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25th March 2023 (11 Topics)

Government to set up panel to ‘improve’ National Pension System

Context

Finance Minister announced the constitution of a committee to propose changes to “improve” the National Pension System (NPS) for government employees in a way that balances their aspirations with fiscal prudence

What is the Old Pension Scheme (OPS)?

  • Often described as a ‘Defined Benefit Scheme’, OPS assures life-long income, post-retirement.
  • Under OPS, employees get a pension under a pre-determined formula which is equivalent to 50% of the last drawn salary.
  • They also get the benefit of the revision of Dearness Relief (DR), twice a year.
  • The pay-out is fixed and there was no deduction from the salary.
  • There was the provision of the General Provident Fund (GPF).
  • The Government bears the expenditure incurred on the pension. The scheme was discontinued in 2004.

Concerns associated with the old pension scheme:

  • No fund for pension liability: As there was no corpus specifically for pension, which would grow continuously and could be dipped into for payments.
  • No fixed source of funding: The Government of India's budget provided for pensions every year; there was no clear plan on how to pay year after year in the future.
  • The burden on Government Budget: The government estimated payments to retirees ahead of the Budget every year, and the present generation of taxpayers paid for all pensioners as of date.
  • The ‘pay-as-you-go’ scheme created inter-generational equity issues — meaning the present generation had to bear the continuously rising burden of pensioners

The New Pension Scheme (NPS):

  • The New Pension System proposed by the Project OASIS reportbecame the basis for pension reforms and what was originally conceived for unorganised sector workers, was adopted by the government for its own employees.
  • The NPS was for prospective employees; it was made mandatory for all new recruits joining government service from January 1, 2004.
  • Contributions:
    • The defined contribution comprised 10 per cent of the basic salary and dearness allowance by the employee and a matching contribution by the government this was Tier 1, with contributions being mandatory.
    • In 2019, the government increased its contribution to 14 per cent of the basic salary and dearness allowance.
  • Schemes under the NPS are offered by nine pension fund managers
    • It is sponsored by SBI, LIC, UTI, HDFC, ICICI, Kotak Mahindra, Aditya Birla, Tata, and Max.

How NPS is a better option?

  • Freedom to allocate savings
    • The biggest fear about the NPS is that it redirects subscribers’ money into the ‘volatile’ stock market.
    • But the fact is that NPS subscribers have complete freedom to allocate their savings to equities, corporate bonds or government securities, or any combination of the three.
    • Risk-averse investors can simply allocate all their money to bonds or gilts in NPS, altogether skipping stocks.
  • Beating Inflation:
    • A 20-year analysis of Nifty50shows that while it frequently delivered losses over one-year periods, stretching one’s holding period to 10 years reduced the loss probability to zero while fetching an 11-12 percent return.
    • While the EPFO has been struggling to declare an 8-8.5 percent return from its ‘safe’ debt portfolio, NPS managers have earned a 13-14 percent returnon equities and 5-9 percent on bonds and government securities over a decade.
  • Greater control:
    • With NPS, an employee has greater control over his pensionas he can save more or allocate more to equities.
    • In the old pension scheme, the employee’s pension is mandatorily limited to half of his last-drawn pay.
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