Changes in National Pension Scheme will ensure new pensioners get a larger rain check post-retirement

Some iron curtain countries (belonging to the Soviet bloc) particularly Poland took pride in giving the last pay as lifelong pension for its retiring employees. With increasing longevity in Europe, this spelt the ruination of finances of these governments.

In India, too, defined benefit pension—50 percent of the current salary of those in the same rank—meant a huge burden on government finances and cast a shadow on fiscal management. To wit, let us say an Additional Secretary to the government of India received Rs 5,000 as his last salary on retirement in 1979; today, if he were to be alive, his pension would be a whopping Rs 1.40 lakh or so, thanks to the generous hike in salary granted by successive pay commissions. Statistics are revealing.

Under the scheme, pensions skyrocketed from Rs 32,690 crore in FY09 to Rs 168,460 crore in FY19, or an increase of 5.2 times versus 3.9 times for all salaries for those who joined central government service before 2004. As a result, the pension-to-salary bill for the government rose from 61 percent a decade ago to 81 percent in FY19.

Imagine what would be the denouement and full impact had the Atal Behari Vajpayee government not bitten the bullet in 2004 and cried a halt at least prospectively to this free lunch?  Nobody grudges our seniors their due but it should not be freeloading.

New Pension Scheme

The Vajpayee government cried a halt to this fiscal profligacy by taking a bold stand—those joining central government service from 2004 will have to earn their pension by contributing to their pension fund as opposed to the old-timers who got their pension free. Thus the new entrants in 2004 and thereafter were asked to participate in a defined contribution pension plan called New Pension Scheme (NPS).

The central government contributed 10 percent and the new employees contributed a matching 10 percent of their salary to their pension fund which was invested by the fund managers and returned 60 percent in lumpsum on superannuation and 40 percent as annuity.

Ever since the government ushered in the defined contribution plan, there has been a clamor to return to the defined benefit plan that still enures for those who entered service before 2004.  But the Narendra Modi government has done well to resist this demand that would have been a regressive move on pension reforms.  At the same time, it has not been insensitive to youngsters’ needs. In an election year it has tread the middle path in terms of propitiating them.

The central government’s contribution goes up from 10 percent to 14 percent of an employee’s salary without a matching burden imposed on the employees.  This will cost the central government Rs 2,840 crore annually and benefit some 3 million employees. Youngsters would get a larger rain check post-retirement. Simultaneously, the government has also leveled the playing field between EPFO and NPS. In both cases, 60 percent received on superannuation would be fully exempt from tax.

Finance Minister Arun Jaitley told the Lok Sabha in his budget speech that India should move towards the ideal of a pensioned society.  The NDA government must be commended for their pension reforms.  The defined contribution plan is of a piece with what Swami Vivekananda said—-think of what you can do to the nation instead of always thinking of what the government can do for you.  Defined benefit plan pampers the latter category whereas the defined contribution plan caters to the former (I contribute and thus earn my pension).

The Vajpayee government started the process of grandfathering the old pension scheme, i.e. defined benefit plan.  The Modi government should grandfather EPFO not by force but by conferring a choice.

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