Pension Schemes in India: Evolution, Challenges & Future Prospects

Introduction: This article dissects the trajectory of pension schemes in India, tracing the journey from the traditional old pension scheme introduced in the 1950s to the contemporary New Pension Scheme (NPS). Examining the challenges and advantages, it aims to provide insights into the evolving landscape and the future for retired employees.

The original pension scheme, established in the 1950s, was exclusively designed for government employees. It ensured a fixed pension amount, equivalent to 50% of the final basic salary, paid on a monthly basis. Additionally, it included Dearness Relief with semi-annual revisions upon retirement, based on either the last ten months’ average wages or the final drawn salary, whichever was more favorable. Notably, the Old Pension Scheme did not involve any provision for employee contributions.

This scheme provided certainty in returns by calculating the monthly pension based on the employee’s last salary. Under this non-contributory, indexed, defined benefit pension, the government covered the entire pension cost. It also incorporated a General Provident Fund (GPF), wherein government employees contributed 10% of their basic pay. Upon retirement, the employee received the accumulated amount along with interest, which the government declared annually.

However, due to identified shortcomings in the system, the Union Government discontinued the Old Pension Scheme from January 2004. Subsequently, both the central government and all states transitioned to the New Pension Scheme (NPS), now known as the National Pension System. The inception of the NPS can be traced back to a report from the Old Age Social and Income Security (OASIS) project, commissioned by the Ministry of Social Justice and Empowerment (MSJE) in 1998.

Pensions under the NPS are financed by the government from the consolidated funds of India, without a specific pension corpus. This means that pension payments are funded through taxes collected from the current working population. The OASIS project report recognized and reported this issue, leading to the shift from the Old Pension Scheme to the NPS in 2004.

Few advantaged:

Several advantages are evident when considering the employment landscape in India based on data from the 1991 Census:

a. Diverse Employment Types: The working population in India comprises approximately 314 million individuals. Among them, 15.2% are employed, 53% are self-employed, and 31% are temporary or contract workers, reflecting a diverse range of employment types.

b. Inclusion in Old Pension Scheme (OPS): A notable portion of the salaried workforce, around 23% or 11.13 million individuals, employed by Central, State, and UT governments and departments, including essential services like post, telegraph, armed forces, and railways, were eligible for the Old Pension Scheme (OPS). This initiative aimed to provide them with a secure financial future post-retirement.

c. Government Employee Coverage: While 23% of salaried employees were eligible for OPS, it is essential to highlight that this figure represents employees in Central, State, and UT governments and departments. This coverage included a wide array of sectors, contributing to the overall stability of the workforce.

d. Non-Government Workers’ Coverage: Approximately 49% (23.18 million) of non-government salaried workers were covered under the Employee Provident Fund (EPF) and the Employee Pension Scheme. This extended coverage indicated efforts to encompass a significant portion of the non-governmental workforce.

e. Unorganized Sector Consideration: Recognizing the needs of the unorganized sector, comprising approximately 268 million workers, such as farmers, shopkeepers, professionals, cab drivers, etc., is crucial. The data highlights that these workers were not covered under any existing provisions, indicating a gap in the formal provision of old-age income security for this substantial segment of the workforce.

f. Limited Formal Provision: Despite the significant workforce in India, only around 34 million individuals, representing less than 11% of the estimated working population, were eligible to share and participate in formal provisions designed to deliver old-age income security. This emphasizes the need for comprehensive strategies to extend social security measures to a larger portion of the working population.

Population rising:

The demographic landscape in India is undergoing a significant transformation, particularly concerning the elderly population:

a. Steady Increase in Elderly Population: Since 1961, there has been a consistent and gradual rise in India’s elderly population. Notably, between 2001 and 2011, the number of individuals aged 60 and above exceeded 27 million, indicating a substantial demographic shift.

b. Projections for the Future: Demographic projections paint a compelling picture of the aging trend, with an anticipated acceleration. By 2026, it is projected that the elderly population will surge to an estimated 179 million, reflecting a considerable increase in the number of seniors in the country.

c. Central Government Workforce and Pensioners: According to data released by the Department of Expenditure, Ministry of Finance, as of March 31, 1998, there were 5.2 million central government employees. This figure encompasses individuals employed in various sectors, including railways, defense services, posts, and telecommunications. Concurrently, the total count of central government pensioners stood at 3.54 million.

d. Dependency Ratio: The data reveals a noteworthy dependency ratio of around 66%. This ratio signifies the proportion of pensioners in relation to the active workforce, shedding light on the economic implications and support structures required for an aging population.

