Choose the National Pension System over the Unified Pension System
UPI’s inflation compensation is superficially appealing, but only the NPS lets you benefit from India’s growth story
The government has notified the Unified Pension Scheme (UPS), a scheme announced months ago, in the wake of concerted demands arising from government employees around the country to revert to the Old Pension Scheme (OPS), abandoning the National Pension Scheme in force since January 1, 2004 for all those who joined the central government service on that day or afterwards. Most state governments have since also migrated their new employees to the NPS, seeing the OPS as an unaffordable luxury.
Both UPS and NPS are less generous to employees than the OPS had been, but are more sustainable, from the government’s perspective, than the OPS. Most employee unions would clamour, once again, for OPS. The more realistic course is to make a rational choice between UPS and NPS. Since UPS offers protection against inflation, many would be tempted to reach for that umbrella, but retirees would be better off sticking with the NPS.
Sustainability of a government pension might sound strange — after all, the government can always borrow to find the resources to pay for anything it pleases.
There are serious limits on how much a state government can borrow, and often, states fail to honour pension commitments on time. Former employees of state transport corporations, for example, find that the corporation would prioritise buying fuel to keep their buses running, over paying pensions, with the state government, implicit guarantor of the pension, incapable of bailing the corporations out.
Even for the Centre, it is not the case that there are no constraints on borrowing. High levels of borrowings can cause macroeconomic stress, leading to inflation, rating agency disapproval, and a rise in the cost of borrowing, leading to higher costs of borrowing for companies as well, as loans to corporates are benchmarked against the lending rate for the risk-free sovereign.
Ever since successive pay commissions began to raise civil service pay to bring it to market parity, and pensions of past employees were revised upwards to bring them up to 50 per cent of the new, Pay Commission-recommended pay slabs for serving employees of equivalent rank, the pension burden has turned significant.
Governments have to squarely face the question, is paying pensions the best way to spend scarce government funds, so as to maximise collective welfare? What if pension payments are made at the expense of say, defence outlays or R&D vital to maintaining strategic autonomy in a world of hegemonic big powers?
This is why the government introduced funded pensions for civil servants, as has been the norm for decades in many rich countries. This would put an end to the practice of dipping into current revenues to pay for past, as well as serving, employees. Today, in Britain, even the pensions of its armed forces personnel are funded, jointly by the soldiers during their service and by the government. The government, in addition, sets aside money for a top-up, in case the pension payout fails to neutralize the effect of inflation. It is this model the government has adopted for the UPS.
The NPS and the UPS are funded pensions, without the need for the government to dip into current revenue to pay pensions.
How do benefits under the two systems compare?
NPS
No revisions on the basis of future pay commission awards
Certainty only about the monthly payout received from the annuity purchased with 40% of the saved corpus
No assured protection against inflation
Lump sum amounting to 60% of the saved corpus, available tax-free, to be invested as per the retiree’s wishes. Recently, the government has allowed retirees to keep this amount in the NPS itself, up till age 75 and continue to earn returns as per saver’s preference for allocation among asset classes and asset manager.
Government’s contribution of 14% of salary to the retirement corpus to accumulate along with the employee’s contribution of 10%
UPS
No revisions on the basis of future pay commission awards
Certainty about monthly pension at the rate of 50% of the average monthly basic pay (NOT basic pay plus allowances) of the final 12 months, adjusted for length of service and missed contributions/withdrawals
Protection against inflation
Lump sum received is 10% of (basic + DA) at the time of retirement multiplied by the number of six-month periods of service (years of service multiplied by 2). If someone has served for 20 years, this would work out to four months’ worth of basic plus DA
The govrernment’s contribution to the retirement corpus will rise to 18.5%. But that is of little operational significance for the employee. The government’s funding of the general pension pool is to create resources to provide inflation relief
Is the UPS a fair approximation of the Old Pension System? It is not. There are no revisions of the pension amount as per Pay Commission Awards for employees in service, as is the case with the OPS.
UPS offers certainty of receiving half the basic pay at the time of retirement, protected against inflation, provided the retiree has served the full qualifying service period of 25 years, made all due contributions, and have not made partial withdrawals. Proportionate reduction in the pension amount would be made for shortfalls in length of service and contributions.
With the finding of monthly household consumption expenditure surveys that the share of food is coming down in the consumption basket of all income classes, it is likely that the government would bring down the weight for food in the consumer price index from the 49% where it stands now. Food and fuel are the most volatile elements of the consumer price index. Inflation as measured by the CPI, which is used to calculate DA, is likely to come down in the future, and so also the value of hedging against inflation.
Can NPS subscribers protect their post-retirement incomes from inflation, on their own? If they wish to stick to traditional saving assets such as fixed deposits, probably not, because they lock themselves into rates that stay fixed, even as climbing inflation erodes the return after adjusting for inflation. If the retiree has the savvy to identify assets that appreciate with or faster than inflation, they would be protected. Company dividends go up with inflation, so do rents. Many stocks appreciate much faster than inflation, but stocks carry the risk of coming down sharply as well. A diversified portfolio of stocks, bonds, exchange-traded funds (including real estate investment trusts (REITS), can offer protection against inflation, and much more.
For those who are risk-averse, and unsure of how to deploy the lump sum received from the NPS at the time of superannuation would be better off with the UPS. Others should stick with NPS.
India is a growing, urbanizing economy. Even for those who fear that India would be caught in the so-called middle income trap, it should be a fairly risk-free assumption that growth would taper off only after the current per capita income, of around $2,500, has at least quadrupled. That means diverse companies across the spectrum of sectors would see spectacular growth. Diversifying investment allocations across asset classes and across sectors is the way to minimize risk and maximise returns. Those who have faith in India’s growth story but do not know how to choose the right say to capture it with their investments should get professional help. NPS will let you ride India’s growth, UPS will keep you safe, but grounded.