Unified Pension Scheme or UPS vs NPS: Which will help central government employees build a bigger retirement corpus?

The government has rolled out a new pension offering, the Unified Pension Scheme (UPS), as an alternative to the existing National Pension System (NPS), for its employees. The government subscribers of the NPS who shift to the UPS or any new joinees can avail of its added safety net of a fixed, inflation-linked pension payout. This new scheme is set to be implemented from 1 April 2025. Is a switch to the UPS really a no-brainer?

The UPS brings in two big tweaks to make it an attractive proposition. First, it includes provisions for a fixed, guaranteed pension payout after retirement. If you work for 25 years or more, you will receive 50% of your average pay for the preceding 12 months as pension. A pension of Rs.10,000 per month is payable after a minimum of 10 years of service. For service periods between 10 and 25 years, the pension payout will be proportional. This assured paycheque offers a security net as opposed to the NPS, where the pension depends entirely on the accumulated corpus, and so is vulnerable to market risks. Unlike the NPS, the UPS does not mandate purchase of an annuity after retirement. Its pension payout is more straightforward and less restrictive. It protects subscribers from interest rate risks—the chance that subscribers get locked into low annuity rates offered by the insurer.

Further, the pension payout under the UPS will be indexed to inflation through regular tweaks in dearness allowance. This will address the longevity risk for retiring subscribers, another aspect missing in the NPS. Nirav Karkera, Head of Research, Fisdom, asserts, “Inflation linkage for pension makes a huge difference to your finances, offering lifestyle protection after retirement.” However, the critical component of this protection is the ability of the relevant index to capture real inflation, Karkera argues. The dearness relief will be based on the All India Consumer Price Index for Industrial Workers. It is debatable if this index has a finger on the pulse of the real inflation trends.

Additionally, the UPS provides for the payment of a lump sum on superannuation, apart from gratuity. The amount is calculated on the basis of one-tenth of the monthly emoluments (pay plus dearness allowance) at the time of retirement, computed for every six months of service. In case of an employee’s demise, the family will receive an assured pension equal to 60% of the employee’s pension eligibility at the time of death. On the contrary, the NPS family pension is determined by the accumulated corpus.

This new pension vehicle is clearly aimed at addressing the perceived shortcomings of the NPS among a large swathe of government employees. When the NPS was first introduced in 2004, it completely revamped the prevailing pension architecture, now referred to as the Old Pension Scheme. For government employees joining service after 1 January 2004, the NPS replaced the assured monthly paycheque of the previous ‘defined benefit’ regime, with a market-linked vehicle in the shape of a ‘defined contribution’ scheme. In simple terms, it shifted the burden of retiral payouts from the exchequer to the capital market. However, it also took away the fixed security net government employees were used to in the previous regime. Today, notwithstanding the stock market boom in recent years, those retiring under the NPS are convinced that their retiral payouts are at risk, and that they could end up fetching a much lower pension than the one they would have received under the OPS. So, a return to guaranteed pension payouts—now a political banana peel—is back in the offing, albeit with a few tweaks.


NPS market-linked, fixed pension with UPS

Unlike the OPS, where employees didn’t contribute their own money to the fund, the UPS retains employee contribution. Employees will contribute 10% of their basic pay, plus dearness allowance. Additionally, the government’s contribution will be hiked from the present 14% to 18.5%. Of the 18.5% contribution made by the government, 8.5% will flow into a separate fund called the guarantee reserve fund. This fund will be drawn upon to meet any shortfall in commitments. Effectively, the UPS offers a hybrid model featuring the fixed benefit of the OPS, along with a contribution-based, marketlinked component akin to the NPS. This provides you with both a guaranteed pension and the possibility of higher returns.

Clearly, for any central government employee desiring a guaranteed, predictable income stream after retirement, the UPS is the go-to option. Karkera avers, “UPS takes away a lot of stress of planning your finances and provides a better sense of control over your retirement.” For those nearing retirement, a shift to the UPS seems like a prudent choice. This will entitle you to a guaranteed monthly pension, with regular adjustments for inflation.

