New pension reform must reduce burden on future generations

Source: This post is created based on the article “New pension reform must reduce burden on future generations” published in Indian Express on 18^th May 2023.

Syllabus Topic: GS Paper 2 – Welfare schemes for vulnerable sections of the population by the Centre and States and the performance of these schemes

Context: Recently, Government has constituted a committee to “improve” the NPS.

The issue of government employees’ pensions is a critical issue. Five states in India have already announced a shift from the New Pension Scheme (NPS) back to the old defined-benefit (DB) Pension Scheme (OPS). The Indian government is taking steps to improve NPS due to its growing importance.

Read about – Old Pension Scheme and New Pension Scheme

What are the challenges of New Pension Scheme (NPS)?

NPS funds are invested in market-linked securities. It has given an impressive annual return over 9% since its inception. However, there is a risk of lower future returns due to global trends of lower interest rates.

Therefore, NPS suffers from market risk and might end up with a reduced pension annuity.

What are the issues with Old Pension Scheme (OPS)?

First, it is neither funded nor fiscally sustainable.

Second, by the year 2100, the dependency ration of India will increase 5 times.  The World Health Organisation’s life expectancy simulations show that for people aged 60, life expectancy would increase from 18 to 27.9 years in this period. Therefore, pension support period will increase by 55 per cent just this century.

Third, the OPS employees currently get pension at 50 per cent of their last drawn salary. This pension further increases with a dearness allowance (DA) to account for inflation, twice every year. If 25 years post-retirement is counted, this pension increases exponentially with higher DA.

Fourth, in OPS, current workers finance those who are retired.

Fifth, with pension costs rising faster than revenue growth, this could potentially lead to decreased development expenditure and increased borrowing, leading to a debt trap.

Sixth, the base for determining the pension is the highest drawn salary instead of some average of earnings over the career followed globally.

What should be done?

A sustainable pension reform should retain contributions and the NPS fund management but avoid periodic increases in the annuity. The government could guarantee a certain percentage of the last drawn salary as a fixed annuity pension.

However, these guarantees should consider the declining trend in global interest rates and India’s economic development stage, both of which could reduce nominal returns on the pension corpus.

Additional benefits, like extending pension to the spouse and providing health and life insurance benefits, can be considered.