Rise and Fall of the NPS: Will the UPS Arrest or Accelerate Its Demise?

On 24 August, the Government of India virtually caved in.

It announced a new avatar of the New (later termed National) Pension Scheme (NPS), consisting of a guaranteed 50 percent pension like in the Old Pension Scheme (OPS) and full funding of pension liabilities in the form of defined contributions following the NPS's principle. This new, supposedly Ardhanarishvara avatar (half OPS and half NPS) has been named the Unified Pension Scheme (UPS).

The NPS is, without a doubt, much less beneficial to government employees, which was an integral part of its design. Government employees have always agitated against the NPS, beginning in 2003-2004 itself, although it was to be applicable only to those joining the government after 1 April 2004.

The succeeding governments resisted the pressure. The Modi government made the first concession in 2018-19 by increasing the government’s contribution to 14 percent. Quite a few state governments led by the Congress and other Opposition parties, 2022 onwards, announced a return to the OPS.

There are still some ‘shortcomings’ in the UPS, as far as employee benefits are concerned, compared to the OPS, such as employees having to make 10 percent of pay as a contribution, and there is no protection of Dearness Allowance (DA) at the point of retirement etc.

Many unions have already announced their opposition to the UPS. They want the full benefits of the OPS. Is the UPS going to be the last concession? Or, is it just another stop on the way to the ultimate demise of the NPS?

NPS Did Away With 50 Percent Assured Pension

The NPS brought a fundamental change in the whole notion of the government paying life-long pensions to its employees after retirement as a kind of deferred wage. The NPS design required the government to pay 10 percent of basic pay and DA as its full and final contribution towards its pension obligation. No deferred wage was left unpaid thereafter.

This fundamental change, described as the shift from the defined benefit (the government pays 50 percent of basic pay and DA of last drawn salary for pension) to the defined contribution (the government pays 10 percent of basic pay and DA every month), marked a complete break from the OPS.

Government servants work typically for 30-35 years. Setting aside the government’s 10 percent contribution every month over such a long period required an institutional record-keeping and investment arrangement. The government created a regulator, more a manager, ie, the PFRDA (Pension Fund Regulatory and Development Authority) to contract out record-keeping and investment institutional arrangements.

The central record keeping (CRA) came into being with the NSDL (National Securities Depository Limited) entrusted to keep the detailed records for each member of the NPS. Initially three, and later a few more, investment managers joined the system to manage pension funds. Over the last 20 years, the government employees’ NPS corpus has grown to nearly Rs 10 trillion.

The government's 10 percent contribution is specific to each individual employee. To chase a significantly substantial retirement corpus for every NPS member, the government built in an equal 10 percent contribution by every employee as well.

For building and managing this individual retirement account corpus, the NPS put the employee concerned in its charge. Every employee could choose specifically from the fund managers and many investment options, which had a mix of equity and debt components.

No one can predict interest rates and equity returns over such a long period of time. There was no way to satisfactorily determine the specific size of the retirement corpus either. Many scenarios were built based on several assumptions. There is also no way to predict monthly basic pay and salary for any employee at her retirement after 30-35 years. Again, you can only make some scenarios.

With both sides of the equation, the pension (what will be the basic pay and DA at the retirement of every employee) and size of the corpus (what kind of investment choices will yield how much corpus) being unknown commodities, the government of the day wisely decided not to make any assurance that the accumulated corpus would lead to 50 percent of the last drawn salary as pension/annuity.

The umbilical cord of 50 percent of the last pay and DA as pension under the OPS between the government and employee was completely and unambiguously cut. The rise of the NPS meant the demise of the assured 50 percent of pay as a pension.

Raising Contribution to 14 Percent Was the Thin End of the Wedge

By 2017-18, the number of government employees covered under the NPS, both at the central and the state level, had crossed 57 lakh, which was more than one-third of the total government employees.

Government employees work very close to the political executive. Consequently, while they do not exceed even two percent of the total electorate, they punch above their weight as they constitute almost the entire election machinery, besides being powerful opinion makers, especially in rural areas.

As the number of NPS employees grew, the politicians began to listen to them and started looking for ‘ways’ to find solutions to their ‘grievances’.

In 2018-19, the Modi government undertook an exercise, though not a very sophisticated one, to assess whether an NPS employee was likely to get 50 percent of pay as pension annuity from the total corpus she accumulates.

The exercise led to the finding that the existing contribution in the individual pension corpus (10 percent of basic pay and DA by the government and the employee concerned) was not adequate. This led to the government deciding to increase its contribution to 14 percent of the basic pay and DA.

The employee associations did not accept the solution and continued to agitate.

The government implicitly linking the government contribution to the notion of 50 percent of pay as pension was, in a way, the thin end of the wedge.

Irresponsible Action by Some States Queered the Pitch

Some Opposition-led states started reverting to the OPS from May 2022 onwards (Rajasthan was the first state to do it), junking fiscal responsibility completely to win the favours of government employees in the not-so-far-away elections.

Curiously, the reversion to the OPS is fiscally cash positive in the short-term as the government does not have to make the 10 percent or 14 percent contribution, and the employees’ 10 percent contribution comes back to it in the GPF (General Provident Fund) accounts and pension payments to NPS cohorts are many years away.

This made several governments take the leap without looking at the future implications at all.

