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The UPS benefits package has five main components, starting with a lifetime monthly pension guaranteeing government employees half of their average base salary during their final 12 months of service before retirement. | Image credit: Getty Images/iStockphoto
The story so far: Over the weekend, the Union Cabinet approved a major shift that will provide old-age income security to central government employees. New Unified Pension Scheme (UPS) It will be launched on April 1, 2025. Around 2.3 million central government employees are expected to benefit from the new scheme, while those participating in the ongoing pension scheme (called National Pension System, initially called New Pension Scheme or NPS) will have a one-time option to switch to UPS. States can choose to bring their employees under the UPS framework and will need to raise funds for the scheme from their own resources.
What benefits does UPS offer?
The advantages of UPS are mainly in five aspects. The first is to ensure Government employees will receive half of their average basic salary in the last 12 months Serving government workers until retirement receive a monthly pension for life. This commitment requires a minimum of 25 years of service. The benefits for government workers with less service will be reduced accordingly, provided they have served in the government for at least 10 years. The minimum pension for a government worker with 10 years of service is Rs 10,000. UPS also provides a family pension equal to 60% of the pension of a government worker at the time of his/her death to support their families. To hedge against inflation, these pension incomes will be adjusted upwards based on consumer price trends for industrial workers – similar to the price relief allowance provided to serving government employees. Last but not least, UPS also promises a lump sum pension payout on retirement, in addition to the pension benefits. This amount is equal to one-tenth of the employee’s monthly salary, i.e. salary + dearness allowance, calculated on a pension basis, for every six months of service.
How does this differ from the current pension system?
Currently, government employees who joined before January 1, 2004, are covered under the so-called Old Pension Scheme (OPS), while for those who joined in 2004 or later, the scheme has been replaced by NPS.
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OPS also provides employees with a guaranteed pension of 50% of their last salary, with a dearness allowance added during the period, a guaranteed family pension of 60% of their last salary, and a minimum pension of Rs 9,000 plus dearness allowance. On retirement, employees can commutate 40% of their pension and receive it as a lump sum. In addition, an additional 20% pension is given to pensioners or family pensioners above the age of 80, which rises to 30% at the age of 85, 40% at the age of 90, and 50% at the age of 95. Pension income is also revised with salary updates based on the recommendations of the Pay Commission. The last salary hike for government employees was in 2016 based on the recommendations of the Seventh Pay Commission. A key difference between OPS and NPS and UPS is that the promise of OPS is funded directly from government revenues when the government pays it. The OPS liability is therefore “unfunded” with no contributions from either the employee or the employer and the same is true for non-government formal sector employees whose retirement savings are governed by the Employees Provident Fund (EPF) Act.
After years of debate on the unsustainability of the Civil Service Pension Act, the Atal Bihari Vajpayee government introduced the NPS through an executive order, abolishing the defined benefit system of the OPS in favor of a “defined contribution” pension system. 10% of the employee’s salary is remitted into a pension account, and the employer (either the central government or the states, as almost all state governments switched to NPS after 2004) contributes a matching amount. Pension fund managers pool and deploy these funds in market-linked securities, with the option of keeping part of the funds in the stock market. At retirement, employees are required to purchase an annuity (an insurance instrument that provides monthly income) with 40% of the funds accumulated in the NPS account and withdraw the rest. The central government has increased its contribution to the NPS to 14% in 2019, but the pension income of NPS members is not as certain as that of the OPS. NPS members (including those who have retired) can now switch to UPS.
UPS combines the defined benefit model of OPS with the defined contribution mechanism of NPS through its promised pension levels and other standard operating procedures. While employee contributions will be limited to 10% of wages, as in NPS, the government will contribute a higher 18.5% of wages to a pooled pension account. The central government will also have to bear any gap between the final benefits of these contributions and the guaranteed pension promise under UPS. It is not clear whether UPS will consider the recommendations of future pay commissions or provide higher pensions for those above 80 years of age, as is done in OPS.
Why did the government choose to change?
Both before and after the NPS was introduced, it faced strong opposition from government employees who were not given any guarantees about pension income, and the fate of civil servants after 2004 was in stark contrast to their predecessors. While such protests were present during the UPA regime, opposition has grown in recent years, especially when some of those who joined the NPS earlier and had shorter service began retiring with what they considered to be poor pension benefits. This dissatisfaction eventually became an electoral issue, with opposition parties such as the Congress promising to restore OPS to civil servants who had received NPS before some assembly elections, and achieving this switch in a few assembly elections. During the second term of the Narendra Modi government, the central government hit back at the states’ reversal of this reform, calling it a fiscally irresponsible bribe.
However, in March 2023, Finance Minister Nirmala Sitharaman announced the formation of a committee to review the NPS for government employees to balance “their aspirations and fiscal prudence”. The committee, headed by former Finance Minister TV Somanathan (now Cabinet Secretary), held extensive consultations with employees and other stakeholders, and while its report is yet to be released, the decision to switch to UPS was made based on the results of its negotiations. If there were any doubts that the UPS package of benefits was related to political considerations after the recent Lok Sabha elections and ahead of several state elections, Information and Broadcasting Minister Ashwini Vaishnaw has dispelled such suspicions. While announcing the UPS, he stressed that the Congress-ruled states that announced the restoration of OPS have not yet implemented it, and Prime Minister Modi has ensured that the results will ensure “intergenerational fairness”.
How will employees and governments react? What are the likely financial implications?
Central government employees generally welcomed the UPS provisions as a recognition of the NPS problem, but there are reservations about the contribution aspect of UPS and the lack of a commutation option like in OPS. Economists, like employee representatives, are also waiting for more details on the contours and calculations of UPS. UPS contributions, including some arrears, are expected to cost an additional ₹7,050 crore this year. Additional funds will also be guaranteed once a price hike is announced. “A guaranteed pension will increase future committed spending by the government while reducing uncertainty for employees. This will have to be factored into the future fiscal consolidation roadmap,” said Aditi Nayar, chief economist at ICRA.
Madan Sabnavis, chief economist at Bank of Baroda, believes that while the immediate impact is just an additional 4.5% contribution to UPS, future expenses will be higher but can be absorbed through higher revenue growth. “We can consider this as the equivalent of a pay commission revision, which is absorbed by the system,” he asserted.
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