The Evolution of Pension Schemes in India: From OPS to UPS

Introduction

The debate over pension schemes in India has been both contentious and transformative, with government employees and policymakers often finding themselves on opposite sides of the discussion. Over the years, the Old Pension Scheme (OPS) was replaced by the New Pension Scheme (NPS) in 2004, causing widespread criticism from employees who missed the security and predictability of the old system. However, a significant development emerged with the Narendra Modi-led government's introduction of the Unified Pension Scheme (UPS), a hybrid model designed to balance the best features of both OPS and NPS. Let's delve into these pension models, their features, and the implications of this new move.

The landscape of pension schemes in India has witnessed profound changes over the years, moving from guaranteed government-backed pensions to market-driven models. This shift has sparked debates and demands for reform, particularly from government employees who favored the security and predictability of the Old Pension Scheme (OPS). To address these concerns, the Narendra Modi-led government has introduced the Unified Pension Scheme (UPS), a hybrid model that amalgamates the benefits of OPS and the New Pension Scheme (NPS). This development marks a pivotal moment in India's pension system.

Understanding the Old Pension Scheme (OPS)

The Old Pension Scheme (OPS) was a defined benefit pension system available to government employees in India before the introduction of the National Pension System (NPS) in 2004. It ensured lifelong financial security for retired employees by providing a fixed pension amount based on their last drawn salary. Unlike the NPS, which operates as a contributory system, the OPS did not require employees to contribute towards their retirement benefits. Instead, the government fully funded the pension, making it a financially secure and predictable option for retirees.

Employees who retired under OPS enjoyed financial predictability, as the pension was directly linked to their last drawn salary, offering a stable and fixed income stream. This assurance was critical for retirees who relied entirely on their pension for living expenses. Additionally, the DA ensured that the pension amount kept pace with inflation, protecting retirees from rising living costs.

Key Features of OPS:

• Guaranteed Pension: Fixed at 50% of the last drawn basic pay. Under OPS, the pension amount was calculated as 50% of the last drawn basic salary plus Dearness Allowance (DA). This formula ensured that retirees received a stable and predictable income after retirement. For example, if an employee’s last drawn basic salary and DA amounted to ₹50,000, they would receive ₹25,000 per month as a pension. This scheme did not require employees to make any direct financial contribution during their service tenure, as the entire pension was funded by the government.
• One of the biggest advantages of OPS was the indexation of pensions with inflation. Retired employees benefited from periodic revisions in Dearness Allowance (DA), ensuring that their purchasing power remained intact despite rising living costs. Unlike market-driven pension schemes, OPS provided lifelong financial security to pensioners without exposure to investment risks.
• OPS also included provisions for a family pension, ensuring financial security for the dependents of a deceased pensioner. In case of an employee’s demise, the spouse or dependent family member would receive a pension amounting to 30%–50% of the last drawn salary. Additionally, retirees were eligible for medical benefits and other allowances that helped them meet post-retirement expenses.

Despite its merits, the OPS posed significant financial strain on the government, especially as life expectancy increased, leading to long-term pension obligations without corresponding contributions from employees.

Introduction of the National Pension Scheme (NPS)

In 2004, the National Democratic Alliance (NDA) government replaced OPS with the New Pension Scheme (NPS) to address the fiscal burden of the older system. Initially available only to government employees, it was later extended to private sector employees and self-employed individuals in 2009. Various schemes under NPS like the NPS Lite, Swavalambhan etc. were launched for the unorganized sector and economically weaker sections of the society with an objective to provide social security/pension for old age.

Later in 2013 Parliament approved the PFRDA Act, creating a Statutory Regulator to safeguard subscribers' interests and advance old age income security through the creation, growth, and regulation of pension funds. The Act goes into effect on February 1, 2014. A minimum assured return scheme is prescribed under the Act.

Key Features of NPS:

• NPS is administered through an unbundled architecture involving intermediaries appointed by the PFRDA viz. Pension Funds, Custodian, Central Recordkeeping Agency (CRA), National Pension System Trust, Trustee Bank, Points of Presence (PoP) and Annuity Service Providers (ASPs).
• Contributory Model: Under NPS, government employees were required to contribute 10% of their basic salary and Dearness Allowance (DA), while the government contributed 14%. This participatory approach aimed to instill a sense of financial responsibility among employees and reduce the government's pension liability. The contributory nature of NPS created a more sustainable model by spreading the funding responsibility. Here NPS is not covered by west Bengal.
• Market-Linked Investments: A defining feature of NPS is its market-linked investment structure, where contributions are allocated to various financial instruments, such as government securities, corporate bonds, and equities. This investment strategy offers the potential for higher returns, albeit with exposure to market risks. Unlike OPS, the pension amount under NPS is not pre-determined but is dependent on market performance and the size of the retirement corpus.
• The NPS provides flexibility to subscribers by offering multiple fund managers and investment options to tailor their retirement portfolios according to their risk appetite. This personalization is a marked departure from the rigid structure of OPS. Additionally, partial withdrawals are permitted after ten years of service, with up to three withdrawals allowed before retirement for specific purposes such as education, medical emergencies, or purchasing a house.
• Another attractive feature of NPS is the tax benefits under Section 80CCD of the Income Tax Act. Contributions up to a certain limit qualify for tax deductions, providing a financial incentive for employees to invest in the scheme. Furthermore, 60% of the accumulated corpus can be withdrawn tax-free at retirement, adding to its appeal as a retirement savings vehicle. However, despite these advantages, NPS faced criticism for lacking the assurance of a fixed pension amount, leaving retirees vulnerable to market fluctuations and inflation.
• Users of NPS can withdraw up to 25% of their own contributions at any time before exit from NPS Tier-I for a maximum of three times during the entire tenure of subscription under NPS for certain purposes specified in the regulations. The partial withdrawals are allowed from NPS Tier-1 after contributing for at least ten years and there should be a gap of minimum five years between successive withdrawals.

