The Centre faced much criticism when it adopted the National Pension Scheme and gradually gave up on the Old Pension Scheme. On one hand, government employees were dissatisfied with the change in policies over National Pension Scheme (NPS), several states and opposition parties were insisting on returning to OPS to woo the voters.
In a bid to balance all sides, the Centre unveiled the Unified Pension Scheme (UPS) in August 2024, which promised to be a mix of both the existing pension schemes. The UPS combines the guaranteed advantages of the OPS with the added benefits of the NPS, providing government employees with a more reliable and secure retirement plan.
The sustainability of pension schemes has been a subject of deliberation among policymakers, economists, and specialists. The defined Benefit Old Pension Scheme (OPS) was favoured by employees because of its reliability and assurance. However, it placed a notable financial strain on the government.
Unlike other schemes, the OPS did not necessitate contributions from employees, rendering it advantageous for employees but concurrently creating a substantial liability for the government. Retired individuals were entitled to 50% of their final salary as a lifelong pension without having made any contributions during their tenure. Furthermore, the OPS granted dearness relief to account for inflation and extended a family pension to dependents.
The National Pension Scheme (NPS) was a significant development as it marked the initiation of a defined contribution system where both employees and the government contributed to the pension fund at rates of 10% and 14% of the employee’s salary, respectively. The employees’ contributions were directed towards market-linked securities like equities, which meant that the final pension amount was influenced by the performance of these investments.
Despite offering investment flexibility and aiming to ease the government’s financial obligations, the NPS exposed individuals to market risks, creating uncertainty regarding the pension benefits. Unlike the Older Pension Scheme (OPS), the NPS did not guarantee specific benefits, which somewhat reduced its appeal among employees.
NPS vs UPS
“NPS is a defined contribution plan where the longevity and interest rate risk lies with the individual. This means that the individual runs the risk of the annuity amount being insufficient and the risk that the individual outlives the money. UPS is a combination of Defined Contribution and Defined Benefit and tries to balance the features of a Defined Benefit Plan like OPS with that of a Defined Contribution Plan like NPS. UPS is a welcome news for the employees who are eligible since it guarantees a pension based on average of last 12 months basic salary and is also index linked. So UPS does reduce the interest rate and longevity risk for the employee since it is now borne by the government,” said Preeti Chandrashekhar India Business Leader, Health and Wealth – Mercer.
How to choose the perfect pension system
From the upcoming financial year, all central government employees who retire on or before March 31, 2025, and are entitled to arrears, will be eligible for the Uniform Pension Scheme (UPS). Employees with the National Pension System (NPS), which is applicable to individuals who entered service after April 1, 2004, have the option to select between the two pension schemes.
To transition from NPS to UPS, employees are required to finalise their decision prior to the scheduled implementation date. Once the choice for UPS is made, it is irrevocable, and a return to NPS is not permissible. The government affirms that over 99% of employees will experience advantageous outcomes through the adoption of the aforementioned new scheme.
“Whether one should opt for UPS or continue in NPS would really depend upon individual circumstances. UPS has a minimum service requirement, so the younger workforce who would want greater flexibility and mobility may still find NPS more advantageous. For the more tenured employees closer to retirement, UPS would have an obvious advantage,” said Chandrashekhar.
Which pension scheme will be more sustainable
The newly approved UPS is designed to strike a balance between the government’s fiscal policy and employee benefits by offering a defined benefit pension similar to the OPS, while maintaining the contributory nature of the NPS. Under the UPS, government employees will receive a guaranteed pension amounting to 50% of their average basic pay drawn over the last 12 months before retirement.
Additionally, the UPS scheme includes inflation indexation based on the All India Consumer Price Index for Industrial Workers (AICPI-IW). Unlike the OPS, the UPS requires contributions from both employees (10% of salary) and the government (18.5% of salary), which is an increase from the previous contribution levels of 14% from the government in the National Pension Scheme and 10% from employees
“Pension liabilities are long term in nature. Defined Contribution schemes like NPS put the onus of sustainability of the benefit onto the individual. Sustainability of UPS which is a Defined Benefit, index linked pension liabilities (with an additional family pension) would be very challenging for the government. While the scheme entails setting aside a guaranteed reserve fund to reduce exposure of the government to additional contributions, the investment of these funds has to be monitored tightly through strong governance of the investments,” said Chandrashekhar.