Pensions and Other Benefits
SA4 Pensions and Other Benefits tests the design, funding, accounting and regulation of retirement benefits: defined benefit and defined contribution schemes, gratuity, superannuation, NPS and annuities. Questions often mix a valuation calculation with accounting or funding judgements.
Core rules and concepts
- DB schemes promise a benefit and carry longevity, investment and salary risks; DC schemes carry contribution and investment risk for the member.
- Gratuity under the Payment of Gratuity Act uses 15/26 × last drawn salary × years of service, with a ₹20 lakh tax-exemption ceiling.
- Actuarial valuation normally uses the projected unit credit method; AS 15 (revised) / Ind AS 19 set the accounting assumptions.
- Key assumptions: discount rate based on market yields on government bonds, salary escalation, mortality, attrition and medical inflation.
- NPS is contributory with individual accounts; at retirement a minimum portion must be annuitised, with the balance available as lump sum.
Worked example
An employee has annual salary ₹600,000, five years' service, retires in ten years with fifteen years' total service. Salary grows 5% and the discount rate is 7%; gratuity is 15/26 of final salary per year. Final salary = 600,000 × 1.05¹⁰ = ₹977,337. Retirement benefit = 15/26 × 977,337 × 15 = ₹8,457,724. Discounted to today = 8,457,724/1.07¹⁰ = ₹4,299,000. Accrued benefit for five of fifteen years = 5/15 × 4,299,000 = ₹1,433,000. The reasoning: project final salary, apply the benefit formula, discount, then attribute the accrued portion.
Traps that cost marks
- Using current salary instead of projected final salary for gratuity.
- Confusing the tax-exemption ceiling with a cap on the benefit itself.
- Using expected asset returns as the discount rate for accounting.
- Ignoring attrition, mortality or past service cost in valuations.