New & Old Pensions Scheme in India
In recent months, several states have seen protests by government employees over the present pension scheme and demanded a shift back to the Old Pension Scheme.
While moving the Finance Bill 2023 in the Lok Sabha for consideration and passage, Sitharaman said representations were received that the national pension system for government employees needs to be improved.
“I propose to set up a committee under the finance secretary to look into this issue of pension and evolve an approach which addresses the need of employees while maintaining fiscal prudence to protect the common citizens. The approach will be designed for adoption by both central and state governments,” the Finance Minister said.
Five non-BJP states namely, Rajasthan, Chhattisgarh, Jharkhand, Punjab, and Himachal Pradesh have informed the Centre about their decision to revert to the old pension scheme.
Protests for the same are currently taking place in Haryana. Earlier this week, Maharashtra government workers called off their strike after the government announced the formation of a three-member committee to conduct a comparative study of the old and new pension schemes and submit a time-bound report.
From 2004, the Central government, under then Prime Minister Atal Bihari Vajpayee, discontinued the Old Pension Scheme and introduced the National Pension Scheme (NPS).
The old pension scheme and the new pension scheme are both retirement savings plans, but they differ in terms of their approach to creating a secure financial future.
Difference between Old & New Pension Scheme
- In the old regime, pension was 50% of the last drawn salary of the employee and the entire amount was paid by the government.
- In NPS, 10% of basic salary and dearness allowance (DA) is compulsorily deducted from an employee’s salary, and the government adds the same amount to the pension fund. The employer contributes 14% for the pension corpus.
Only government employees are eligible for receiving a pension under the old pension scheme after retirement. On the other hand, the new pension scheme can be availed by all citizens between 18 and 65 years.
Under the old pension scheme, income is not subject to taxation. However, under the new pension scheme, 60% of the corpus on maturity is tax-free, while the remaining 40% is taxable when invested in annuities.
The old pension scheme provides return certainty, as it bases the monthly pension on the last wage received by the employee. On the other hand, the new pension scheme offers market-linked returns without any guarantee.
Crux of the Challenge
Population– India’s elderly population has been steadily increasing since 1961. Between 2001 and 2011, more than 27 million people were over the age of 60. According to the Report of the Technical Group on Population Projections for India and States 2011–2036, it anticipates in 2021, it represented a roughly 34 million elderly persons increase over the Population Census of 2011, with an additional 56 million elderly people expected to be added in 2031.
Life Expectancy– As per UN estimates, India’s life expectancy, which is presently (as of 2022 figures) 70.19 years, will be 81.96 in the year 2100.
There is a large existing population of destitute elderly people aged 60 and up. Given the government’s financial situation and the size of this population, there are no simple solutions to providing them with income security. At the same time, given the magnitude of the problem, this issue cannot be overlooked.
One such instrument of the social safety net is the pension fund. The government established a pension schemes for its employees.
Limited coverage of Old Pension Scheme– Only 34 million (or less than 11%) of India’s estimated working population is eligible to participate in formal provisions designed to provide old-age income security as it limited to solely government employees.
Financial Burden– Pensions are paid for by the government; there is no pension-specific corpus that grows and is available for payments. As a result, taxes collected from the current working class are used to pay for benefits. The number of people receiving central government pensions exceeds the number of active employees. There are more pensioners, about 77 lakh, than active-duty personnel, which is about 50–60 lakh.
A data from the Centre for Monitoring Indian Economy (CMIE) states that the share of pension spending in state revenue has been steadily increasing. It was less than 10% at the beginning of the reform period and had increased to more than 25% by 2020–21.
It further estimates that “the total pension liability for the three states, Chhattisgarh, Jharkhand, and Rajasthan, comes to ₹3 lakh crore. When looked at in relation to own tax revenue, the pension liabilities of states would be as high as 450% of own tax revenue in the case of HP and 138% of own tax revenue in the case of Gujarat.”
National Pension Scheme (NPS)
The NPS is a defined contribution, voluntary pension system that is administered and regulated by the Pension Fund Regulatory and Development Authority (PFRDA). Initially designed in 2004 as an alternative to pensions for government employees, it was voluntarily extended to all Indians in 2009, including self-employed professionals and others in the unorganised sector. Employees contribute 10% of their basic salary to NPS, while employers contribute up to 14%.
NPS is a market-linked annuity product in which you invest a set amount on a regular basis during your working life and receive an annuity when you retire. Individual contributions to the NPS are consolidated into a pension fund, which invests in a diversified portfolio of government bonds, bills, corporate debentures, and shares.
PFRDA-regulated professional fund managers (PFMs) manage the investments, which include SBI, LIC, and UTI, among others. If your pension is less than Rs. 2 lakh, you can withdraw the entire amount when you retire. Otherwise, you can withdraw up to 60% of the corpus and invest the remaining 40% in one of the eight available annuities.
NPS has a two-tier structure: a pension account that provides tax benefits and is required for NPS enrolment, and an optional account that allows for withdrawal flexibility. The Tier-1 account is the required primary account that also serves as the pension account. Tier-2 accounts are linked to Tier-1 accounts and are intended to be used as investment accounts. Depending on your investment objectives, you can invest exclusively in a Tier-1 account or in a combination of Tier-1 and Tier-2 accounts.
The OPS provides a fixed amount of pension every month for government employees. They also get the benefit of increases in DA twice a year. For example, if a government employee’s basic monthly salary plus DA at the time of retirement is Rs.10,000, he would be assured of a pension of Rs.5,000 every month. Additionally, the monthly pension increases when the DA increases. If there is an increase of 4% in DA, the monthly pension will increase to Rs.5,200 (An increase of 4% is calculated upon the pension amount, i.e. Rs.5,000).
However, under the NPS, the pension amount is determined by various factors, such as the amount of contribution, age of joining, type of investment and the income drawn from the investment.
For example, if an employee is 35 and the retirement age is 60, the total investing period will be 25 years. When his basic salary and DA is Rs.10,000, the monthly contribution towards NPS will be Rs.2,400 (10% employee contribution on Rs.10,000, i.e. Rs.1,000 + 14% government contribution on 10,000, i.e. 1,400).
When the employee becomes 60 years, he will receive a monthly pension of Rs.4,595 when he invests 40% of the accumulated contributions in annuities. He will get the 60% of the accumulated contributions as a lump sum, i.e. Rs.13,78,607. Thus, he will get a monthly pension and a lump sum, which he can re-invest. When he invests 60% of the accumulated contributions in annuities, he will get a monthly pension of Rs.6,893 and get Rs.9,19,071 as a lump sum.
Both the old pension scheme and the new pension scheme have their own advantages and disadvantages. While the Old Pension Scheme (OPS) provides return certainty and income that is not subject to taxation, the NPS offers more freedom, control, and potentially higher returns. It is important to understand these schemes and compare them before deciding which one is best suited for your needs.