Pension battles: Why NPS isn't ageing well

After serving in the Indian army for 20 years, this Naib Subedar retired in 1997. In September 2000, the ex-serviceman from Mandi in Himachal Pradesh, was hired as a Vidya Upasak—an ad hoc position to fill vacant posts of teachers in government schools—under the quota for armed forces.

Initially, he received a fixed monthly honorarium of ₹2,500. When regularized as a ‘junior basic teacher’, a permanent position in October 2007, his salary rose to ₹8,000-9,000 per month. By the time he retired at the age of 58, as a head teacher in March 2015, his pay had jumped over five times to ₹50,000.

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However, his first month’s pension was a paltry ₹1,999.

This may seem shocking to those who do not know how the National Pension System (NPS) works. Or, to those who still think of pension as a defined monthly entitlement, as it was under the NPS’s predecessor, the Old Pension Scheme (OPS).

Every month, NPS subscribers contribute 10% of their salary (basic pay and dearness allowances) towards the pension fund. A matching contribution is made by the state government. At retirement, they are allowed to withdraw up to 60% of the accumulated pension corpus while the rest is used to purchase an annuity to provide monthly pension for a lifetime. The withdrawal and annuitization, hence, are a function of the size of contribution, term of investment and return on investment, which is market-linked. The lump sum withdrawal under the NPS is tax exempted, whereas the annuity income (pension) is not.

The retired teacher received around ₹8 lakh—60% of his corpus—after retirement. The rest, he has been receiving as his monthly pension. A crucial point: he was an NPS subscriber for only 7.5 years, after his appointment was regularized. A typical government employee contribute to the corpus for roughly 30 years.

Soon after, many Vidya Upasaks like the retired teacher moved the Shimla High Court to consider their period of ad hoc service for the purposes of pay scale, annual increment, pension, etc. And the court, in a popular judgement in the case of Joga Singh and Others vs State of Himachal Pradesh in 2015, ruled in favour of the petitioners. His appointment was, hence, considered since 2000, making him eligible for the OPS. The NPS came into effect in May 2003 in Himachal Pradesh.

When the state government finally implemented the judgement, he started getting a pension, based on OPS calculations, of around ₹29,000 since October 2017. This was further revised upward to ₹42,000 in March 2022.

The retired teacher’s second pension is because of his service of 20 years in the armed forces—about ₹29,000 a month. There is a provision that simultaneously allows civil as well defence pensions.

And the third? Well, he continues to receive his NPS pension.

Given the 15x and 20x pension amounts in the other two cases, he does not even refer to his NPS pension as “pension" any longer.

Pension politics

The huge difference in the pension received under the two systems by some is often cited by the leaders of the National Movement for Old Pension Scheme (NMOPS), a body that has mobilized government employees across states. They want their members to pressurize every state government to revert to the OPS. Things are turning in favour of protesting employees, at least in some states.

The central government mandated the NPS system for its employees since 1 April 2004. All states, except West Bengal, adopted the NPS at different points of time, with most coming under its ambit by 2005-06. Chhattisgarh and Rajasthan, which are ruled by the Congress, were the first two states to opt out of NPS in May 2022. Jharkhand followed suit. The Punjab government, led by the Aam Aadmi Party, decided to revive OPS in November 2022. And on 13 January, the Congress-led Himachal Pradesh government reinstated the OPS in its first cabinet meeting, becoming the fifth state to do so.

In the state elections held in December last year, the Congress gained majority. Bhartiya Janata Party (BJP) leader Sushil Kumar Modi had then remarked that not reverting to the OPS was the “main" reason for the debacle of his party in Himachal Pradesh.

The leaders of NMOPS are pumped up after the Himachal Pradesh results, and are hoping to double down on their demand in states where elections are due in 2023 and 2024. “The issue of OPS has united government employees beyond caste, religion and political affiliation," said Vijay Kumar ‘Bandhu’, a college lecturer in Uttar Pradesh and the national president of NMOPS.

“Our members are on an indefinite strike in Karnataka. We are hoping to see OPS being revived there, or poll results will be affected by this issue," he added.

Political scientists aren’t sure if one issue can have such an effect. “Government employees are, of course, going to prefer OPS over NPS, but popularity of one scheme does not mean that it can also swing votes in a large number," said Rahul Varma, a fellow at the Delhi-based think tank Centre for Policy Research.

First, the bloc of government employees and their families is not large enough to affect the poll outcome on its own. Its proportion may be high in states like Himachal Pradesh, where the OPS may have had an effect, but we cannot be sure of its extent. Second, government employees are largely urban and belong to forward castes, and these groups are more likely to align with the BJP, he added.

