payment penalty.

Late payment: Late payments will be charged be Re1 to Rs10 per month depending on the contribution amount.

Where to enrol: All Points of Presence (Service Providers) and Aggregators of National Pension System. The banks, as POP or aggregators, may employ BCs/Existing non-banking aggregators, micro insurance agents, and mutual fund agents as enablers for operational activities.

Additional Benefits: The government would co-contribute 50% of the subscriber contribution or Rs1000 per annum, whichever is lower, for those who are not income tax payers.

Distribution phase: Upon completion of 60 years, the subscribers will submit the request to the associated bank for drawing the guaranteed pension.

Tax: This scheme is mainly targeted at non-tax payers and those not cover under a social security scheme. Hence, there is no tax benefit on contributions. In the distribution phase too, the pension income is not exempt from tax. It will be added to your income and taxed accordingly.