Explained: Pros and cons of New and Old Pension Schemes

It is necessary to separate the Old and New Pension scheme debate from political expediency and objectively assess pros-and cons to understand which of these provide a better old age security coverage without bleeding the exchequer.

| Updated: 21 March, 2023 9:54 pm IST

The pension system is an integral part of the economic and social security system of a country which provides financial security to elderly citizens and helps them meet their daily expenses when they’re old. From the Old Pension Scheme to the New Pension Scheme, India has gone through several changes in the pension system over the years.

The Old Pension Scheme (OPS) and the New Pension Scheme (NPS) are both retirement savings plans, but with different approaches to creating a secure financial future.

While the old pension scheme provides a guaranteed stream of income after retirement, NPS invests part of the money in the stock market, thus providing the potential for higher returns, however, with this increase in potential comes increased risk, as the performance of the investments is not guaranteed and the returns depend on the subscriber’s ability to make wise asset allocation decisions throughout their employment years.

While the OPS provides return certainty and income that is not subject to taxation, the NPS offers more freedom, control, and potentially higher returns.

Applicable only to government employees, the old pension scheme was introduced in the 1950s. Under this scheme, government employees are entitled to receive 50% of their last drawn basic salary plus a Dearness Allowance (DA) upon retirement or an average of their wages over the previous ten months of employment, whichever is more favourable to them. This scheme does not require any employee contributions and provides a guaranteed income after retirement.

The New Pension Scheme was introduced by the National Democratic Alliance (NDA) government in December 2003 and came into effect on April 1, 2004. It is applicable to both government and private sector employees. Under the NPS, employees contribute 10% of their base pay, while their employers can contribute up to 14%. With this scheme, consumers have more freedom and control over their destinies, as they can benefit from market-linked returns but without any guarantee of returns.

Additionally, 60% of the corpus on maturity is tax-free in NPS, while the remaining 40% must be invested in annuities that are 100% taxable.

The old pension scheme provides return certainty, as it bases the monthly pension on the last wage received by the employee. On the other hand, the new pension scheme offers market-linked returns without any guarantee.

Under OPS, income is not subject to taxation. However, under NPS, 60% of the corpus on maturity is tax-free, while the remaining 40% is taxable when invested in annuities.

Only government employees are eligible for receiving a pension under the old pension scheme after retirement. On the other hand, the new pension scheme can be availed by all citizens between 18 and 65 years.

Monthly payments under the old pension scheme are equivalent to 50% of the last salary drawn. In the new pension scheme, employees are required to contribute 10% of their salaries, while employers can contribute up to 14%.

The old pension scheme did not have much flexibility as it provided a fixed monthly income. The new pension scheme, however, gives the subscriber more freedom and control over their finances, and has the option to choose their asset allocation, allowing them to generate higher returns and build a larger retirement corpus. Yet, the final outcome would largely depend on how well the corpus is managed by the fund manager.

Experts believe that there are many market risks that the employee is subject to in the case of the new pension scheme. The market may not deliver expected returns or may even wipe out a large chunk of the savings in the event of a financial crash, as happened with American pensioners during the 2008 financial crisis.

Some experts believe that the real beneficiaries of the shift are the fund managers earning fees and commissions for managing other people’s money with no commitment to ensure a guaranteed return.

Reforms are a precondition to successful development. Yet, reforms can backfire if they are not well-conceived. Experts believe that the New Pension Scheme is set to replace the philosophy of pension assets in India from a ‘’defined benefit’’ model to a ‘’contribution model’’.

Experts also believe that being a government-backed scheme, there is an element of trust associated with the NPS making it that much more appealing. With oversight and regulation by the PFRDA (Pension Fund Regulatory and Development Authority), the entire setup is very transparent and allows you to monitor and review the performance of your investment constantly.

NPS provides the subscriber a choice of savings and investment products with different asset allocations, professional fund management, centralized administration, and an option to transfer pension rights from one job/location or from one fund manager to another at a low cost.

Arguing that the NPS has not delivered on its promises, states like Rajasthan, Chhattisgarh, Jharkhand, Punjab, and most recently Himachal Pradesh have gone back to the Old Pension Scheme. All these states are run by non-BJP parties. The RBI has cautioned against the economic cost of the politically expedient move.

Also Read Story

Rahul Gandhi to retain Rae Bareli, Priyanka Gandhi to contest from Wayanad

PM Modi to release Rs 20,000 Cr under PM-KISAN scheme during Varanasi visit

Congress criticizes Modi after West Bengal train collision

US security adviser Sullivan visits India to advance India-US strategic partnership