Be that as it may, non-BJP parties will continue to make the OPS an agenda in upcoming elections. BJP, especially at the centre, has so far been seen as pro-NPS.

A fair ask?

Now, the crucial question. Are government employees justified in demanding a revert to the OPS?

The protesting employees refer to the OPS as their “constitutional" right, a practice going on since 1972—the Central Civil Services (Pension) Rules, 1972, came into force on 1 June 1972.

Let us go beyond these charged arguments and look at how the scheme compares to the NPS in numbers.

As employees who are NPS subscribers since 2004 will begin to retire after 2034, Mint undertook a hypothetical exercise to compare their pension amounts. The calculation assumed the basic salaries to be indexable to 5% inflation every year; a return of 8% on the NPS corpus (slightly higher than G-sec yield on 40 years); and 10% contribution by both employees and governments on basic salary and dearness allowances.

A government employee, recruited at the age of 28 in 2004, would retire after serving for 30 years in 2034. If she had purchased an annuity for 40% of the corpus, she would roughly get half the monthly pension amount under the NPS as compared to the OPS, in the first month of retirement.

If we assume the government contribution to be 14% instead of 10% (as has been done for central government employees since 1 April 2019), the monthly pension under the NPS goes up to two-thirds of that under the OPS.

If an employee goes for 100% annuitization of their corpus, the first monthly pension under the NPS could be as high as 1.7 times of that under OPS.

The lump sum withdrawal under the NPS is a feature somewhat similar to that of the General Provident Fund (GPF), with key differences. The GPF earns retirement benefits at a fixed interest rate, whereas the NPS payouts are subject to market risks. The GPF also allows advances up to 50% of the account balance, which is essentially an interest-free loan. No such provision exists under the NPS.

With the introduction of the NPS, the GPF for government employees appointed after its adoption was abolished. Employees contributed a minimum 6% of their salary towards the GPF.

In summary, the OPS provided a defined monthly pension, which was significantly higher than the NPS. The OPS also didn’t come with a salary cut—remember, under the NPS, the employee has to make a 10% contribution. Second, the provisions of the GPF, which has been abolished, were quite generous. Having said that, the NPS offerings are not negligible, and the government has been trying to make it more attractive. The centre has increased its contribution from 10% to 14% (which could be emulated by state governments as well) and has allowed employees to choose their fund managers and asset allocation.

Unsustainable privilege

The OPS was done away with after the recommendation of the old age social & income security (OASIS) project, which was commissioned in 1999. The OASIS report had recommended to introduce a contribution-based pension scheme, as the old pension provision could “impose a serious strain on future government finances".

Data indeed shows such a trend. The states’ aggregate pension outgo, as a share of their revenue receipts, has increased sharply, from 4.7% in 1990-91 to 13% in 2022-23. The increasing longevity and an ageing population will only bloat the future pension burden if an unfunded scheme like the OPS were to continue.

A recent report by SBI research estimated that the present value of aggregate pension liability, if all states were to revert to the OPS, would be ₹31 trillion, which is roughly 45% of the total outstanding liabilities of all states, as of 2021-22. The burden on five states that have already reversed the NPS order would be ₹4.4 trillion.

Subhash Chandra Garg, the former finance secretary of India, said that the NPS represented a recast of the pension benefits contract and, therefore, was made applicable only to the employees who joined government services after the conditions of employment had been modified. They joined willingly, he added. “There is no justification in even opening this subject. States who are switching over to OPS despite the employees being contractually bound by it are acting irresponsibly," said Garg.

Nonetheless, Gourav Vallabh, a national spokesperson of the Congress, justifies the demand from government employees. He argued that the OPS is required in the absence of a “solid" social security.

Is there a way states reverting to the OPS can finance it?

States switching to the OPS will start facing growing costs only after 2034—when the current crop of NPS subscribers begin to retire in bulk. Vallabh said that states will figure a way around, such as putting aside pension funds, to ensure adequate cash flow when it is required.

A government official from Chhattisgarh informed that no actuarial assessment of reverting to the OPS has been done yet by the state, as NPS subscribers will only start retiring from 2037.

“Reverting to OPS is fiscally expensive for states, which do not have much control on the revenue side, especially after the goods and services tax. There should be, hence, a lot more focus on the quality of expenditure," said Abhishek Upadhyay, senior economist at ICICI Securities Primary Dealership.

“One way to limit the expense could be by stopping the pay commission-linked upward revision of pensions. Otherwise, I worry that this could be at the expense of other productive expenses such as capex, education or health," he added.

Tarun Kumar, a chartered accountant in Delhi; Harshvardhan Roongta, a financial planner; and Neil Borate in Mumbai assisted with the calculations.

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