These demographic shifts and statistics underscore the importance of comprehensive planning and policies to address the evolving needs of an aging population. As the number of elderly individuals continues to rise, there is a growing imperative to ensure adequate social security measures, healthcare provisions, and financial support systems to promote the well-being of seniors in the country.

Rise in life expectancy rate:

The concept of “life expectancy,” representing the anticipated additional years a person can expect to live, is a crucial indicator of a population’s overall health and well-being.

Over the years, India has witnessed a remarkable rise in life expectancy, underscoring positive trends in public health and lifestyle choices:

a. Historical Perspective: In 1950, India’s life expectancy was recorded at 35.21 years. As of 2022, this figure has more than doubled, standing at 70.19 years. This significant improvement reflects advancements in healthcare, sanitation, and awareness about healthy living.

b. Current Progress and Future Projections: The life expectancy is projected to continue its upward trajectory, reaching an estimated 81.96 years by 2100. This positive trend indicates sustained efforts in promoting health and well-being across the population.

c. Factors Contributing to Improvement: The observed rise in life expectancy suggests a growing awareness of the benefits associated with a healthy lifestyle and regular exercise. These positive lifestyle choices contribute to overall well-being and have a direct impact on life expectancy.

d. Challenges for Aging Population: Despite the encouraging statistics, there are challenges, particularly for the vulnerable population aged 60 or older. Addressing the financial needs of this demographic group poses a complex challenge, given the government’s financial constraints and the sheer size of the population.

e. Guaranteed Income Challenges: Providing a guaranteed income for the elderly, especially considering the large population, is a complex task. The government faces challenges in balancing financial resources to meet the diverse needs of an aging population.

Unfunded, impermanent and unsustainable Pension Liability:

The government’s old pension scheme is facing challenges, rendering it unfunded, impermanent, and unsustainable. Several factors contribute to this situation:

a. Increasing Pension Liability: The pension liability is on the rise every six months, primarily due to escalating benefit costs such as dearness relief. This upward trajectory is further fueled by improvements in medical facilities, leading to an increase in life expectancy. Over the past three decades, pension obligations for both the Centre and states have surged significantly.

b. Challenges in Sustainability: Finance Secretary T.V. Somanathan has emphasized the unsustainability of reverting to old pension schemes, cautioning about implications for future governments. He highlights the importance of maintaining a balance, with the pace of increase in revenue expenditure for interest payments, pensions, and subsidies being lower than the nominal growth rate of the economy. Failing to address this issue adequately can have adverse financial consequences for states making such changes.

c. Escalating Pension Bills: The pension bills for both the Central Government and state governments have witnessed substantial growth over the years. The data reveals a significant increase in pension payments from 1990-91 to 2020-21, with the Centre’s payment soaring 58 times and state payments increasing 125 times during this period. Combined, pension payments consume a quarter of states’ own tax revenue, and when combined with state employee wages and salaries, it virtually leaves states with negligible tax revenue.

d. Equality and Generational Concerns: The current structure raises concerns about equality between generations. Taxpayers today bear the burden of funding ever-increasing pensions for retirees. The effect of Pay Commission awards has led to the pension of retirees from the past being comparable to those retiring in recent times. This creates a massive pension burden on the resources of both Union and state governments.

e. CAG Report Insights: The Comptroller and Auditor General of India (CAG) report underscores the severity of the situation, indicating that the union pension payment constituted 132% of its expenditure on salary and wages in the fiscal year 2019-20.

f. Pension Payments Trends:

Rs. In crores

New Pension Scheme (NPS)

The New Pension Scheme (NPS) stands as a distinctive contributory and voluntary pension initiative, overseen and regulated by the Pension Fund Regulatory and Development Authority (PFRDA). Originally crafted in 2004 as an alternative pension avenue for government employees, it later expanded its reach voluntarily to encompass all Indians, including self-employed professionals and those within the unorganized sector, in 2009. Participants from the government workforce contributing to the National Pension Scheme (NPS) allocate 10% of their basic income, while employers match this commitment with up to 10% of the total. Starting April 1, 2019, the employer contribution was elevated to 14%, surpassing the previous parity with the worker’s contribution.

