The story so far: Last weekend, the Union Cabinet signed a major shift in the approach to providing old-age income security to central government employees, laying the foundation for a new Unified Pension Scheme (UPS) to be launched on April 1, 2025. Around 23 lakh central government employees are expected to benefit from the new scheme, while employees under the ongoing pension scheme known as the State Pension Scheme (formerly known as the New Pension Scheme or NPS) will be given a one-time option to switch to the UPS. States have been given the option to include their employees under the UPS framework and will have to fund the scheme from their own resources.
What benefits does UPS offer?
The UPS benefit has five main components. It starts with the assurance that government employees will receive a monthly pension for life equal to half of their average basic salary during the last 12 months before retirement. This promise is subject to a minimum of 25 years of service. The benefit is proportionally reduced for those with less service if they have served the government for at least 10 years. The minimum pension amount for retirement is set at ₹10,000 for those with 10 years of service. UPS also provides a family pension equal to 60% of the employee’s pension at the time of death to support dependents. To provide a hedge against inflation, these pension benefits are increased in line with consumer price trends for industrial workers. This is similar to the cost of living relief allowance provided to working government employees. Finally, UPS promises to pay a lump sum severance payment in addition to the severance benefit upon retirement. This is equivalent to 1/10th of the employee’s monthly salary, i.e., the sum of salary and cost of living allowance if the employee has served for six months as of the date of payment.
How does this differ from the current pension system?
Currently, civil servants who enlisted before January 1, 2004 are covered by a system known as the Old Pension Scheme (OPS), which has been replaced by the National Pension Scheme (NPS) for those who enlisted in 2004 or later.
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OPS also provided a guaranteed pension of 50% of the last salary received by the employees, with an additional cost of living allowance added to the process, a guaranteed family pension of 60% of the last pension received and a minimum pension of ₹9,000 plus a cost of living allowance. Employees could commute 40% of their pension as a lump sum upon retirement. In addition, an additional 20% pension would be paid to pensioners above 80 years of age or family pensioners, which would increase to 30% at 85 years, 40% at 90 years and 50% at 95 years. Pension income would also be adjusted according to salary updates as per the recommendations of the Pay Commission. The last salary hike for government employees was from 2016 onwards as per the recommendations of the 7th Pay Commission. The key difference between OPS and NPS and UPS is that the payments were funded directly from government revenues. Hence, the liabilities of OPS were “unfunded” and not contributed by employees or employers. This is the case for non-government regular sector employees whose pension savings are managed under the Employees Provident Fund (EPF) Act.
English: After years of debate over the unsustainability of the civil servant pension bill, the NPS, launched by an executive order of the Atal Bihari Vajpayee government, abolished the OPS’s defined benefit system and converted it into a ‘defined contribution’ pension scheme. Ten percent of an employee’s salary was transferred to a pension account with matching contributions by the employer (Centre or State; almost all States that converted to NPS after 2004) The funds were pooled and placed in market-linked securities, with the option for the pension fund manager to park some of the funds in the stock market. On retirement, the employee was required to purchase annuities (insurance products that provide monthly income) with 40 percent of the assets accumulated in the NPS account and withdraw the remainder. The Centre increased the contribution to NPS to 14 percent in 2019, but did not provide any element of certainty about the pension income of NPS members, as it did with OPS. NPS members, including those who have already retired, can now switch to UPS.
UPS combines the OPS’s defined benefit model with the defined contribution NPS mechanism through promised pension levels and other SOPs. While employee contributions are capped at 10% of salary as in the case of NPS, the government contributes a higher 18.5% of salary to the pooled pension account. The central government also has to bear the gap between the final income for these contributions and the guaranteed pension promise under UPS. It is not clear at present whether UPS will follow the recommendations of the future Salary Commission or provide a higher pension for those above 80 years of age as OPS has done.
Why did the government choose to change?
The NPS scheme faced strong opposition both before and after its launch, due to the loss of security of pension income for government employees and the stark contrast between the pension benefits of government employees and their predecessors since 2004. While this uproar continued during the UPA era, opposition to the NPS has grown in recent years, especially as some early NPS contributors with short service years have started retiring with what they see as inferior pension benefits. This backlash eventually became an electoral issue, and opposition parties such as the Congress promised to restore OPS to state employees covered by the NPS ahead of some assembly elections, and implemented the switch after several terms in power. The central government, in its second innings under the Narendra Modi government, has resisted the reversal of these reforms, calling it a fiscally irresponsible concession to the states.
However, in March 2023, Finance Minister Nirmala Sitharaman announced a committee to review NPS for government employees in a way that “balances their aspirations with fiscal prudence”. The committee, headed by former Finance Minister TV Somanathan (now a Cabinet minister), had consulted extensively with employees and other stakeholders, and while its report is yet to be made public, the move to UPS was informed by the consultation. If there were any doubts that the UPS benefit was tied to political considerations in the wake of the recent Lok Sabha elections and ahead of several state elections, Information and Broadcasting Minister Ashwini Vaishnau put an end to it. While announcing UPS, she stressed that Congress-ruled states that had announced a return to OPS were yet to implement it, but PM Modi had ensured a result that would ensure “intergenerational equity”.
How have employees and the government reacted? What are the likely financial implications?
While central government employees have broadly welcomed the UPS provision as an acknowledgement of the problems of NPS, there are still reservations about the contribution aspect of UPS and the lack of commuting options like OPS. Like employee representatives, economists are also waiting for details on the contours and mathematics of UPS. The UPS contribution, including some arrears, is expected to cost an additional ₹7,050 crore this year. A price hike, if announced, would also warrant additional funding. “A pension certainty would add to the government’s future spending commitments while reducing uncertainty for employees. This should be part of the roadmap for fiscal consolidation going forward,” said Aditi Nayar, chief economist at ICRA.
The immediate impact is only an additional 4.5 per cent contribution to UPS, but future payments will be higher but could be absorbed by higher earnings growth, estimates Madan Sabnavis, chief economist at Bank of Baroda. “We can see this as the equivalent of a salary commission revision being absorbed into the system,” he asserted.