However, the decision to switch is not as straightforward. The NPS still retains some advantages over the UPS. As an equity-linked savings vehicle, NPS affords potential for higher wealth creation if the time horizon is sufficiently long. The scheme allows government subscribers in the ‘LC50’ option of the NPS to invest up to 50% of the corpus in equities up to age 35, and is, thereafter, gradually moderated to 10% by age 55.

According to calculations by Axis Pension Fund, employees’ retirement corpus and pension income would vary substantially under the NPS and the UPS, depending on when they shift to the NPS. For instance, an employee starting at age 25 under the NPS and later shifting to the UPS at age 35 (assuming an accumulated corpus of Rs.15 lakh and a monthly pay of Rs.50,000), would get a lump-sum payout of Rs.11.28 lakh on retirement at 60 years, with 5% yearly increase in salary.

His starting monthly pension on retirement— at 50% of average of last 12 months’ salary—would be around Rs.80,627. With 4% hike in DA, the employee’s monthly pension would rise to Rs.2.51 lakh by the age of 90. Comparatively, the same employee continuing under the NPS would accumulate a corpus of Rs.4.17 crore on retirement, based on historical returns from the NPS. If the subscriber parks the entire accumulated corpus in an annuity paying 4.75%, it would fetch a static monthly pension of around Rs.1.6 lakh for the next 30 years. Clearly, sticking with the UPS is a prudent choice here.

However, if instead of taking 100% annuity payout, the subscriber splits the NPS corpus, with 60% in SWP payout and the remaining 40% in annuity, he will be in a position to draw the same pension as under the UPS, while retaining a corpus of nearly Rs.8.54 crore by age 90. A subscriber shifting to the UPS at age 45 will also fetch a lower monthly pension initially compared to a 100% NPS annuity, but it will rise significantly higher with age. With a 60-40 split, the subscriber can fetch an equivalent annuity along with a sizeable leftover kitty.

However, there are more nuances to this choice. Experts argue that the NPS provides more flexibility in investments and withdrawals. Rohit Shah, CEO, GYR Financial Planners, says, “The NPS allows you to increase or decrease the exposure to equities at any time. It also lets you extend the accumulation phase up to age of 70, allowing you to grow the retirement corpus for longer.” The NPS now also permits subscribers to initiate an SWP (systematic withdrawal plan) from the accumulated corpus on retirement, instead of taking the lump-sum payout. This can let you plan your regular income flow as per your requirement. The ability to choose from among different asset classes and fund managers allows you a greater degree of control under the NPS. Comparatively, the UPS lacks any flexibility. For these reasons, experts feel government employees should not write off the NPS.

Taxability is also still a grey area. Under the NPS, up to 60% of the accumulated corpus can be withdrawn tax-free at the time of retirement. The remaining 40% has to be mandatorily put in an annuity, from which the subscriber draws a pension that is taxable at the slab rate. It is not yet clear how the lump-sum payout under the UPS will be taxed. However, the pension income will be taxed at the slab rate.

Finally, experts maintain that the guarantee built into the UPS also remains a grey area. Its sustainability depends entirely on the fiscal health of the government, and how the corpus is managed. If the erstwhile OPS is any indication, the payouts today will simply pass the tab on to future generations. Deepak Shenoy, CEO, Capitalmind argues that the new UPS is a throwback to the defined benefit schemes of the past that hurt us even today.

Shifting to UPS is not a straightforward choice
NPS will afford higher corpus on retirement even as monthly pension under UPS will be higher over the years
^includes annuity and SWP, if any
Assumptions: Accumulated corpus in NPS at age 35 is Rs15 lakh, at age 45 is Rs40 lakh. Monthly basic salary at age 35 is Rs 50,000, at age 45 is Rs1 lakh. Annuity rate with 25 years left for retirement is 4.75%, with 15 years is 5.5%. Return from SWP with 25 years left is 6%, with 15 years left is 7%. Increase in yearly pension at 4%.

Source: Axis Pension Fund

“Guaranteeing a growing benefit just passes the pain down to future years, especially as government salaries increase to come closer to those in the private sector,” Shenoy adds.