The NPS presents an intriguing option for retirees, allowing them to extract a lump sum from their pension fund. Sixty percent of this redemption amount enjoys tax-free status, while the remaining 40% is earmarked for investment in annuity plans, ensuring a steady income or pension. Functioning as a market-linked pension product, the NPS enables consistent investment throughout one’s working years, culminating in a pension post-retirement. The individual contributions to the National Pension are amalgamated into a pension fund that strategically invests in a diversified portfolio comprising government bonds, corporate debentures, and stocks. The management of these investments is entrusted to Professional Fund Managers (PFMs) regulated by the PFRDA, including entities like SBI, LIC, and UTI.

The NPS boasts a two-tier structure of retirement accounts, combining tax benefits with withdrawal flexibility. Tier-1 accounts serve as the fundamental and mandatory primary accounts, doubling as pension accounts. Linked to the Tier-1 accounts, Tier-2 accounts are designed as investment accounts. Depending on one’s investment objectives, individuals can opt to invest exclusively in a Tier-1 account or diversify across both Tier-1 and Tier-2 accounts. This flexibility contributes to the broad appeal and adaptability of the NPS within the spectrum of retirement planning.

World Bank on Pension scheme:

World Bank in its various report has also outlined that pension system should be fiscally and politically sustainable to achieve their income support objective. Unsustainable pension systems shouldn’t be an obstacle to fiscal stability, economic-growth, poverty reduction and infra-structure development.

• Pension eligibility age: Normal pension eligibility age should depend on retirement age, however flexibility in retirement may be desirable. Benefits for early retirees should be adjusted to reflect the longer period for which they are paid.

• Adequacy: As per general principle, sufficient pension should be paid for from the pension fund pool. In defined benefit scheme, this is more complicated to achieve, however actuarial technique can be used to find out which combinations of parameters and rules are feasible.

• Indexation: Changes in living costs or living standards should be automatically adjusted and reflected in pension benefits. Indexation ensures adequacy in a dynamic sense, without which pension purchasing power of pension can decline quickly.

• Secure and efficient: Pensions are inflation protected, sustainable and affordable. Management is efficient and costs are as low as possible.

Ways ahead

Looking ahead, the financial landscape of the National Pension Scheme (NPS) in India is undergoing a thorough examination and reevaluation. Finance Minister Smt. Nirmala Sitharaman, in a parliamentary announcement on March 24, 2023, revealed the initiation of a committee under the Finance Secretary’s stewardship. This committee is tasked with delving into the intricacies of the NPS issue, aiming to craft an approach that caters to the needs of employees while upholding fiscal prudence, safeguarding the interests of the common citizens.

A cautionary note has been sounded by a State Bank of India (SBI) report, asserting that reverting to the old pension scheme by states could trigger a fiscal time bomb. The potential fallout of such a move could lead to a domino effect, with other states following suit, creating a race to the bottom. The report outlines that a wholesale migration to the old scheme, assuming an entry-level age of 28 years with a 5% inflation indexation, could result in implicit pension liabilities reaching around 13% of GDP, discounted by the current G-sec yield on 40 years. Such a step backward would be a significant setback to the years of reforms initiated in the late 90s, starting with the OIASIS report that laid the groundwork for transitioning to the funded New Pension Scheme.

Deepak Mohanty, Chairman of the Pension Fund Regulatory and Development Authority, sheds light on ongoing efforts to develop a pension scheme that guarantees a minimum assured return. He emphasizes the need for attractive returns while exploring the possibility of an assured return product to be introduced in the near future.

Former RBI Governor Sh. Raghuram Rajan echoes concerns about reverting to the old pension scheme, characterizing it as a substantial long-term burden. He advocates for exploring less costly alternatives to meet the needs of government pensioners.

A proposed reform advocates for the NPS scheme to offer a minimum guaranteed fixed pension at 45%-50% of the last drawn basic pay, eliminating market-linked uncertainties. Additionally, to counteract inflation, the NPS should incorporate an inflation-adjusted Dearness Relief (DR), mirroring features of the old pension scheme. These adjustments aim to protect pensioners’ salaries at the time of retirement in real terms, addressing employee concerns without unduly burdening the government. Emphasizing the contributory nature of the NPS, the proposed changes suggest a fixed eligibility requirement, akin to the old pension scheme, fostering social welfare and inclusive growth. As India strides forward with a robust annual growth rate of 7%, expanding the coverage of a guaranteed pension is positioned as a pivotal step in nurturing demand-led growth and contributing to the welfare of the nation.