Is the Unified Pension Scheme sustainable?

Last Updated on August 28, 2024 at 10:27 am

The government will offer the Unified Pension Scheme (UPS) as an alternative to the National Pension Scheme (NPS) from 1st April 2025 to all central government employees. State government employees are also eligible if the states join.

Update: Use our free calculator linked below to compare NPS and UPS!

The salient features are:

• Assured pension: 50% of the average basic pay drawn over the last 12 months before superannuation for a minimum qualifying service of 25 years. This pay is to be proportionate for a lesser service period up to a minimum of 10 years of service.
• Assured family pension: @60% of employee pension immediately before her/his demise.
• Assured minimum pension: @10,000 per month on superannuation after a minimum of ten years of service.
• Inflation indexation: on assured pension, on assured family pension and assured minimum pension
• Dearness Relief is based on the All India Consumer Price Index for Industrial Workers (AICPI-IW) for service employees. The last 10-year average annual increase is about 5%
• lump sum payment at superannuation in addition to gratuity 1/10th of monthly emoluments (pay + DA) as on the date of superannuation for every completed six months of service without reduction in the quantum of assured pension
• Government NPS subscribers can switch to the UPS.
• For UPS subscribers, the monthly employee contribution will be at 10% of basic+ DA, and the government contribution will be 18.5% (variable according to actuarial considerations).

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Underlying logic: Can your future NPS corpus provide the same pension expected from UPS (with inflation indexation)? The NPS annuity provides part of this pension. Inflation indexation is provided via systematic withdrawals from the balance NPS corpus (if any!). If the answer is yes, then stay in NPS. If the answer is no, find out how much the shortfall is. For example, you expect to live 30 years after retirement, and NPS can provide an inflation-indexed pension for 29 years. The shortfall (1Y) is small. NPS and UPS are still comparable. If the shortfall is large (several years), UPS is better than NPS.

I am still coming to terms with the features of the scheme. I am part of the government NPS and must consider whether switching to UPS makes sense for my family and me. I am emotionally attached to my NPS corpus. So, based on the current information and using the above calculator, I will stay put in NPS. It gives many more options, either for a pension (via a Gilt bond purchased via RBI Retail Direct) or a retirement bucket strategy.

Sustainability:  As a strong supporter of the NPS – Why the old pension scheme is unsustainable and the NPS essential – I am trying to understand this additional pension burden.

I quickly ran the numbers for a few cases with a poll held on social media.  If the entire NPS corpus is used to purchase the same UPS annuity, the annuity rate (pre-tax) is 6% to a little more than 10% (depending on salary and service). I have not factored in the inflation-indexed component. That will make the effective annuity rate even higher! Such an annuity product (with inflation indexation close to 5%) does not exist in the market (i.e. with life insurers). Taxation on the annuity as per slab will reduce the pension burden.

However, aside from Group A and higher-ranked offers (about 3% of the entire staff), I expect the effective annuity rate pre-tax (without factoring indexation) to be 6% to 8% or so (perhaps lower in some cases, especially for early retirement, depending on the proportional factor used). This annuity rate will depend on service, the NPS asset allocation and returns. It will change yearly for the same person.

I think the government hopes to gain (return + dividends) from the stock and bond market an amount close to the annuity payout by prudently investing in the UPS corpus. This will make a big difference in making the scheme self-contained (without recourse to higher taxes) and sustainable.

The key difference between the OPS and the UPS is the capital market-linked (especially equity) NPS corpus (of those who switch to UPS), which has grown largely untouched for the last 20 years. The future growth of this, plus further contributions, should take care of near-term sustainability. However, this has to be periodically reviewed. It is best to expect modifications in the currently announced features down the line. Also, the employee did not contribute to the scheme in the OPS. In the UPS, it will be 10% of basic + da.

One question I have, though, is, why an 18.5% government contribution? As things stand, the government will contribute more to the pension fund and pay out more pensions.

My limited understanding is that making the employee contribution 18.5% (or higher) and the government contribution fixed at 10% (or lower and only linked to basic and not DA) will lower the pension burden significantly. After all, if an employee wants an assured pension indexed to inflation, he/she should pay more for it.

In summary, based on the available information, my initial impression is that the unified pension scheme will be sustainable in the near term if the UPS corpus (from NPS subscribers who switch) is prudently invested. Inflation management will be key, though. If this is contained below 5%, the pension burden will be bearable, at least in the near term. Regular reviews of sustainability are essential. UPS subscribers should expect changes in features down the line.

In the next article, we shall discuss options for existing NPS government subscribers. We urge readers not to act in a hurry. Please wait for the UPS circular, make a detailed calculation of your situation, and then decide.