December 7, 2022
Devinder Dhingra
Satyam (The Truth)
NPS, the New Pension Scheme, was adopted by the Government of India in 2004. Before that, there existed a pension scheme, now popularly known as OPS (Old Pension Scheme) in which the pension was given to an employee based on the last drawn salary and even those who had served at least twenty years in service were eligible for it if VRS was opted.
Recently, we have seen a couple of states announcing reverting to the OPS again and some other political parties promising a similar rollback in some other states where elections were due.
Which is actually beneficial – OPS or NPS?
What are the pitfalls? What is optimum and what should the Government do?
Let us analyse everything in detail:
In the sixth pay commission (year 2006), salaries of government employees saw a huge jump. There was no extra benefit for the employees who were in NPS. Everybody got equal increments whether one was in OPS or NPS. Due to which, those who were in OPS got an advantage of earning tax free and the best in the market fixed returns from the GPF (Provident Fund) as well as an assurance of a pension till death after retirement with a basic amount of half the salary one was drawing at the time of the retirement, while those in NPS were just given ten percent of the Basic + DA contribution from the government.
Lately in 2019, the government raised its contribution to 14% but still there are resentments and a demand for roll back to OPS.
I would now take a case study before we discuss the advantages and disadvantages of each scheme, so as to know where the difference lies and how the change affects the employees.
Suppose an employee X joins in OPS and another employee Y joins in NPS, both are drawing an equal initial salary in the same pay band of the seventh pay commission, say band 6, i.e. an initial salary of Rs. 35400 and both go for VRS after putting in twenty years of service.
For simplification, we shall ignore the ACP and promotions since different states have different rules on it. We shall even ignore the DA component since it keeps on varying. These assumptions will not impact our analysis since we are comparing here two schemes, NPS and OPS, and not the actual amount that shall be receivable by the employee, which obviously would be much more than the figures presented here.
At the end of 20 years, both employee X and Y would have a basic salary of Rs. 62200. Employee X under OPS would be offered a pension at 50% rate, i.e. Rs. 31100 + DA. In the same 20 year period, the NPS contribution amount (employee Y contributing 10% and government contributing 14%) for employee Y would be about 54.6 Lacs at an average return of 7% per annum. If the same amount is converted into an annuity at 7 percent, the monthly pension would be about Rs. 31800.
Wow! The figure sounds interesting. Anyone would say it is the same pension amount, in fact a little more in the case of NPS, then why is there hue and cry.
If we deduct this component, the pension provided by the government contribution reduces to about Rs. 18600 per month.
The second thing, the seven percent return is an assumption and not guaranteed. It may be more than 7 or may even be less. A one percent change in return would cause about Rs. 2000 change in the pension owing to the government contribution component. The change would be upwards if the return is more and downwards if the return is less.
The third thing, the pension in the case of OPS also has a DA component which is linked to inflation. True that even an NPS employee can get an increase in the pension every year if he chooses an annuity with no return of premium option, but there is no initial DA component and the increase in the pension would be a fixed percentage offered by the annuity providers, obviously not linked to the inflation.
The fourth thing, annuity rates keep on varying and there is no guarantee that they would remain suitable at the time when an employee retires.
On the other hand, there are some benefits in the case of NPS. The first: if someone opts for annuity with return of premium, the legal heirs stand benefited after the death of the employee. This benefit will be more if an employee dies early after retirement.
The second advantage: if someone is good in money management, he or she may earn even higher by investing differently rather than choosing an annuity option.
And then there is a further twist as well. If the service of an employee is about thirty years, the pension component has a different equation. Like, for the example discussed above, if both employee X and Y retire after working for thirty years, the pension for employee X under OPS would start at Rs. 41800, whereas employee Y with NPS would get a pension of about 80000 (at 7%), out of which the government contribution based pension would be about Rs. 46700.
If the service is of thirty five years, the difference in the pension component would further increase and the employee Y with NPS will earn about 22000 Rs. more from the government contribution component and which will easily beat the OPS even after DA component is taken into account, apart from an additional benefit of retaining the NPS corpus.
Thus, it is obvious that when the service increases and touches about thirty years, NPS is a clear winner just in the pension amount (the Government component). Even for the employees whose service touches twenty five years or more, NPS may be a good option for many of them.
So, what should be the right way? What should the government do?
More to read
About Criss Cross
Criss Cross, the Satyam Shivam Sundaram section, has three goals. Satyam is for truth - highlighting various issues and identifying problems. Shivam aims for the solution since identifying problems is a job quarterly done. Sundaram is for guidance and everything else.If you have a solution to a specified problem in this blog or any feedbacks, you may contact us at author@ddplanet.in.
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