Caving into demands from government employees for an assured return pension scheme, the Central government has designed the Unified Pension Scheme (UPS). The scheme will be rolled out for the 23 lakh Central government employees who joined government service from January 2004 and may later be expanded to State government employees.
How much pension will government employees receive?
Government employees will receive a monthly pension on retirement, at 50 per cent of their last-drawn basic pay. The minimum pension will be ₹10,000 per month. This pension will be adjusted over time for inflation in the CPI- Industrial Workers index. Only employees with 25 years of completed service will receive a full pension at 50 per cent of their basic pay. Those with less service will see proportionate reduction. Those with less than 10 years of service will not get a pension. On death of the employee, his or her immediate family will receive 60 per cent of the basic pay earned by the employee just before his demise.
Is this a replacement for National Pension System (NPS)?
No, UPS will be an option within the NPS. Employees who joined the government after 2004 can either choose UPS or stay with the current NPS contribution.
How is the government funding this pension?
The payouts are funded partly by the government (read the taxpayer) and partly by employees. Government employees will be required to contribute 10 per cent of their basic pay during their working lives (this is what they’re already contributing to NPS) to the scheme. The government, which is now contributing 14 per cent of the employee’s basic pay, will increase this contribution to 18.5 per cent. Of the 18.5 per cent, 10 per cent will go into the NPS along with the employees’ contribution. The extra 8.5 per cent will go into a common pool maintained by the government. The 20 per cent contribution (10 per cent each from employee and government) will be used to fund the guaranteed pension payout. If this corpus proves inadequate, money will be drawn from the common pool to make up the shortfall. At retirement, government employees will need to surrender 100 per cent of their maturity proceeds to receive full pension, as opposed to the 40 per cent they surrender today. Non-government subscribers to NPS can withdraw 60 per cent of maturity proceeds as a lumpsum at retirement, while using the remaining 40 per cent to purchase an annuity.
What will this cost taxpayers?
The Committee that designed this scheme estimates that the increased government contribution (from 14 per cent of each employee’s basic to 18.5 per cent) for UPS will entail an additional budget outlay of ₹6,250 crore this year. This is over and above pensions and salaries for government employees already provided for in the budget. However, this calculation is based on the current workforce and age mix of Central government employees, as well as return and longevity assumptions. As these variables change over time, the government contribution can also turn out higher or lower than the 18.5 per cent, with the budget outlay also changing.
Where will the contributions be invested?
For their individual corpus (where 10 per cent of their contribution and the government’s is parked), government employees will be allowed to choose any asset allocation mix from the four options on the Central government NPS menu. The first is a default scheme, where 85 per cent is invested in fixed income and 15 per cent in equities. The second has a 100 per cent allocation to government securities. Third is a lifecycle fund where the asset mix changes with age, but the equity allocation is capped at 25 per cent. Fourth is a lifecycle fund where equity is capped at 50 per cent.
At retirement, however, the government will evaluate whether the pension can be fully funded based on the performance of the default option of the NPS. If the returns turn out lower due to the employee opting for other choices, that shortfall will not be met by the government. However, if the investment choice of the employee leads to a higher corpus than the default option, he will receive a higher annuity.
Will government employees be using the NPS’ prescribed annuity providers?
This looks unlikely because the current annuity providers under NPS offer a fixed pension without inflation adjustment. The UPS promises inflation-adjusted pension that will rise with time.
What should private sector employees take away from the structure of the UPS?
The government’s calculations have shown that to set up an inflation-adjusted pension at just half of the employee’s last-drawn salary, investments during his working life need to be between 20 per cent and 28.5 per cent of his pay (government plus employee contribution under UPS). As private subscribers to the NPS are unlikely to find generous employers willing to chip in with 18.5 per cent of their pay, their own savings need to make up the gap. The UPS stipulates a minimum working period of 25 years to earn full pension. This shows that adequately funding your expenses post-retirement requires a very long time horizon, so that compounding can work its magic. To be able to contribute to your retirement fund for 25 years, you need to start investing at the age of 35 at least. However, UPS bases its calculations on contributions that are invested very conservatively – 85 per cent in debt and only 15 per cent in equity. Private sector employees can take on higher risk and invest most of their retirement savings in equities. This can help you fund your retirement without having to devote 20 per cent plus of your monthly paycheque to your retirement goal.