Changing pension landscape in India: NPS Vatsalya set to be a game-changer

Employers and employees must contribute a percentage of their basic salary plus DA towards the UPS fund - which differentiates it from OPS but makes it similar to NPS

The NPS Vatsalya scheme proposed by the Central Government in the Union Budget 2024 appears to be a true game changer, nudging the gen Alpha to turn into astute and savvy investors by getting early onto the prudent financial behaviour bandwagon.
 

Such reforms unleashed in the pension sector promise to put India on a fast dial vis-à-vis developed nations like the United States. It may be noted that even in the US, younger cohorts of the working population, chiefly those at the bottom ladder of contractual remuneration/benefits, have been contributing little toward retirement in worker-managed pension plans such as 401(k)s. In fact, there is increased pressure to allow more corpus to flow into private equity giants like KKR and Charles Schwab/Fidelity. That should be a lesson apparent for us to take calibrated and calculated steps while launching new schemes.

Against this background, the idea of introducing NPS Vatsalya looks perfectly timed.

Pension sector reforms in India started with the OASIS report in 1999 as part of the financial sector reforms. The basic aim of these reforms was to transform the financial markets on free market principles. However, the major fillip in this respect was taken when in 2003 the Central Government in the Budget announced winding up of the pay-as-you-go (PAYG) pension for central government employees and migrate all new employees to the then new pension scheme (NPS) which was a defined contribution scheme (DC). It was then made a mandatory scheme for new recruits in the Central Government (excluding the armed forces) from January 1, 2004.

Under the PAYG scheme, the contributions of the current generation of workers were explicitly used to pay the pensions of current pensioners. Hence a PAYG scheme involved a direct transfer of resources from the current generation of taxpayers to fund the pensioners. The PAYG scheme thus had no accumulated funds for pension obligations and hence was a clear fiscal burden. Interestingly, the PAYG scheme is always an attractive dispensation for political parties as the current aged people can benefit from PAYG even though they may not have contributed to the pension kitty.

The introduction of NPS was a revolution in pension reforms. The NPS currently covers all individuals working in both the public and private sectors to plan their financial securities after retirement.

The NPS history showcases how the scheme has been evolving over the past years. As on August 31, 2024, the NPS subscriber base stood at 18 million and AUM is Rs 12.65 trillion, which is 4.6 per cent of India’s nominal GDP. Out of the total NPS fund, state government share is 36.2 per cent in subscribers and 51.0 per cent in AUM, while central government share stands at 14.3 per cent in subscribers and 27.8 per cent in AUM. For the decade since 2014, the AUM managed under NPS has cumulatively grown close to 26 times, standing at Rs 12.66 trillion as of end-August 2024.

Returns of NPS have been higher compared to other long-term tax-saving instruments like Public Provident Funds majorly because a portion of the invested amount goes to the equities universe, allowing NPS to outstrip other forms of investment options. Despite the higher earning potential, the associated risk is significantly low as the equity exposure is capped (50 per cent to 75 per cent for all NPS return rates). Moreover, the equity portion reduces by 2.5 per cent every year once an investor crosses 50 years of age. That safeguards the funds from market volatility and stabilises the risk-return equation to assist an investor.

Interestingly, the government announced a new employee pension scheme on August 24, 2024, the Unified Pension Scheme (UPS), effective from April 1, 2025. UPS offers a balanced approach by combining the benefits of NPS and OPS. UPS provides a fixed pension amount, including an assured minimum pension, inflation indexation and an assured family pension. However, employers and employees must contribute a percentage of their basic salary plus DA towards the UPS pension fund — that differentiates it from OPS but makes it similar to NPS.

Under NPS, if someone joins at the age of 25 (say in 2024) and contributes an average Rs 30,000 per month for the next 35 years (considering retirement at the age of 60), the corpus should grow to Rs 11.48 crore at the time of retirement (based on the current return of 10-11 per cent). As per NPS, 60 per cent can be withdrawn, which will give tax-free payment of Rs 6.89 crore and the rest 40 per cent will be invested in annuity.

If we assume annuity returns of 6 per cent, the subscriber should get a monthly pension of around Rs 2.29 lakh per month. If we consider the 60 per cent corpus gets deposited in a bank with returns of 6 per cent, the subscriber-depositor will get additional monthly income for 20 years (240 months) of Rs 3.41 lakh per month, while keeping the original corpus of Rs 6.89 crore intact.

So, the total monthly amount received by the subscriber is around Rs 5.70 lakh per month (2059). Under UPS, the pensioner would likely get Rs 6.8 lakh per month (2059) as pension at the time of retirement. In fact, if the returns are higher, NPS 

corpus can easily be more than the UPS corpus.

Clearly, the NPS appears to be as good an option as UPS, as NPS will give the 60 per cent corpus in the hand of the subscriber, which is huge and better as upfront payments made which can be passed on to the next generation or can be utilised by the financial intermediary to finance growth.

To sum up, NPS Vatsalya could just be an ideal scheme for India to turn into a land of investors.

The writer is member, 16th Finance Commission, and group chief economic advisor, State Bank of India. Views are personal