Old Pension Scheme Vs National Pension System: Which Scheme is Better for Employees?

1. Global Pension System Archetypes: Defined Benefit (DB) vs. Defined Contribution (DC)

Governments all over the world offer two types of pensions plans: defined benefit (DB) and defined contribution (DC). In a DB plan, employers give a committed pension to the employee until death and take the risk of the non-fulfilment of pension liability. The employee is free from longevity risk in the DB pension plan. Whereas, in the DC plan, employers contribute a specified amount towards the employee pension during the service and free themselves from the pension liability.

The third category is a hybrid pension plan, with characteristics of both DB and DC pension plans. There are several variants of these pension plans worldwide, but broadly, all pension plans can be categorized into DB or DC. Invariably, in all the pension plans, sponsors, mostly employers, invests the pension assets in different investment instruments such as government bonds, stock markets, corporate bonds, etc.

As per the Global Pension Assets Study (2021) which covers the twenty-two major pension markets, including the seven largest pension markets, namely Australia, Canada, Japan, Netherlands, Switzerland, UK, and the USA showed that assets under management of DC pension plan have increased from 35 percent to 53 percent from 2000 to 2020.

2. Global Pension Assets Benchmark: India’s Comparative Standing

Despite the Covid 19 pandemic, the pension fund’s assets in 2020 have increased by 11 percent, amounting to USD 2.2 trillion in the twenty-two largest pension fund markets, out of which 92 percent are from the seven largest pension markets.

According to the study, India has a total estimated asset of USD 184 billion, which is only 7.1 percent of its GDP (an increase from 4 percent of GDP in the last decade). Netherlands has the highest with USD 1,900 billion, which is 214.4 percent of GDP; the USA tops in the total assets of USD 32,567 billion, which is 156.5 percent, and Australia has USD 2,333 billion, which is 175.8 percent of its GDP.

3. The Indian Pension Landscape: Shift from OPS to NPS in 2004

In India, different pension schemes are made available for government (both state and central) employees, the organized private sector, and the unorganized sector. For the organized private sector, the pension scheme is organized by Employee Provident Fund Organization (EPFO), for unorganized sector Pradhan Mantri Shram Yogi Maan-Dhan Yojna (PM-SYM) and National Pension Scheme for the Traders and Self-Employed Persons (NPS-Traders), Atal Pension Yojana, etc. Besides these schemes, various pension schemes are provided by the insurance companies in India.

For public sector employees (except defence), India shifted from DB (Old Pension Scheme, OPS) to DC pension plan (National Pension System, NPS) in the year 2004. This article analyses the NPS and OPS to find out which pension scheme is better for government employees under different circumstances.

Every public sector employee is curious to know which plan would be beneficial: OPS or NPS? The question is, which scheme is beneficial for employees? And under what circumstances? The following mathematical equations help to answer these questions.

4. Mathematical Modeling & Comparative Pension Formulas

5. Empirical Simulation: Pension Under 40% vs. 60% Annuity Allocation

Table 2 evaluates the monthly pension payouts under both systems for an initial basic salary plus dearness allowance of Rs 1 across six distinct economic scenarios, testing 40% and 60% annuity investment allocations.

Table 2 showcases only four possible scenarios. We can conclude from the above table that, if the average annual growth rate of salary is higher than CAGR, and if the employee has fewer years of service and CAGR is very low, then OPS is better.

NPS would be better for employees if CAGR is higher than the average annual growth rate of salary and employees work for a more extended period. Similarly, the pension under NPS and OPS can be calculated using the above formulas under different circumstances.

6. Strategic Policy Alternatives for the Government

As inferred from Table 2, in some circumstances, NPS pension is higher than OPS and vice versa. If the pension is less than OPS, the government can contribute the balance at the time of retirement or voluntary retirement. If the NPS pension is more than OPS, an extra amount can be deposited in the government’s account. This can create a balance and compensate the government for the additional burden.

To reduce the taxpayer’s burden, instead of forty percent at the time of retirement, the employee, who opt for a pension as per the OPS, can be allowed to withdraw only twenty-five to thirty percent, and the rest of the amount can be used to buy an annuity.

Table 3 shows that if seventy to seventy-five percent of the corpus is invested in an annuity, then the difference between pension under NPS and OPS would be reduced. The difference can be reduced further if, instead of ten percent contribution, employees also contribute fourteen percent of basic plus dearness allowance. This can reduce the pension expenditure of the government and save the taxpayers money.

References

1. Department of Personnel and Training (DOPT), Govt. of India. (2021). Central Civil Services (Implementation of National Pension System (NPS)) Rules, 2021. https://documents.doptcirculars.nic.in/D3/D03ppw/NotifiedRule_NPS_300320219S1qV.pdf
2. Thinking Ahead Institute. (2021). Global Pension Assets Study – 2021. https://www.thinkingaheadinstitute.org/content/uploads/2021/02/GPAS__2021.pdf
3. World Bank. (2019). Total Population. https://data.worldbank.org/indicator/SP.POP.TOTL