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Reforming India’s Pension System

Context

  • The Old Pension Scheme (OPS) was recently mentioned as a prominent election promise in Himachal Pradesh and Gujarat.
  • Previously, the states of Rajasthan, Chhattisgarh, and Jharkhand transitioned from the reform-oriented contributory National Pension System to the non-contributory defined benefit OPS in April 2022. (NPS).
  • While highlighting the fundamental differences between OPS and NPS, the article provides a broad overview of India’s pension system.

Relevance

GS Paper – 2: Government Policies & Interventions, Welfare Schemes, Issues Related to Elderly, Human Resource

Mains Question

In countries such as India, modern social security has been a response to many issues that have arisen as a result of the development process. Discuss. (250 words)


National Pension Scheme (NPS):

  • NPS is a voluntary and long-term investment plan for retirement administered by the Pension Fund Regulatory and Development Authority (PFRDA), Ministry of Finance, Government of India.
  • It was launched in January 2004 for government employees when the Government of India decided to discontinue defined benefit pensions for all employees hired after 1 April 2004. (PIO).

Old Pension Scheme

  • The old pension scheme (discontinued in 2004) ensures a lifetime income after retirement.
  • Typically, the assured amount is equal to 50% of the most recently drawn salary. The cost of the pension is borne by the government.

Why is there such a strong desire to restore OPS?

  • Rising pension bill: For example, pension expenditure as a percentage of revenue expenditure has risen from 16 to 18% in the last five years.
    • According to the CAG, the combined pension bill of 30 states and UTs in 2019-20 was 62% (Rs 3.38 lakh crore) of their total salary and wages expenditure (Rs 5.47 lakh crore).
    • According to the latest edition of the RBI Handbook of Statistics on Indian States, the combined pension expenditure of all states and UTs has more than doubled to Rs 3.45 lakh crore in 2019-20 from Rs 1.63 lakh crore in 2013-14.
  • Less revenue for development expenditure: For example, only about one-third of the state’s total revenue receipts were available for developmental outlay in 2020-21.
    • State Own Tax Revenues (OTR), which include taxes such as State GST, State Excise, Stamp Duty and Registration Fees, Land Revenue, and so on, have also remained very low in recent years, putting additional strain on the exchequer by NPS contribution.
  • Trade unions have opposed the NPS because it does not provide guaranteed returns, does not allow withdrawals until retirement age of 60, and the corpus is not tax-free at maturity.

Global comparison of India’s pension system

  • The Mercer CFA Institute Global Pension Index ranks pension systems worldwide.
  • The pension system in India is ranked 41 (Grade D) out of 44 countries in the 2022 edition of this index. Iceland, the Netherlands, and Denmark (Grade A) topped the index. This trend is concerning because India has consistently ranked low on this index, despite the fact that only 16 countries were examined in 2011.

India’s pension system has limitations.

  • Disturbing exclusions: At least 85% of current workers are not members of any pension scheme and will likely remain uninsured or receive only a social pension in retirement.
    • 57% of the elderly receive no income support from government spending, while 26% receive social pensions as part of poverty alleviation.
  • A few major cornering chunks: As government ex-workers (or their survivors), 11.4% of the elderly receive defined benefits, accounting for 62% of system costs.
  • State government pension burden: The old-age income support system consumed 11.5% of public spending, with state governments bearing more than 60% of the burden.
  • Rising interest payments: Contributory programme funds invested in government securities absorb 40% of all state government interest payments.

World Bank pension framework

  • Zero pillar: A non-contributory basic pension from public funds that explicitly addresses the poverty-alleviation goal.
  • First pillar: A mandatory public pension plan with earnings-linked contributions, with the goal of replacing some pre-retirement income.
  • Second pillar: Mandatory defined contribution (DC) accounts in occupational or personal pension plans with financial assets.
  • Third pillar: Voluntary and fully funded occupational or personal pension plans with financial assets that, when compared to mandatory schemes, can provide some flexibility.
  • Fourth pillar: A voluntary system that operates independently of the pension system and provides access to a variety of financial and non-financial assets as well as informal support such as family, healthcare, and housing.

Way ahead

  • The origins of retirement benefits as a state obligation can be traced back to former monarchies, where meritorious public servants were rewarded with benefits upon retirement.
  • Modern states, on the other hand, outlive monarchies and may extend benefits beyond the life of the public servant.
  • The National Institute of Public Finance and Policy (NIPFP) working paper thus calls for adequate calibration, as failure to do so could result in a sharp increase in resulting benefits.

Conclusion

Pension reforms are critical for the nation’s financial health, and simply shifting between OPS and NPS is insufficient because the former is problematic in terms of sustainability, while the latter suffers from intergenerational inadequacy. As a result, India requires a new debate to rethink its pension system.


February 2023
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