Persist with the National Pension System

If any reforms are required in the NPS, then they are in the areas of punctuality of contributions and management of withdrawals. The former is linked to timely payment of salaries and remittance of contributions. Withdrawals are necessary at times, and indeed, NPS has provisions for partial withdrawals for medical needs and marriages

A couple of issues figure prominently in the current debate on adoption of National Pension System (NPS) for Government employees.

They include:

- Contributions by both employer and employee in NPS, unlike in the Old Pension System(OPS)

- Uncertainty about the eventual pension receivable by the employee on retirement under NPS

These issues are being raised NPS critics, who question the wisdom of continuing with NPS, and seek restoration of the old pension regime.

1. A closer examination of these issues, however, suggests that they are not well-founded and tend to obfuscate the rationale behind NPS. As is well known, the primary reason for the switch-over was the fact that a ‘pay as you go’ defined benefit scheme like OPS was not sustainable for the government, considering the rising number of employees, periodic salary revisions, rise in cost of living, among several such factors. While it is true that employees did not contribute anything towards their pensions in OPS, there was a minimum mandatory 6% contribution they had to make to the General Provident Fund (GPF), which could go up to 100% voluntarily. This mandatory contribution was done away with when NPS was introduced, and was replaced by a mandatory 10% contribution to pension by employees in NPS. Therefore, the contribution by employees under NPS should be viewed against their contributions to GPF under the old regime.

More important is the fact that these contributions, both of employer and employee, are invested regularly and given the effect of compounding, and they end up with a considerably higher amount on retirement, compared with their GPF maturity amount. NPS investments since inception in 2012, have earned a return of 9.1% pa, as compared to about 7.1% pa. Based on this, the amount available to a junior employee at retirement after 40 years of service would be 75-80% more in NPS than the GPF maturity amount under OPS. Needless to say, the returns in NPS are market linked and could vary over time, but the showings of the past 10 years indicate that they would surpass GPF returns.

2. On the question of uncertainty of the pension amount in NPS, it is true that the pension that would be available to an employee on retirement cannot be determined in advance. However, on the basis of the performance of NPS funds till date, it would not be overly optimistic to state that pension under NPS would be higher than in OPS.

I cite an example to drive home the point: The example is based on the salary of a junior government employee, with a basic monthly pay of Rs 18,000 and DA of Rs 6,120. For the sake of simplicity, it is assumed that she superannuates in the same way as you grade after 40 years, drawing a salary of Rs 56,900 and DA of Rs 19,436 pm as currently exists. Her median salary and DA during her career of 40 years is assumed at Rs 50.000 pm.

In NPS, her investment of 10% would be combined with Govt contribution of 14%, and the earnings and maturity amount would be as under:

An employee is permitted to withdraw a maximum of 60% of the retirement corpus in lump0 sum in NPS, with the remainder being used to purchase an annuity from an insurance company for payment of pension. In the above example, the employee purchases a minimum annuity of Rs2.09 crore (40% of retirement corpus), which would yield a monthly annuity for life with return of purchase price to nominee, of Rs 91,350 as per LIC’s Jeevan Akshay VII policy. As against this, in the OPS, the employee would receive a pension of Rs 38,168 pm, being 50% of last drawn salary. The difference in pension is considerable, notwithstanding, the fluctuations on market returns.

Another point to bear in mind is that in NPS, the lump sum withdrawal, which is tax-free, is more than the employee’s own contribution, in contrast with GPF, where only the employee’s contribution is available tax-free. This is because in NPS, employees contribute 42%(10/24), but withdraw 60% tax-free. This is a substantial benefit.

Taking it further, one ought to remember that although the advantages to employees under NPS are significant, there are certain things that have to be kept in mind for full realisation of these advantages.

These are: a) Continuance of subscriptions till retirement; 2) regularity of subscriptions; 3) limited or preferably no withdrawals.

Long term investments work on the principle of compounding, and the snowballing effect of compounding is enhanced with regular contribution over long periods. Any breaks or interruptions to the flow will reduce the benefits of compounding and affect the retirement corpus.

If any reforms are required in the NPS, then they are in the areas of punctuality of contributions and management of withdrawals. The former is linked to timely payment of salaries and remittance of contributions. Withdrawals are necessary at times, and indeed, NPS has provisions for partial withdrawals for medical needs and marriages. However, if these urgent needs are met through interest-free loans by the government, which can be adjusted from the NPS corpus available on retirement, it would be beneficial to employees, because their NPS corpus could grow unhindered with compounding, and they would have a much larger amount at their disposal on retirement to settle the loans.

Another relief that could be provided to employees is takeover of the investment management fees of NPS Fund Managers, which are currently recovered from NAV and therefore affect the corpus of employees.

In sum, NPS is a well planned and executed pension scheme and can deliver good results if it is persisted with and some streamlining as suggested above is done.

(The writer is former chairman of PFRDA)