Anticipated Government Move: Guaranteed Pensions in NPS by Year-End

In a significant move, the Union government is on track to overhaul the National Pension Scheme (NPS) by the end of this year. The aim is to provide employees with a retirement payout that guarantees a minimum of 40-45% of their last-drawn salary. This development stems from recommendations made by a high-level panel currently examining the matter, as disclosed by two informed sources.

The subject of pension reform has recently become a politically divisive issue, with several states governed by Opposition parties opting for the older pension scheme (OPS). Under the OPS, retirees receive monthly benefits equivalent to 50% of their final salary, making it a more enticing option for employees. The existing NPS, which was launched in 2004, lacks such assurances and operates on a market-linked model. Another point of contention is the contribution structure, with NPS requiring employees to contribute 10% of their salary, while the government chips in 14%. In contrast, OPS does not entail any employee contribution.

The revamped NPS will introduce changes in "actuarial calculations" aimed at delivering higher returns, according to one official. Furthermore, adjustments to the distribution of contributions between employees and employers (central government and states) are likely. As the first official noted, the actuarial framework may allow for a guaranteed base payout.

Currently, NPS permits pensioners to withdraw 60% of their corpus at retirement, tax-free, and invest the remaining 40% in an annuity, which is taxable.

States governed by Opposition parties, including Rajasthan, Chhattisgarh, Jharkhand, Himachal Pradesh, and Punjab, have reverted to the old pension system, a move that some economists warn could strain state finances.

Under the existing NPS, approximately 8.7 million government employees, both federal and state, contribute 10% of their basic salary, while the government contributes 14%. The ultimate pension payout is contingent on the returns generated by the invested funds, primarily in government debt instruments.

In contrast, the old pension system offers a fixed pension of 50% of an employee's last-drawn salary, without requiring employee contributions. It is often described as an "unfunded" retirement scheme.

The government does not plan to revert to the unfunded old scheme but aims to introduce a more robust model that assures a basic indexed amount. As the second official stated, "A better model can be put in place that gives an assured basic amount, which will be indexed to inflation."

The ruling Bharatiya Janata Party-led central government, facing a general election next year and state elections in four states, established a committee led by TV Somanathan in April to evaluate the current pension system.

The revised pension scheme will maintain a link to market returns, but the government could implement a methodology to ensure a minimum of 40% of an employee's last-drawn salary. This means that the government would step in to bridge any gap in pension payments if they fall short of the base amount. Presently, employees typically receive returns ranging from 36% to 38% on average.

The old pension scheme is deemed fiscally unsustainable and could exacerbate the debt burden of state governments, according to Soumya Kanti Ghosh, the group chief economic adviser of State Bank of India, the nation's largest lender. In the 2023-24 fiscal year, India's federal pension budget stood at ₹2.34 lakh crore.

The appeal of the old pension scheme adopted by several states lies in its assurance of a fixed benefit, set at 50% of the last-drawn basic pay. Furthermore, pensions under the old scheme, like salaries, are regularly adjusted to account for inflation.

According to Ghosh's research, pension liabilities of state governments have shown a sharp increase over the long term. The compounded annual growth in pension liabilities for the 12-year period ending in 2021-22 was 34% for all state governments. In 2020-21, pension outlays accounted for 13.2% of revenue receipts, as indicated by Ghosh's findings.