Shivanand Pandit
The Union Cabinet has approved the Universal Pension Scheme (UPS), which includes minimum assured pensions under certain conditions and will be implemented starting April 1 of next year. This new scheme provides an alternative to the National Pension System (NPS) for government employees who joined on or after January 1, 2004 or those who will join in the future. It also offers a one-time opportunity to switch from NPS to UPS. Presently, about 23 lakh Central government employees are eligible to choose the UPS. The scheme will bring an additional financial burden of ₹6,250 crore per year to the exchequer.
The Centre has decided to reinstate guaranteed pensions for its employees, partially meeting their demands while still attempting to uphold principles of fiscal prudence. Pension schemes globally, whether they are contributory and market-linked or funded directly by the government, are experiencing challenges due to various factors, including demographic changes. According to the Reserve Bank of India, the total budget estimates for pension expenditures by various States and Union Territories for the year 2023-24 amounted to around ₹5,22,105 crore, accounting for 6% to 21% of their total revenue receipts. Pensioners view pensions as deferred wages; however, it can also be argued that funding pensions through the exchequer burdens future generations.
To manage rising pension costs, governments are increasingly outsourcing jobs through contracts and implementing new measures like Agnipath, a short-term service scheme for military personnel. Additionally, many government positions remain unfilled. These strategies are leading to two significant consequences: first, they are weakening state capacity, and second, they are reducing opportunities for government and public sector employment, which is concerning given India's growing population of young job seekers. The NPS, which was introduced during a stock market boom and is managed by an independent entity, is market-linked. However, as employees who joined after January 1, 2004, began to retire, it became clear that the payouts under the NPS were much lower than those from the previous pension scheme.
New wine in the new bottle
Under the UPS, employees who have completed a minimum qualifying service of 25 years will receive an assured pension amounting to 50% of the average basic pay drawn over the last 12 months before retirement. For those with service periods between 10 and 25 years, the pension will be proportionate to the length of service. In the unfortunate event of an employee's death, their family will receive an assured pension equal to 60% of the employee's pension immediately before their demise.
The scheme also guarantees a minimum pension of ₹10,000 per month for employees who retire after completing at least 10 years of service. All pensions under the UPS, including the assured pension, assured family pension, and assured minimum pension, will be adjusted for inflation. Dearness Relief will be provided based on the AllIndia Consumer Price Index for Industrial Workers (AICPI-IW), similar to that for current service employees.
Additionally, employees will receive a lump sum payment upon retirement, which is calculated as one-tenth of their monthly emoluments (pay plus dearness allowance) for every completed six months of service. This lump sum payment is separate from any gratuity received and does not affect the assured pension amount. Employees opting for the UPS will not face any additional financial burden. Their contribution rate will remain at 10%, while the government's contribution will increase from 14% to 18.5%.
The assured minimum pension under the UPS will be determined based on the ‘Default Mode of Investment' option. In this mode, the Pension Fund Regulatory and Development Authority (PFRDA) allocates funds among three public sector fund managers: SBI Pension Funds Private Ltd, UTI Retirement Solutions Ltd, and LIC Pension Fund Ltd. Each of these managers invests 85% of the funds in fixed-income instruments and 15% in equity and equity-related instruments.
Under the scheme, the pension corpus is divided into two separate funds. The first is an individual pension fund, where both the employee's contributions and the matching contributions from the government are credited. The investment of this fund is guided by the employee's chosen investment preferences. The second fund is a separate pooled corpus consisting solely of an additional government contribution, which amounts to 8.5% of the basic salary and dearness allowance of all employees and is invested independently.
Numerous questions remain unanswered
The UPS is a defined benefit pension scheme, which differs significantly from the NPS. A defined benefit scheme promises a specific pension formula to its beneficiaries. This is advantageous for employees eligible for the UPS, as they are guaranteed a pension amounting to 50% of their average basic pay over the last 12 months before retirement. Additionally, the scheme includes provisions for a family pension and dearness relief. The introduction of a lump sum payment and a minimum pension are also beneficial developments that are not expected to substantially increase the overall cost of benefits. What distinguishes the UPS from the NPS is the inherent uncertainty regarding the total cost, which is now a responsibility borne by the government.
While an employee's fixed contribution is 10% of their salary and the government's contribution is 18.5%, it's important to clarify that these are merely contributions toward the UPS and not the fixed cost of the scheme. This distinction is crucial because, during the briefing, there were multiple references to the UPS being fully funded. Although contributions will be made, funds will be allocated, and the scheme will be budgeted for, this does not mean that the current contributions can fully cover the promised benefits in the long term. The ultimate cost of any defined benefit scheme is unpredictable at this time.
This uncertainty arises from several unknown factors, including investment returns, mortality rates, changes in longevity, future inflation, and salary growth. The cost-neutral standard contribution rates for new entrants into a scheme similar to the old pension system would be significantly higher than those proposed under the UPS. It is crucial to understand the calculations and actuarial assumptions used to evaluate the long-term sustainability of the UPS framework. As previously noted, any associated risks and future costs will ultimately be absorbed by the government, although the creation of a separate fund represents a notable positive development.
There may be specific operational details within the UPS that could help reduce long-term costs, although these are not yet fully clear. For example, is there a difference between the contributory salary and the salary definition used for pension calculations, aside from the 12-month average provision?Are there modifications to the dearness relief indexation method compared to the Old Pension Scheme (OPS)? For instance, could it be adjusted to a straightforward inflation-based cost of living adjustment, similar to practices in other countries?Will there be changes to investment allocation benchmarks, considering that the government is now assuming the risk, whereas employees were previously under the NPS?Although the benefits under the new UPS are comparable to those of the OPS, specific details are still unclear. For instance, it is not yet known whether the UPS will offer an increase in benefits if the pensioner lives longer or if and how much of the remaining corpus might be returned.
The full impact remains to be seen, but it appears we are moving back to a defined benefit model, though with possible mitigations. On a positive note, the government has recognized the importance of separate funding and the need for actuarial reviews, similar to those used for the Employees' Pension Scheme 1995 and Atal Pension Yojana. However, many questions remain about the scheme's design and the actuarial assumptions behind the sustainability of the 28.5% contribution rate.
Based on the available information, it appears that theUPS is likely to be sustainable in the short term, provided that the UPS corpus, which includes funds from NPS subscribers who switch, is invested wisely. Containing inflation below 5% will be crucial for keeping the pension burden manageable in the near term. Ongoing evaluations of the scheme's sustainability are necessary, and UPS subscribers should anticipate potential adjustments to its features in the future.
To conclude, the outcome of the general election and the anticipated strong challenge from the Opposition in the upcoming Assembly elections seem to have prompted the central government to introduce the ‘Unified Pension Scheme,' which guarantees assured pensions. This shift appears to be driven by the government's concern over retaining power, as evidenced by its reconsideration of other issues, such as the lateral entry scheme into the bureaucracy. This change highlights how arrogance influenced the government's previous stance. Nonetheless, the introduction of this scheme is a positive step, even if belated. Government employees, often criticized for high salaries and minimal accountability and productivity, have been pushing for increased financial benefits. It's undeniable that substantial funds are allocated for pensions for government employees and legislators. To address this, the government should develop a uniform pension policy that is free from political considerations.
The writer is a tax specialist, financial adviser, author, guest faculty and public speaker based in Goa. He can be reached at panditgoa@gmail.com or 9822983420
