Date: 17/12/2022

Relevance: GS-2: Welfare schemes for vulnerable sections of the population by the Centre and States and the performance of these schemes

Key Phrases: Old Pension Scheme (OPS), New Pension Scheme, market-linked instruments, bad economics, bad politics, volatile stock market, ever-increasing pensions, Breaking a consensus on pension reforms.

Why in news?

• With the new Chief Minister of Himachal Pradesh reiterating that the Old Pension Scheme (OPS) will be restored by the newly elected government, the State would now become the fourth to do so.

Old Pension Scheme:

• The old pension scheme promises a fixed monthly income to government employees after retirement.
• Amount of pension:
  • It provided 50 percent of the last drawn salary as a pension.
• Taxation:
  • No tax benefits are applicable to the employees.
  • Income under the old pension scheme doesn't attract tax.
• Eligibility:
  • Only government employees are eligible for receiving a pension under the old pension scheme after retirement.

New Pension Scheme:

• Introduction: It was introduced in the year 2004 by the Government of India.
• Contribution:
  • In NPS, employees contribute money from their salary during their employment tenure. The amount is invested in market-linked instruments.
  • Under NPS, employees make a monthly contribution at the rate of 10 per of their salary. A matching contribution is also made by the government. Starting April 1, 2019, the employer’s contribution rate has been enhanced to 14 percent for central government employees.
• Pension amount and tax:
  • After retirement, an employee can withdraw a part of the pension amount in a lump sum.
  • As per the rule, 60 percent of the corpus on maturity is tax-free, while the remaining 40 percent is taxable and must be invested in annuities for a regular income or pension.
• Eligibility:
  • Any Indian citizen, resident or non-resident, between the age of 60- 65 years can also join NPS and continue up to the age of 70 years in NPS.
  • The NPS is also meant for government employees. However, private sector employees can also join NPS.
  • NPS is mandatorily applicable to Central government employees except armed forces recruited on or after January 1, 2004. State governments too follow the NPS for their employees.

Why is the OPS both bad economics and bad politics?

• Burden on the exchequer:
  • In 30 years, the cumulative pension bill of states has jumped to Rs 3,86,001 crore in 2020-21 from Rs 3,131 crore in 1990-91.
  • Overall, pension payments by states eat away a quarter of their own tax revenues. For some states, it is much higher.
    • For Himachal, it is almost 80 percent (pensions as a percentage of the state’s own tax revenues); for Chhattisgarh 24 percent; and for Rajasthan 30 percent.
  • If wages and salaries of state government employees are added to this bill, states are left with hardly anything from their own tax receipts.
  • Funding a small number of former government employees by utilizing a chunk of taxpayers’ money cannot be good politics.
• Short-term gain:
  • States reverting to OPS can achieve some short-term gains as they need not put up the matching contribution of 10% towards employee pension funds.
  • But with a greying population, the burden of payments will fall on future generations.
• Inter-generational equity:
  • There is also the larger issue of inter-generational equity. Today’s taxpayers paying for the ever-increasing pensions of retirees, with Pay Commission awards almost taking the pension of old retirees to current levels, means the pension of someone who retired in 1995 may well be the same as that for someone who retires in 2025.

How NPS is a better option:

• Freedom to allocate savings:
  • The current clamour by government employees for the old scheme seems to be based on misconceptions about how the NPS works. The biggest fear about the NPS is that it redirects subscribers’ money into the ‘volatile’ stock market.
  • But, the fact is that NPS subscribers have complete freedom to allocate their savings to equities, corporate bonds or government securities, or any combination of the three.
  • Risk-averse investors can simply allocate all their money to bonds or gilts in NPS, altogether skipping stocks.
• Beating Inflation:
  • The biggest challenge for any retirement saver is to beat inflation. Equities do this job better than any other asset class.
  • A 20-year analysis of Nifty50 shows that while it frequently delivered losses over one-year periods, stretching one’s holding period to 10 years reduced the loss probability to zero while fetching an 11-12 percent return.
  • While the EPFO has been struggling to declare an 8-8.5 percent return from its ‘safe’ debt portfolio, NPS managers have earned a 13-14 percent return on equities and 8.5-9 percent on bonds and government securities over a decade.
• Greater control:
  • With NPS, an employee has greater control over his pension as he can save more or allocate more to equities.
  • In the old pension scheme, the employee’s pension is mandatorily limited to half of his last-drawn pay.

Conclusion:

• Breaking a consensus on pension reforms and reverting to OPS amounts to an imprudent option as it will only benefit organized government sector employees, increase the fiscal burden of carrying these payments and take up a significant portion of the State’s budget, thereby curtailing its outlays on general welfare as a whole.
• Rather than focusing on immediate return and relief, political parties need to take a longer-term view and resist the temptation for such fiscally imprudent moves.

Source: The Hindu

Mains Question:

Q. What are the differences between the Old Pension Scheme and the New Pension Scheme (NPS)? Explain why a return to the old pension system would be fiscally damaging.