Currently old pension scheme in India is a subject of discussion as many states have reverted to old pension scheme from new pension scheme. Before we compare both the schemes, let us understand their history.
What is a pension scheme?
A pension scheme is a social security system whereby a person gets a flow of monthly income after retiring from active working like. It is a responsibility of the government to provide a pension scheme to support comfortable living of old aged people and also to develop the economy.
Most of the developed countries has a well-defined social security system whereby all citizens get an income support in their old age. However, developing countries including India don’t have a universal social security system.
History of pension scheme in India
The pension scheme history in India is dated back to British raj. The Royal Commission on Civil Establishments in 1881 first awarded pension benefits to the government employees. This was further modified by the Government of India Acts of 1919 and 1935. The provision of this scheme was later expanded to all cover public sector working population.
In fact this scheme is commonly referred to as old pension scheme.
Post-independence several provident funds were set up to cover the private sector workers for their retirement funds.
The old pension scheme
Structure of the old pension system
The pension system in India comprises of three component – provident fund, gratuity and old pension scheme. The provident fund and gratuity provide lumpsum money at the time of retirement, while the old pension scheme provide monthly income or annuity.
The eligibility to get benefits under these component is based on occupation, earnings and tenure of service. The central, state and union territories provide benefits under these components to their employees as a part of the pay package.
In addition, a large number of public and local bodies and autonomous institutions run their own pension schemes which are guaranteed by the government. The central government alone administers separate pension programs for civil employees, defense staff and workers in railways, post and telecommunications departments.
Benefits under old pension scheme
The major benefit under old pension scheme is its non-contributory nature i.e. the workers do not contribute during their working lives. They have to choose between provident fund or pension scheme. If provident fund is chosen, employer will contribute to provident fund. If pension is chosen, employee has to forego the employer’s contribution to provident fund.
The superannuation benefit is a monthly pension fixed at fifty percent (50%) of the average monthly salary during the last year of service. It is linked to the dearness allowance or inflation to provide a real annuity to the retirees. The entire pension expenditure is charged in the annual revenue expenditure account of the government.
The public employees, in addition to their pension benefits are also covered under the General Provident Fund (GPF) scheme. The GPF is a program where only workers themselves contribute a minimum of six percent (6%) of their monthly earnings. The accumulation under the GPF account is returned to the worker in lump sum at the time of retirement.
In 1995 Employees’ Provident Fund (EPF) was partially modified to introduce Employees’ Pension Scheme (EPS). This scheme is mandatory for employee earning ₹15,000 or less. EPF enrolled employees automatically get enlisted in the EPS. The individual will receive minimum ₹1000/- as pension. Both employer and employee contribute 12% towards the EPF scheme. Employer contribute 8.33% of basic salary and dearness allowance towards PF and the remaining 3.76% towards EPS.
In addition to the provident fund, workers in both public and private sectors receive a second tier of lump sum retirement benefit known as gratuity governed by Gratuity Act 1972. It is paid to the workers who fulfil certain eligibility conditions like a minimum qualifying service period of five years. The formula for calculation of gratuity is (15 X last drawn salary X working tenure in years)/26 or 30 depending upon coverage by Gratuity Act. or not. The cost of gratuity is entirely borne by the employer. These schemes are largely the privilege of the organized sector workers.
Provident funds
The provident fund system, consisting of the Employees’ Provident Fund (EPF) and a number of smaller provident funds is the largest benefit program operating in India. It is a contributory fund where both employer and employee contribute a defined amount (10%-12% of salary). The accumulated amount including interest is paid to the employee at the time of retirement as a lumpsum amount.
Workers in the unorganized and informal sectors have access only to a few voluntary schemes like Public Provident Fund and pension plans offered by the Life Insurance Corporation of India. Organized sector employees can also subscribe to these schemes to augment their retirement savings.
The other relatively smaller provident funds are Coal Mines Provident Fund Scheme (1948), Assam Tea Plantation Provident Fund Scheme (1955), Jammu & Kashmir State Provident Fund Scheme (1961) and Seamen Provident Fund Scheme (1966). All these funds offer benefits that are similar to the EPF with minor variations.
National Pension Scheme
Considering the fragmentation and coverage to small group of workers by the old pension scheme, the Government of India introduced the National Pension Scheme (NPS) in 2004. It is regulated by Pension Fund Regulatory and Development Authority (PFRDA). Initially it was open for Central Government employees. Subsequently it was made open for state government employees, All Indian Citizens, corporate sectors and a simplified version as Atal Pension Yojana. However it is excluded for Armed force.
Anybody in the age group of 18-65 years can open account with NPS, which is known as Tier-I account. Minimum contribution is ₹6,000 per annum and minimum tenure 5 years.
Premature withdrawal is not permitted. At the time of retirement, 40% of accumulated money need to be utilised to purchase an annuity. Balance amount is allowed to withdraw as lumpsum. Tax benefit is available in NPS under section 80CCE and 80CCD(2). Therefore it can be part of Tax Planning.
Employee contribute 10% of their salary towards NPS and matching percentage is contributed by the employer.
Subscribers can choose to open a Tier-II account, which is voluntary.
With the introduction of NPS, the old pension scheme has been discontinued. However, any state wants to continue can do so by providing budgetary allocation.
Conclusion
Comparatively old Pension scheme is much better for employee as
- the contribution is made by the employer
- The pension amount is defined and it is known to the employee what he or she will get at the time of retirement.
However, old pension scheme is not good for governments as it has to be paid out of their budgetary allocation. As governments are running short of revenue, providing for pension for its own source has become increasing difficult.
On the other hand, NPS is good for the governments as they do not have to ensure a defined pension amount which is linked to last year salary of the employee. Instead under NPS pension amount at the time of retirement is ascertained by the market.