DH Deciphers | Pension contention: Here is all you need to know about the old versus the new

With nine states fighting elections this year, demand for restoration of the old pension scheme is once again in the limelight, serving as a major poll plank for several political parties. Opposition ruled states - Rajasthan, Chhattisgarh, Punjab, Himachal Pradesh and Jharkhand - have already resuscitated the erstwhile scheme. The Reserve Bank of India has on the other hand, repeatedly cautioned states against such a move, citing significant financial risks. In this issue of DH Deciphers, Shakshi Jain decodes the two schemes in detail.

How is the National Pension System, also known as the new pension scheme (NPS), different from the old pension scheme (OPS)?

In the new pension scheme government employees contribute 10% of their income (basic + dearness allowance) towards their pension while the government adds 14%. Upon retirement, employees are required to purchase an annuity plan for a monthly pension with a minimum of 40% of the accumulated corpus. The remaining tax-free 60% can be withdrawn in lump sum. Private sector employees aged between 18-65 years can participate voluntarily in the scheme and continue till 70 years of age, with their employer’s contribution being optional. Under NPS, the employee is entitled to claim a tax deduction of up to Rs 1.5 lakh under Section 80C of the Income-tax Act, 1961, along with an additional deduction of Rs 50,000 for investments under 80CCD (1b). Government employees who joined services on or after January 1, 2004, currently fall under the ambit of NPS.

In the old pension scheme employees are not required to make any contribution towards their pension plan. Upon retirement, the candidate receives 50% of his/her last drawn salary (basic + dearness allowance) or 50% of an average of the last 10 months’ salary, whichever is more advantageous. Income under the scheme is not taxable and the employee is entitled to inflation-linked dearness relief every six months.

Why was the old pension scheme discontinued?

The Atal Bihari Vajpayee-led NDA government in December 2003 mandated the national pension system for government employees (barring the armed forces), effective from January 1, 2004, to cut mounting pension bills. Many states (excluding West Bengal) had switched to the new pension scheme “after realising that the old system was unsustainable in the long run,” an RBI report highlighted in 2022.

According to the apex bank’s data, pension expenditure alone accounts for 12.4% (average of 2017-18 to 2021-22) of total revenue expenditure of the 10 most indebted states. It is estimated that the pension outgo will continue to be in the range of 0.7-3.0% of gross state domestic product in the ten most indebted states until 2030-31.

What has been the Reserve Bank’s stance on the debate?

The Reserve Bank of India in a January 16 report stated that the annual saving in fiscal resources that this move (reversion to the old pension scheme by some states) entails is short-lived. By postponing the current expenses to the future, states risk the accumulation of unfunded pension liabilities in the coming years.

The report highlighted that as the current state government retirees are primarily the beneficiaries of the old pension scheme, the immediate financial strain will not be felt if the states choose to revert to the old pension scheme. However, when state government employees who joined after 2004-05 under NPS begin to retire from 2034 onwards, the cost of such a move will become apparent. In other words, the adoption of the old pension scheme is likely to benefit the current generation at the expense of future generations.

What are the pros and cons of the new pension scheme?

As opposed to a defined benefit plan (OPS), NPS is touted as a fixed contribution plan. Thus, uncertainty appears to be the most significant challenge under NPS as the scheme is a market-linked pension plan. Besides market related risks tied to your investment, one cannot gauge the exact amount he/she would receive in periodic pension. Furthermore, a long lock-in period coupled with higher inflexibility as compared to mutual funds appear to be other drawbacks.

However, pensioners can choose from a host of pension fund managers registered with the Pension Fund Regulatory and Development Authority, as well as decide the percentage of fund allocation in four categories - corporate bonds, equities, government securities and alternate assets like infrastructure investment trusts, real estate investment trusts or commercial mortgage-backed securities. However, the allocation to equity should not surpass 75% and that of alternate assets must not exceed 5%.

Who will be affected by a reversion to the old pension scheme?

Experts say that if a state decides to switch from NPS to OPS, the state government’s employees who were inducted on or after the date of adoption of the scheme by the state, will be impacted by the move. Private sector employees on the other hand, will continue to be a part of NPS.

However, Union Finance Minister Nirmala Sitharaman recently said that “as per law, the money in the central kitty of NPS cannot go back to state governments. It can only go back to the contributing workers”. Her junior, Bhagwat Karad, Union Minister of State for Finance, made it clear that there is no legal provision in the PFRDA Act and other relevant regulations for a refund of NPS contributions.

Which scheme is better?

Finance experts who spoke to DH, unanimously voted in favour of the new pension scheme citing the scope for building a higher retirement corpus via investment in a host of financial instruments.

However, many in the 30+ age bracket from the private sector, that DH spoke to, don’t appear to be a part of NPS due to lack of knowledge about their personal finance options or other investments which suffice for purposes of savings from a taxation point of view.