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National Pension Scheme Expected to Undergo Amendments by Year-End to Enhance Retirement Payouts

National Pension Scheme (NPS) allows pensioners to withdraw 60% of the corpus at the time of retirement (tax-free), and buy an annuity for the remaining 40%, payments from which are taxable.

Shivangi Rai
Currently, employees earn returns of between 36%-38% on average. (Image Courtesy- Freepik)
Currently, employees earn returns of between 36%-38% on average. (Image Courtesy- Freepik)

The Indian government is considering amending the national pension scheme (NPS) by the end of the year, aiming to provide retiring employees with a retirement payout of at least 40-45% of their last-drawn salary.

This initiative is based on the recommendations of a high-level panel currently investigating the matter. The issue of pension reform in India is a contentious one, with several states governed by opposition parties reverting to the old pension scheme (OPS), which guaranteed pensioners a monthly benefit equivalent to 50% of their last-drawn salary at the time of retirement.

In contrast, the current NPS, launched in 2004, lacks such guaranteed base amounts. Additionally, NPS is structured with an employee contribution of 10% of their salary, with the government contributing 14%, whereas OPS does not require any employee contribution.

The proposed modifications to the NPS will involve changes in "actuarial calculations" to offer higher returns, as stated by an official. It is also likely to involve alterations in the distribution of contributions made by employees and employers, in this case, the central government and states. These changes may enable the assurance of a base amount as a retirement payout, depending on the actuarial framework used.

Currently, NPS allows pensioners to withdraw 60% of their corpus at the time of retirement, which is tax-free, and purchase an annuity for the remaining 40%, with annuity payments being taxable.

Several states governed by opposition parties, including Rajasthan, Chhattisgarh, Jharkhand, Himachal Pradesh, and Punjab, have returned to the old pension system, a move that some economists argue could lead to financial strain on state governments.

Under the current national pension scheme, nearly 8.7 million federal and state government employees contribute 10% of their basic salary, while the government contributes 14%. The final retirement payout depends on the returns on the investment fund, which is primarily invested in government debt instruments.

In contrast, the old pension system guarantees a fixed pension of 50% of an employee's last-drawn salary, with employees not required to make contributions. This makes it an "unfunded" retirement scheme.

It's essential to note that the government is not reverting to the unfunded old scheme but is working towards establishing a more sustainable model that guarantees an assured basic amount for retirees, indexed to inflation, as stated by another official.

The ruling Bharatiya Janata Party (BJP)-led central government, preparing for a general election the following year, established a committee led by TV Somanathan in April to review the current pension system. The proposed modified pension scheme will continue to be linked to market returns, but the government may develop a methodology to ensure a minimum payout, such as 40% of an employee's last drawn salary. This means that the government might have to step in to cover the gap in pension payments if they fall below the base amount. Presently, employees typically earn returns of around 36%-38% on average.

The old pension scheme is often seen as politically attractive as it offers a guaranteed benefit to retirees, set at 50% of their last-drawn basic pay. Additionally, like their salaries, pensions under the old scheme are routinely adjusted to account for inflation.

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