The development queered the pitch and caused immense concern in BJP-ruled states. They also wanted to jump the NPS ship. The Modi government, however, refrained from taking any hasty step. It appointed a committee, headed by the then Expenditure/Finance Secretary.

No BJP state reverted to the OPS.

Incidentally, the reversion to the OPS did not save the Congress governments in Rajasthan and Chhattisgarh, ie, they lost assembly elections held in late 2023. In the 2024 Lok Sabha elections too, the Modi government did not suffer any damage in the other congress-ruled OPS state of Himachal Pradesh.

The UPS is a Half-way Compromise

There are two prominent messages in the UPS package announced by the Modi government on 23 August.

First, the government has accepted the principle of 50 percent of pay as pension. The defined benefit is in. As far as government employees are concerned, the main feature of the OPS is back in. Second, the government declared its intent to keep the UPS pensions fully funded by increasing government contributions.

With the government raising its contribution to 18.5 percent and assuring to increase the contribution in future when needed, the government believes that the UPS is the NPS as it is as fully funded as the NPS has been.

The OPS for employees and the NPS for the government — that is the supposed beauty of the UPS.

Employees Will Be Back Soon to Agitate

There are at least two features that make the UPS a poor cousin of the OPS for government employees.

Firstly, the government has assured 50 percent of the average basic pay of the last 12 months as a pension and not 50 percent of the basic pay and dearness allowance of the last drawn salary.

The government has promised to protect the UPS pension, calculated as above, from inflation by providing adjustments on it linked to the CPI-IW (Consumer Price Index for Industrial Workers). If a government servant’s average basic pay and applicable DA on the date of retirement is, say, Rs 60,000 and Rs 27,000 respectively (together Rs 87,000), the UPS pension is Rs 30,000 and not Rs 43,500.

The employee will get inflation protection post-pension. For example if, after a year, the CPI-IW rises by five percent, the inflation adjustment in this case will be Rs 1,500.

There is a lack of complete clarity on this interpretation. However, my reading of the package announcement is quite clear, that the UPS pension is 50 percent of the average basic pay only.

Second, the employees will continue to contribute 10 percent of pay and DA towards the UPS pension instead of their contribution getting re-directed towards their general provident fund (GPF) accounts.

The government has promised to pay a lumpsum (10 percent of the monthly pay for every six months of service). This is, perhaps, intended to partly compensate the employees for their 10 percent contribution. This lumpsum, however, is a lot less than what it would accumulate to in the GPF account.

No state, other than Maharashtra, has announced the adoption of the UPS so far. However, many employee associations have started demanding a stop to the 10 percent of employees’ contributions and they will soon want a full restoration of the OPS package.

Full Funding is a Temporary Fiscal Saving Grace

The government is expected to come out with the UPS's modalities soon. It has already announced that 8.5 percent of the 18.5 percent contribution would be managed in a separate fund. The government is likely to set up this fund, on the lines of the Employees' Provident Fund Organisation though managed, most likely, by the PFRDA.

For employees opting for the UPS (my expectation is that almost everyone will opt for it), the corpus in their individual NPS account will be transferred to this new UPS fund. The employees would receive their pensions from this fund.

The government has promised many benefits in addition to the 50 percent pension, ie, pension to family members in the case of death, Rs 10,000 per month minimum pension after 10 years of service, additional lump sum payment at the time of retirement and the like.

The accumulations from the 10 percent contribution by the employees and the government would be managed under a standard default option. The investment pattern of this corpus should be spelt out soon. There is, however, a major issue likely to crop up, which is that the state governments would want to lay their hands on the part of the corpus built for their employees.

The whole set of promises and the unclear fund management status make it very difficult for the government to estimate the required government contribution. Fixing the 18.5 percent contribution is only a guestimate.

Will the government get an actuarial assessment done? Unless it is done, the sanctity and adequacy of the 18.5 percent contribution will remain quite suspect.

The government’s commitments might also undergo changes if there are further dilutions. Moreover, future governments may not stick to the commitment to make the 18.5 percent (or higher contribution) to the UPS fund.

At this stage, the government’s commitments can be accepted at their face value. If it adheres to it, it will be a good fiscal saving grace. The grace, though, may not last very long.

End of the Road for the NPS?

It is quite unfortunate but appears inevitable. The power of government servants is massive.

There are about 75 lakh pensioners under the Employees' Pension Scheme (EPS) operated by the EPFO. Nearly half of these pensioners receive a minimum pension of only Rs 1,000 per month. For many years, they have been fighting to raise the minimum pension to Rs 2,000 per month. Every time, their representation is rejected by the government.

The UPS promises a minimum pension of Rs 10,000 per month for those with a minimum of 10 years of service. It is not difficult to see the contrast and the evidence of the power that government servants hold.

The rules require the EPS corpus to be actuarially evaluated every year. The last valuation was done for the year 2018-19. One of the reasons for not getting the actuarial evaluations done thereafter is the government’s lack of inclination to make up for the shortfall in the EPS fund.

It might as well be the case for the promise of keeping the UPS fully funded. If that happens, that would mark the end of the road for the already half-dead NPS.

(The author is former Economic Affairs Secretary and former Finance Secretary of India. This is an opinion piece and the views expressed above are the author’s own. The Quint neither endorses nor is responsible for the same.)