A New Pension Pact: New Pension Reform Must Reduce Burden on Future Generations

26-08-2023

11:43 AM

1 min read

Why in News?

Against the backdrop of five states announcing a reversion from the New Pension Scheme (NPS) to the defined-benefit (DB) Old Pension Scheme (OPS), the Government of India has constituted a committee to “improve” the NPS.
The issue of government employees’ pension has become a serious political issue.

OPS offers pensions to government employees based on their last drawn salary; 50% of the last drawn salary.
The attraction of the OPS lay in its promise of an assured or ‘defined’ benefit’ to the retiree. It was hence described as a ‘Defined Benefit Scheme’.
Moreover, like the salaries of government employees, the monthly pay-outs of pensioners also increased with hikes in dearness allowance or DA announced by the government for serving employees.
The OPS was discontinued by the Central government in 2003.

The pension replacement rate (How much pensions replace salaries) is much lower for higher-paid employees in the OECD (Organisation of Economic Cooperation and Development) economies compared to 50 percent of the last drawn salary for all OPS employees.
OPS covers family too.

The main problem was that the pension liability remained unfunded- there was no corpus specifically for pension, which would grow continuously.
The Government of India’s budget provided for pensions every year; there was no clear plan on how to pay year after year in the future.
The scheme created inter-generational equity issues-the present generation had to bear the continuously rising burden of pensioners.
The pension increases twice a year with a DA to account for inflation and fitment awarded in Pay Revision Commissions which happen every five years - burden on exchequer.

As a substitute of OPS, the NPS was introduced by the Central government in April, 2004.
Under NPS, the employee contributes 10% and the government 10-14% of the salary to a pension fund.
The fund invests in securities; therefore, its returns are market linked.
At retirement, pensioners must buy a fixed annuity from the market whose value depends on the accumulated corpus and expected future returns.
The money invested in NPS is managed by PFRDA-registered Pension Fund Managers. Currently, there are eight pension fund managers.
Any Indian citizen between 18 and 60 years can join NPS.NRIs (Non-Residential Indians) are also eligible to apply for NPS.
The subscriber must contribute a minimum of 6,000 in a financial year. If the subscriber fails to contribute the minimum amount, their account is frozen by the PFRDA.

This pension programme is open to employees from the public, private and even the unorganised sectors except those from the armed forces.
The scheme encourages people to invest in a pension account at regular intervals during their employment.
After retirement, the subscribers can take out a certain percentage of the corpus.
The beneficiary receives the remaining amount as a monthly pension, post-retirement.

Tax liability: Despite the tax exemptions, NPS ends up attracting a lot of tax upon maturity. 60% of the corpus is added to taxable income.
Limited withdrawals: Since the NPS is a pension scheme, only a limited amount and number of withdrawals are allowed before maturity. This may pose a problem if a subscriber has a financial emergency and needs urgent lump sum funds.
Limited exposure to equity: After the age of 50, NPS reduces the percentage of equity exposure by 2.5% every year. The equity exposure is reduced to 50% by the age of 60. This may be unfavourable for some.
Market Risk: Since long term global trends point to low interest rates, so corpus growth, and therefore annuity pay-outs, might be lower than expected. Therefore, pensioners under NPS bear market risk also face a lower likely pension annuity.

Increase in typical support period: According to UN’s population pyramid for India, there will be a fivefold increase in dependency ratio between 2020-2100.Hence the typical pension support period will go up by 55%.
Accumulated stress on exchequer will increase: Pensions as a share of states’ revenue receipts and own revenues are already 13.2% and 29.2% respectively. Also, pension liabilities of states have risen annually by 15-20% in the last decade.
- In states like HP and Punjab, pensions as percentage of development spending already account for 37 per cent and 31 per cent and are among the highest anywhere.
Reallocation of resources: Away from the state’s development expenditure which benefits the poor, and towards a much smaller group of people who have benefitted from a secured and privileged job throughout their working life.
Catastrophic impact on poor populations: The reversal will cause a debt trap depriving the poor of essential services such as health and education, lower economic growth in the states and worsen inequality.

For a start, any sustainable pension reform should retain the contributions and the NPS fund management.
It should avoid periodic increases in the annuity. The government could then guarantee a certain percentage of the last drawn salary as a fixed annuity pension.
The pensioner would purchase the annuity at retirement, and the government could bridge the gap, if any, between the guaranteed pension and the purchased annuity.
The guaranteed pension could be topped with additional benefits, currently unavailable to NPS pensioners.
They include extending pension to the spouse, albeit with a lower annuity, health and life insurance benefits, and a minimum pension to cover for those with lower service tenures.

The governments must see beyond OPS’ fiscal burden and financial viability and focus on the economic trade-offs and how it will affect the poor and development of the state.
NPS is one of the most far-sighted reforms in India with respect to the pension reforms.
There might be some disadvantages of NPS and the government should focus on incorporating new provisions to the NPS.
This too will strain the budget but it may be the best that can be offered without irreparably burdening future generations.

Source: The Indian Express