Unified Pension System: Reversal of pension reform should have been avoided

The new modified pension scheme is better than OPS, but switching to NPS was one of the biggest reforms in recent decades and would have benefited the country in the long run

Last week, the Union Cabinet approved a new pension scheme for government employees, called the Unified Pension Scheme (UPS), which will come into effect on April 1, 2025. This will benefit government employees who joined after January 1, 2004, and are part of the New Pension System (NPS). Under the UPS, a central government employee will get an assured pension worth 50 per cent of the average basic pay drawn over the last 12 months’ service, provided the employee has served for at least 25 years. This will be lower for employees with fewer years served but with a minimum of 10 years. An assured pension of Rs 10,000 will be paid on superannuation to employees with a minimum of 10 years of service. The UPS will have other features like family pension and indexation to inflation. With the approval of the UPS, the government has tried to take a middle path by marrying the features of the Old Pension Scheme (OPS) and the NPS.

The issue of pensions became politically emotive in some recent Assembly elections. Some states, then run by non-National Democratic Alliance governments — such as Rajasthan, Chhattisgarh, and Punjab — reverted to the OPS, which will shift the pension burden to future generations. The Union government on its part formed a committee under then finance secretary T V Somanathan to look into the matter. Instead of “pay as you go” in the OPS, while the UPS will have a defined benefit, it will also have a defined contribution like the NPS. In the UPS, the employee will continue to contribute 10 per cent of the basic pay plus dearness allowance. The government on its part will now contribute 18.5 per cent instead of 14 per cent, which was stipulated in the NPS. The additional contribution would cost Rs 6,250 crore in the first year and another Rs 800 crore as a one-time expenditure on account of arrears. People who have taken voluntary retirement since the launch of the NPS will also be allowed to switch to the UPS. The scheme will be open to state government employees.

What the Union government has done is address the fear of uncertainty regarding pensions among government employees. With an assured pension, they will not have to worry about how their pension fund performs over the years. For the government, besides the increased outgo due to higher contributions, it will also need to cover any shortfall later if the pension corpus fails to generate sufficient returns to pay the assured amount. However, this is still a better option than going back to the OPS, as some states have done because the burden on future generations will be limited compared to the OPS.

Although the UPS has tried to address the concern of government employees, it remains to be seen how it is received politically. It may still appeal to some states to go back to the OPS because of the short-term benefit of saving on the contribution front. However, from the macroeconomic standpoint, reversal on such hard-won reforms will impose significant costs on the economy. In the current year, for instance, the outgo on pensions at Union level is estimated at about 10 per cent of the Centre’s tax revenue. Switching to the NPS was one of the biggest reforms in recent decades, and it would have benefited the country in the long run, and any reversal, even partial, should have been avoided.