Insights on Old Pension Scheme and New Pension Scheme

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1. Old Pension Scheme (OPS): Under the Old Pension Scheme, government employees are eligible for statutory retirement benefits. They will receive either 50% of their last drawn basic salary along with a dearness allowance or an average of their wages over the previous ten months, whichever is more favourable. To qualify for the pension, they must have completed a minimum of 10 years of service. This scheme does not require any employee contributions and ensures a guaranteed income post-retirement.¹
2. New Pension Scheme (NPS): It was introduced by the central government in December 2003. NPS applies to employees in both the public and private sectors. The NPS requires employees to contribute 10% of their base pay, while employers may contribute up to 14%. This scheme gives employees more freedom and control over the amount, as they can receive market-linked returns without any guarantee on fixed returns. Additionally, 60% of the maturity corpus is tax-free, while the remaining 40% must be invested in annuities that are taxable.²
3. Old Pension Scheme as a crucial social welfare measure: Some State governments have argued that the restoration of the OPS for government employees is a crucial social security measure, emphasising its significance in safeguarding officials during their retired years.³
4. Double Payment since the introduction of NPS: One of the major reasons has been the problem of “double payment” that has increased the fiscal liability of the state governments contrary to the aim of the reform. Currently, the state government pays for both groups of employees; it has a pension bill for retirees and a contribution bill for employees. Financial benefits of the NPS will not be realised until current employees begin to retire.⁴
5. NPS aims to reduce States’ Debt-to-GDP ratio in the long-run: The issue of fiscal sustainability of the OPS is also highlighted by the RBI report on State Finances (January 2023).⁵ In the fiscal year 2020–21, Punjab, Rajasthan, Kerala, West Bengal, Bihar, Andhra Pradesh, Jharkhand, Madhya Pradesh, Uttar Pradesh, and Haryana were among the states with the highest debt-to-GDP ratios in India. These 10 states also accounted for more than half of the total expenditure of state governments in the country. States like Haryana, Uttar Pradesh, West Bengal, Kerala, and Punjab faced significant debt burdens, with committed spending, including interest payments, pensions, and administrative expenses, consuming over 35% of their total revenue expenditure. This limits the fiscal resources available for developmental spending.
   On average, from 2017–18 to 2021–22, pension spending alone accounted for 12.4% of total revenue expenditure in these 10 states. Furthermore, it is projected that pension outlay will remain between 0.7% and 3.0% of GSDP (Gross State Domestic Product) until 2030–31. Adding to the challenges, own tax revenue has declined in states like Madhya Pradesh, Punjab, and Kerala, while non-tax revenue has sharply decreased in most states in recent years. Therefore, implementing the OPS not only raises concerns about fiscal sustainability, but also exacerbates intergenerational inequalities.
6. NPS is financially more sustainable for State Governments, as it reduces Fiscal Liabilities: Considering the ongoing demographic transition, there is a notable probability of governments witnessing a further rise in their pension obligations in the future. This escalation can be attributed to factors such as an increase in life expectancy, periodic adjustments to the cost of living, and the practice of linking pensions to current salary levels. Moreover, the structure of pensions, which is often based on an individual’s final wage earned, has inadvertently encouraged early retirement by creating an incentive for employees. The OPS would soon become financially unsustainable because there is no means to fund the growing pension liability with the existing tax buoyancy.
7. State reverting to OPS are at risk of accumulating Unfunded Pension Liabilities: The report⁸ states that, the major risk looming large on the subnational fiscal horizon is the likely reversion to the OPS by some State governments. The annual saving in fiscal resources that this move entails is short-lived. By postponing the current expenses to the future, authorities risk the accumulation of unfunded pension liabilities in the coming years. Further, state governments have made considerable progress in addressing pension liabilities, having already reached the halfway mark. In the next two decades, as the NPS cohorts start retiring, the positive outcomes of the reform will become evident and materialise.⁹
8. Double Burden of OPS: Reverting to the OPS presents significant challenges because it is burdened by two fundamental issues — it lacks proper funding and is fiscally unsustainable. Without any contributions from employers and employees, it operates as a pure Pay-As-You-Go (PAYG) system, where the current workforce finances the retired population. This poses a problem as birth rates decline and life expectancy increases, placing a strain on the system.¹⁰
9. Trends suggest NPS growth rates may decline over the next few decades: The NPS has demonstrated remarkable annual returns exceeding 9% since its establishment, in comparison to pension funds in the Organisation for Economic Co-operation and Development (OECD) countries that have experienced growth rates ranging from 3% to 5% over the last 15 years. However, considering long-term global trends that indicate low-interest rates, there is a possibility of reduced corpus growth and subsequently lower annuity payouts than currently anticipated. Consequently, individuals enrolled in the NPS bear market risk and may face a potential decrease in their expected pension annuity, which is a ground for NPS reform.
10. A mixed approach like “Guaranteed Pension” Scheme can aim to protect pensioners from market volatility: Implementation of a guaranteed pension system, resembling the OPS, wherein retirees receive a pension amount equivalent to 50% of their final salary. This pension would be indexed to inflation and funded through employee contributions. It is important to note that this proposed pension amount is not a minimum but rather the intended entitlement. Consequently, if the market delivers a rate of return higher than this guaranteed amount, the surplus would be retained by the state. However, if the market performance falls short of expectations, the state would be responsible for covering the remaining balance.¹¹
    Case Study of Andhra Pradesh: Andhra Pradesh¹² has already revised their NPS framework. The approach combines elements of the old and new pension schemes by introducing a “defined contribution” from employees and offering two “defined benefit” options. In the first option, with a 10% monthly contribution from employees matched by the government, a guaranteed pension equivalent to 33% of their last salary would be provided. Increasing the contributions to 14% would raise the guaranteed pension to 40%. However, regardless of the chosen structure, the responsibility of fulfilling the “defined benefit” obligation would ultimately rest with the government.

Endnotes

1. Old pension scheme vs new pension scheme: A comprehensive comparison https://mintgenie.livemint.com/news/personal-finance/old-pension-scheme-vs-new-pension-scheme-a-comprehensive-comparison-151678436996584
2. Ibid.
3. Rajasthan: Gehlot defends old pension scheme as a social security measure https://www.thehindu.com/news/national/other-states/rajasthan-gehlot-defends-old-pension-scheme-as-a-social-security-measure/article66275416.ece
4. Ibid.
5. State Finances — A Study of Budget 2022–23, Reserve Bank of India https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/0STATEFINANCE2022233E17F212337844888755EFDBCC661812.PDF
6. Why we need to debate the Old Pension Scheme https://www.nipfp.org.in/blog/2023/04/05/why-we-need-debate-old-pension-scheme/
7. Ibid.
8. Ibid.
9. Giving up on NPS a tragedy for state govts. DB pensions are ad hoc, delay fiscal stress https://theprint.in/opinion/giving-up-on-nps-a-tragedy-for-state-govts-db-pensions-are-ad-hoc-delay-fiscal-stress/1023963/
10. Ibid.
11. Should States revert to the Old Pension Scheme? https://www.thehindu.com/opinion/op-ed/should-states-revert-to-the-old-pension-scheme/article66892723.ece
12. On Andhra Pradesh pension scheme: An imprudent proposal https://indianexpress.com/article/opinion/editorials/on-andhra-pradesh-pension-scheme-an-imprudent-proposal-8427900/