Under the Active Choice option in the National Pension System (NPS), Non-Government sector subscribers have the flexibility to decide the proportion of their investments across different asset classes. Unlike government employees, whose allocations follow predefined limits, these subscribers can choose how much to invest in each category within the maximum limits set by NPS. They can allocate up to 100% in Government Securities, which are low-risk bonds issued by the government, up to 100% in Debt Instruments like corporate bonds, up to 75% in Equities for higher returns but with market risks, and up to 5% in Asset-Backed & Miscellaneous Investments, which include instruments like Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs).

Alternatively, subscribers can opt for the Auto Choice investment strategy, where their contributions are managed based on their age and risk profile. There are three predefined Life Cycle Fund options:

1. LC75 (Aggressive Life Cycle Fund), where equity exposure starts at 75% and gradually decreases with age;
2. LC50 (Moderate Life Cycle Fund), which starts with 50% in equities; and
3. LC25 (Conservative Life Cycle Fund), where equity exposure is limited to 25%. This option is ideal for individuals who prefer a systematic risk-adjusted approach without manually adjusting their asset allocation over time.

However, while NPS offered the potential for higher returns, it lacked the assurance of a fixed pension amount, making retirees vulnerable to market fluctuations. This unpredictability was a significant concern, particularly for employees who were accustomed to the guaranteed benefits of OPS.

Challenges and Employee Backlash

The transition from OPS to NPS was met with widespread criticism from government employees who missed the stability of the old system. Employees were particularly concerned about the absence of a guaranteed pension, which left them vulnerable to market fluctuations. The NPS's lack of inflation protection further exacerbated worries, as retirees feared a decline in their purchasing power over time.

The exposure to market-linked uncertainties created apprehension, especially for those nearing retirement. The inability to predict the exact pension amount undermined financial planning, causing dissatisfaction among employees. Additionally, concerns were raised about the administrative complexities and potential delays in fund withdrawals.

Recognizing these grievances, the Modi government formed a committee headed by T.V. Somanathan to explore pension reforms. After extensive consultations, the Union Cabinet approved the Unified Pension Scheme (UPS), aiming to provide a comprehensive solution that balances fiscal responsibility with the need for employee security.

The Unified Pension Scheme (UPS): A Game-Changer?

The Union Cabinet, chaired by Prime Minister Shri Narendra Modi, has approved the Unified Pension Scheme (UPS), which aims to provide a structured and assured pension system for government employees. This scheme introduces a defined benefit pension model, ensuring financial security for retired employees and their families.

The UPS brings several key features, including an assured pension, family pension, inflation protection, and a lump sum superannuation benefit, making it a comprehensive post-retirement financial plan. The newly introduced UPS aims to combine the security of OPS with the flexibility of NPS. It addresses long-standing employee grievances while maintaining fiscal responsibility.

Key Features of UPS:

• Assured Pension: One of the most significant provisions of UPS is the assured pension, which guarantees 50% of the average basic pay drawn over the last 12 months before superannuation for employees with at least 25 years of qualifying service. For those with a service period between 10 to 25 years, the pension amount is adjusted proportionately
• Family Pension: in case of an employee's demise, their family will receive an assured family pension equal to 60% of the pension amount that the employee was receiving.
• Minimum Pension Guarantee: The scheme also provides a minimum assured pension of ₹10,000 per month, ensuring that even employees with at least 10 years of service receive a basic level of financial support post-retirement.
• Inflation Indexation: To protect pensioners from the impact of rising costs, the scheme includes inflation indexation, meaning that the assured pension, family pension, and minimum pension will be periodically revised based on the All-India Consumer Price Index for Industrial Workers (AICPI-IW), similar to how Dearness Relief (DR) is adjusted for in-service employees. This ensures that pensioners maintain their purchasing power despite inflation.
• Gratuity Payments: Apart from the regular pension benefits, the scheme also provides a lump sum payment at the time of superannuation, which is 1/10th of the monthly emoluments (basic pay + DA) as on the date of retirement for every completed six months of service. This lump sum is given in addition to gratuity and does not reduce the assured pension amount. This extra financial provision helps retirees manage immediate post-retirement expenses while still receiving their full pension benefits.

Overall, the Unified Pension Scheme (UPS) aims to provide a financially stable and inflation-protected retirement plan for government employees. By combining an assured pension, family pension, inflation-adjusted payments, and a lump sum superannuation benefit, it offers long-term economic security for retirees and their families.

Comparing OPS, NPS, and UPS

Conclusion: Striking a Balance

The Unified Pension Scheme is a significant step towards addressing the concerns of government employees while maintaining fiscal prudence. By blending the best aspects of OPS and NPS, the government has created a pension model that promises financial security, inflation protection, and flexibility. As India navigates its economic challenges, this reform serves as a reminder of the importance of balancing employee welfare with economic sustainability. The UPS could very well become a model for other countries seeking to reform their pension systems.

As the scheme comes into effect in FY 2025-26, its implementation and effectiveness will be closely watched. Only time will tell whether the Unified Pension Scheme can truly strike the right balance between security and sustainability.