UPS vs NPS: Which is better for you?

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In a move to placate the rising concern of a section of government employees who were demanding some sort of guarantee for their pension income after retirement, the central government launched the Unified Pension Scheme (UPS) on August 24. Only employees who are currently subscribers of the New Pension Scheme (NPS), including retirees, will be allowed to opt for the UPS. The question is: should you switch from the NPS to the UPS? Experts are divided.

Guarantee vs no guarantee

The choice boils down to whether the pensioner aims for equity market type of returns, or prefers a guaranteed income. Dhirendra Kumar, Chief Executive Officer (CEO), Value Research, says: “If you believe in India’s growth story and have many years to go till retirement, then stick to the existing NPS and get equity market returns. If you understand how equity markets work, then for those with at least 10-20 years remaining in government service, your NPS has the potential to grow substantially.”

Suresh Sadagopan, a SEBI (Securities and Exchange Board of India) registered investment adviser and CEO of Ladder7 Wealth Planners, says that the lure of guaranteed income is too big in the newly-introduced UPS. Since the scheme offers 50 percent of the average basic pay drawn over the last 12 months, this can amount to a substantial monthly pension  for many government employees. “Eligible NPS subscribers can consider shifting to the UPS so that at least their basic post-retirement lifestyle can be taken care of. For everything else, they can carve out a separate equity investment plan,” he adds.

Although UPS offers  guaranteed pension, it doesn’t resemble the OPS (Old Pension Scheme). The UPS is a fully-funded scheme; employees will contribute 10 per cent of their basic + dearness allowance. The employer’s contribution (in this case, the central government) will now be 18.5 percent, up from 14 percent under NPS.

Under the OPS, the employees didn’t contribute towards the fund, though they did contribute to the General Provident Fund (GPF). This amount, plus interest, was paid back to the employee at the time of retirement. The OPS assured a defined pension income  based on the last drawn salary.

“An inflation linked scheme like UPS does reduce the interest rate and longevity risk  for the employee since it is now borne by the government,” says Preeti Chandrashekhar, India Business Leader, Health and Wealth, Mercer Consulting .

Will the guarantee work?

Experts say that since this a mix of a defined benefit and defined contribution scheme, the  corpus will have to be managed very carefully. The UPS entails that both the employer (the central government) and the employee will contribute towards the corpus. Of the 18.5 percent contribution made by the government, 8.5 percent will go into a separate fund called the guarantee reserve fund.

Chandrashekhar points out that this reserve fund will be drawn upon to meet any shortfall that may arise in meeting the commitments. “Which is why, the corpus needs to be well-managed,” she says. “Strong governance will be required around investment of the funds (especially the guaranteed reserve fund) to ensure sustainability of the scheme without any additional burden on the government. Given the long-term nature of pension liabilities and the increase in longevity, this will need to be monitored on a regular basis,” she adds.

Further, the government is yet to clarify who will manage the UPS. Experts like Kumar and Sumit Shukla, CEO, Axis Pension, say that it appears (from an initial reading) that it might come under the ambit of the Pension Fund Regulatory Authority of India (the country’s pension sector regulator). "We are still awaiting the details, but it does seem like this will be enabled within the NPS architecture. Hopefully, the corpus for government employees will continue to be managed by NPS fund managers," says Shukla.

How will UPS be taxed?

On this too, clarity is awaited. However, experts say that pension income will be taxed at income-tax rates. It is to be seen how the lump sum payment will be taxed.

Under the NPS, pensioners get 60 percent of their accumulated corpus by way of a lump sum at the time of retirement. This is entirely tax-free. The remaining 40 percent is compulsorily invested in an annuity product and the pensioner then gets a monthly pension, which is taxed per their income-tax rates.

Unified Pension Scheme Vs New Pension Scheme: What should you do?

The central government should hopefully communicate to its employees in the days to come some illustrations to help them make the choice. The UPS will be available as an option for employees. Existing as well as future employees will have an option of joining the NPS or UPS. The government has said that the choice, once exercised, will be final.

Remember, that although equities have outperformed all other asset classes over the long term, central government employees can invest just up to 15 percent of their corpus in equities under the NPS. This, says Piyush Gupta, Director, Fund Research, CRISIL Market Intelligence and Analytics, will not be as significant as, say, private sector employees who can invest up to 75 percent of their NPS corpus in equities. Therefore, it all comes down to whether you believe in equities and how many years to have left in government service, and thereby the NPS, explains Gupta.

“For government employees in their 20s and 30s, the NPS might still work better as you will have 20-30 years to go before retirement,” says Gupta. Senior employees nearing retirement, on the other hand, might well shift to the UPS as that makes them eligible for a higher monthly pension, which will be adjusted against inflation per the scheme details announced on August 24.

Under NPS, while there's the benefit of staying invested in equities for the long-term  for younger employees, Chandrashekhar also points out that the scheme mandates a minimum of 10 years of  employment to be eligible for the newly-announced UPS. “But the UPS is not as flexible. Today’s young population is mobile. What if they wish to leave their government jobs and go to the private sector?”, she says.

Preeti Kulkarni contributed to this story