The Union Budget is around the corner. And this article makes a few suggestions on measures the government could take to improve India’s pension system.
Difference between NPS and UPS
In August 2024, the government announced that central government employees in the National Pension Scheme (NPS) would have the option to switch to a “Unified Pension Scheme” (UPS). While the details of the UPS remain unclear, it is likely that the UPS will have a component of assured returns, and will strain public finances over the long term. If the UPS is perceived as synonymous with the NPS, it could mislead those not employed by the central government into thinking that the NPS offers guaranteed returns. The government must promptly clarify the UPS’ details and ensure clear communication to distinguish it from the NPS.
Choice between the EPF and the NPS
The Employees’ Provident Fund (EPF) managed by the Employees’ Provident Fund Organisation (EPFO) is the retirement vehicle for those in the private sector. The EPFO provides assured returns while NPS returns are market-linked. The EPFO is the default choice in most private-sector firms. Participation in the EPFO is mandatory only for employees who earn a basic salary of less than Rs 15,000 per month and are employed in specific formal sectors. It is potentially voluntary for those who earn more than Rs 15,000 per month. The Ministry of Finance could clarify this provision to further facilitate employees to choose between the EPF and the NPS.
Critics would argue that EPF provides assured returns while NPS does not, and therefore, no one would want to shift to the NPS. That may well be true. The legacy advantages of the EPF may mean that most members will likely stay with the EPFO. But the point of such a policy is to only provide the opportunity for choice. Individuals should ideally have the freedom to decide what best secures their future. In fact, choice between the NPS and the EPF can spur healthy competition between schemes.
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Partial withdrawals at retirement
The EPF currently only allows for lumpsum withdrawal at retirement. The NPS, on the other hand, requires the member to use at least 40 per cent of the corpus to purchase an annuity. While a full lumpsum withdrawal might mean that the retiree runs out of wealth over time, mandatory annuitisation might mean that the retiree does not get her money’s worth, especially if the annuities markets are not mature. Annuitisation also implies that the wealth cannot be bequeathed to heirs, if the retiree dies relatively early.
A scheme for partial withdrawals might provide a middle ground—allowing retirees to keep their wealth, while drawing it down over the years.
The government should consider alternatives for both the EPF and the NPS, such as allowing retirees to manage their funds through systematic withdrawal plans or offering annuity products with greater flexibility and transparency. These changes will require an amendment to the respective Acts, and should be done through a process of stakeholder consultations.
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Leveraging NPS and APY for gig workers
The gig economy has become an important component of our informal sector workforce. There have been multiple efforts at providing social security for gig workers. But more schemes under newer welfare boards are not going to provide retirement security.
The Budget could take the opportunity to announce the intent of building the necessary infrastructure to integrate gig workers into the NPS and the Atal Pension Yojana (APY). Both schemes are already functioning, scalable, and can accommodate diverse segments of the population. The NPS is a flexible scheme, and has a low-cost structure. Gig workers with irregular income can contribute to the NPS when they have the funds. The APY provides guaranteed returns and can provide a safety net for those at the lower end of the income spectrum.
Rather than fragmenting the market with new schemes, the government should invest in awareness campaigns, simplified enrolment processes, policies to accommodate gaps in the contributions due to job loss or lack of income, and digital tools that make participation in these existing systems seamless. Further, the government should ensure that the APY continues to be financially sustainable. These measures can ensure that gig workers are not left behind in the broader push for financial inclusion and retirement security.
Evaluate international diversification
India’s retirement savings are invested domestically. The Pension Fund Regulatory and Development Authority Act for example does not allow for funds to be invested in international markets. A lack of international diversification means that Indian savers miss out on the growth and stability opportunities presented by global markets.
Critics would argue that international diversification would subject retirement funds to greater risk without adequate returns, especially in an environment of global uncertainty. However, this is an empirical exercise that can certainly be conducted for historical data.
The government could announce its intent to constitute a committee that would study the issue of international diversification in retirement savings. The committee could examine best practices from other countries, and evaluate the risk-return trade offs. The study could simulate what portfolio returns and risks would have been had we allowed for international diversification decades ago, including historical periods of economic turmoil. This could become the basis for a phased approach to incorporating global investments into Indian retirement portfolios.
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Social pensions
Social pensions—non-contributory payments provided by the government to destitute elderly—play a vital role in ensuring basic income security. The Indira Gandhi National Old Age Pension Scheme (IGNOAPS) under the National Social Assistance Programme (NSAP), provides pensions to elderly individuals living below the poverty line.
One of the policy agendas on pensions has to be to evaluate how well the IGNOAPS is faring on the adequacy of benefits, coverage and delivery mechanisms. Accordingly, budgetary allocations must be made to improve its outreach and impact.
The decisions made in the upcoming Budget have the potential to affect retirement wealth for millions of workers. By prioritising choice, flexibility, and global integration, the government can lay the foundation for a system that provides adequate benefits while being financially sustainable.
Renuka Sane is managing director at TrustBridge, which works on improving the rule of law for better economic outcomes for India. She tweets @resanering. Views are personal.
(Edited by Theres Sudeep)