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Defined Benefit Vs. Defined Contribution

Defined Benefit Vs. Defined Contribution. Existing PRBS (Post Retirement Benefit Scheme) is a defined benefit scheme. From 01.01.2007 the Scheme will be converted to a defined contribution scheme. Defined Benefit.

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Defined Benefit Vs. Defined Contribution

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  1. Defined Benefit Vs. Defined Contribution Existing PRBS (Post Retirement Benefit Scheme) is a defined benefit scheme. From 01.01.2007 the Scheme will be converted to a defined contribution scheme.

  2. Defined Benefit Defined Benefit Scheme: A defined benefit (DB) plan is a plan in which the benefit on retirement (pension) is determined by a set formula. For example Rs.100 pension for each month of service. The funds are managed from a common pool to which the employer and plan members contribute.

  3. Defined Contribution Defined Contribution Scheme: In a defined contribution plan, contributions are paid into an individual account for each member. The contributions are invested and the returns on the investment are credited to the individual's account. Similar to our PF account. On retirement, the accumulation in the member's account will determine the pension.

  4. The New Scheme As per the DPE Guidelines, an employer can contribute 30% of an employee’s Basic + DA towards retirement benefits w.e.f. 01.01.2007. The retirement Benefits include PF, Gratuity, Medical Benefits and Pension. Currently 12% is contributed towards PF, gratuity accounts for 1.5%. Medical benefits for the period 2007 to 2012 are valued at 1.5%.

  5. The New Scheme The balance 15% will be contributed towards the pension scheme. (The medical benefits and gratuity % will be reviewed every year, as such the % of pension contribution will vary) In addition to the employer contribution, employee will contribute 3% of his Basic + DA (Contribution to start from 01.04.2012). Further the existing contribution equiv. to Uniform Allowance will continue without any change.

  6. The New Scheme Thus the individual’s pension account will receive three contributions: Employer’s Employee Amount Contribution + Contribution + Equiv. to (balance of 30%) 3% Uniform all. The trust will invest this amount and interest credited to individual’s account.

  7. The Existing Scheme The Total corpus under PRBS as on 31.12.2006 is to be transferred to the individual account under the new scheme through a defined formula. Under the new scheme each employee will get a regular monthly employer contribution to his account. The later the retirement beyond 2007, the more the contribution will be. While employees retiring nearer to 2007 will not be able to build a big corpus under new scheme

  8. Conversion of the Existing Scheme As such the conversion formula takes into account the length of service the employee has put in till 31.12.2006, the period for which he has been a member of the PRBS and his basic pay as on 01.01.2007 (revised). The formula aims to provide benefits in terms of the above three factors.

  9. Conversion Formula The conversion formula is: Every employee who has completed 33 years of reckonable service (as defined under the PRBS) will be given a pension of 50% of his basic salary as on 01.01.2007. This pension amount will be converted into annuity corpus by multiplying with the annuity factor of 132.59669 (the rate as on 31.03.2012).

  10. Conversion Formula For example if an employee has a basic salary of Rs. 50000 as on 01.01.07 and has completed 33 years of reckonable service. The pension amount will be 50000 * 50% = Rs. 25000 And the conversion corpus will be: 25000 * 132.59669 = Rs. 33,14,917

  11. Conversion Formula The percentage pension will be proportionately reduced for reckonable service less than 33 years. For example if the employee has completed 25 years of reckonable service with basic as 50000 as on 01.01.2007. The applicable conversion pension will be: 50% * (25/33) * 50000 = Rs. 18939.39 And Conversion pensionable corpus will be 18939.39 * 132.59669 = Rs. 25,11,300.95

  12. Conversion Formula However the conversion benefit will be payable only on the date of retirement i.e. the employee has earned the pension benefit but the pension has not become due. It is due only on the date of retirement. If in the example above, the employee is actually retiring on 30.06.2015, the pension corpus of Rs. 25,11,300.95 earned by him as on 01.01.2007 is payable only on 30.06.2015.

  13. Conversion Formula The corpus to be transferred to the employee’s account as on 01.01.2007 will be arrived at by calculating the present value (as on 01.01.2007) of Rs. 25,11,300.95 payable on 30.06.2015. In simple terms it means how much should be invested as on 01.01.2007 given a return percentage so that it grows to Rs. 25,11,390.95 on 30.06.2015. The return percentage is the discounting factor.

  14. Conversion Formula The rate of return or the discounting factor used in the conversion formula is 9.5%. So the conversion benefit in the above example will be the amount to be invested on 01.01.2007 which earns 9.5% every year, so that it grows to Rs. 25,11,300.95 on 30.06.2015, which will be: 2511300.95 / (1+9.5%)^8.5 = 11,61,124.39 Thus Rs. 11,61,124.39 will be transferred to the employee’s account in the new scheme from the old scheme.

  15. Conversion Formula Thought the scheme is applicable from 01.01.2007. The DPE guidelines had been finalised only by 2009. The conversion workings were completed by 2012. As such the effective date of corpus transfer has been kept as 31.03.2012. So the discounting of the conversion corpus will be done till 30.03.2012 instead of 01.01.2007. In the example above, the conversion corpus will be: 2511300.95 / (1+9.5%)^3.25 = 18,69,833.23

  16. Conversion formula As a result of the conversion formula, the conversion corpus for some of the members will fall below the actual contribution put in by the members till 31.12.2006. For such cases the contribution made till 31.12.2006 along with 8.5% interest will be the conversion corpus. Thus the higher of the contribution with 8.5% interest or the amount arrived at by the conversion formula, will be transferred to employee’s account. As per our analysis, officers joining on or after 1995 will have to be provided protection of corpus with interest.

  17. Conversion Formula Based on the above conversion methodology, the fund position as on 31.03.2012 was reviewed and a shortfall of Rs. 1624 crores was envisaged. The infusion of this amount for conversion of the scheme has been approved by the ONGC Board as well as the Ministry.

  18. Income Tax Impact As per section 17(2)(vii) of the IT Act any contribution by the employer to the superannuation fund of an employee above Rs. 1.00 lac is taxable. During the Year 2007 & 2010 PRBS was reviewed and around Rs. 900 crs & Rs. 160 crs. was infused by ONGC in the scheme. This infusion had exhausted the exemption limits for the years 2007-08 to 2010-11.

  19. Income Tax Impact The conversion is being effected in the year 2013-14. Thus for tax purposes, the consolidated impact from 2007-08 to 2013-14 will be considered i.e. the employer’s contributions made from 2007-08 to 2013-14 along with conversion corpus received from Rs. 1624 crore infusion as reduced by the exemption limits for the year 2011-12 to 2013-14 (Rs. 3.00 lacs) will be taxable.

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