Last Updated on August 28, 2024 at 10:29 am
Several readers have asked us for a calculator to help them decide if they should switch from the National Pension Scheme (NPS) to the newly announced Unified Pension Scheme (UPS). Such a calculator is now available for free download, but several caveats must be considered.
This is not an easy calculation, especially for those new in government service (less than ten years), as it will involve projecting future contributions into the NPS and UPS (for comparison). Many variables influence these, including promotions, pay commissions, increments, and DA twice yearly.
Only when the service is significant and the NPS corpus large enough can a reasonable comparison be made. I shall now discuss how to compare NPS and UPS using a simple illustration.
The ideal comparison would be to check if the NPS corpus can generate a pension plus periodic inflation-indexed withdrawals comparable to the UPS. Only those close to retirement can make such a meaningful comparison. For others, there are too many variables at play.
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For what it is worth, this is the ideal thumb rule for comparing UPS vs NPS.
- Project your future NPS corpus at the time of retirement.
- Find the pension one can obtain with a reasonable annuity rate from an insurer with 40% of the future corpus.
- NPS is better if this pension is greater than or equal to 50% of your basic pay at retirement. You should then be able to generate the 5% inflation indexation with the rest of the corpus. This is the case for me. So, it makes sense for me to stick with NPS.
- If not, you must see how much of the NPS corpus you must use to get a pension = 50% of the last drawn basic and how much of the corpus is left. The more the NPS corpus is used, the more favourable it is for UPS.
- The problem with this is that the projection has too many variables and is not reliable unless one is close to retirement.
- My preliminary impression is that for those with basic > 1L, the final NPS corpus will be reasonably high (if they are far away from retirement). Then, the minimum 40% NPS pension will be reasonably high. They could manage with NPS if their other investments are substantial.
Note: The corpus from other investments is crucial here. If this is significant, one can afford to stay with the NPS even if UPS is more beneficial. So, we must go beyond the calculator and look at personal circumstances.
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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.
Note: The numbers used are only for illustration and may not represent actual situations. This annuity rate will depend on service, the NPS asset allocation and returns. So it will change yearly for the same person. We held an anonymous poll on social media and are currently processing it. We will post the results later.
Case 1:
- We will consider an employee with a basic pay of Rs. 50,000.
- Service: 18 years
- NPS Corpus: Rs. 30 Lakhs
- Monthly Pension if he quits now, choosing UPS: 50,000 X 0.36 = 18,000. The factor is 0.5 (half) for those with 25 years of service or more. So, the proportional factor assumed is 0.36. The actual factor may be different.
- To get a monthly pension of Rs. 18,000 with an NPS corpus of 30 lakhs (assuming the full corpus is annuitised), the rate required is 18000×12/3000000 = 7.2%
- This annuity rate excludes the about 5% annual increase in pension due to dearness allowance hikes.
Case 2:
- An employee with a basic pay of Rs. 90,000.
- Service: 25 years
- NPS Corpus: Rs. 55Lakhs
- Monthly Pension if he quits now, choosing UPS: 90,000 X 0.56 = 45,000.
- To get a monthly pension of Rs. 45,000 with an NPS corpus of 55 lakhs (assuming the full corpus is annuitised), the rate required is 45000×12/5500000 = 9.82%
- This annuity rate excludes the about 5% annual increase in pension due to dearness allowance hikes.
The annuity rate in case 1 is quite nominal. In case 2, it is quite high. In both cases, no annuity products provide close to a 5% indexed pension. Who should switch to UPS and who can afford not to depends on the basic pay, expenses, the corpus outside NPS, and family circumstances. Please follow the guidelines mentioned above and make a projection.
Also, see: Should I switch from the National Pension Scheme to the Unified Pension Scheme?
In any case, we urge readers not to act in a hurry. Please wait for the UPS circular, make a detailed calculation for your personal situation and then decicde.
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