National pension scheme or NPS as it is generally referred to is a Government-sponsored pension scheme introduced in 2004 for government employees and was later opened to all sections in 2009. Since its launch, there have been demands from many sections/employee unions for its rollback. There have been many examples of employees who have got paltry pension under NPS on retirement.
The rollback of National Pension Scheme (NPS) and the introduction of OPS (Old Pension Scheme) by the government is almost impossible. Only time will tell which scheme is better but amidst the preoccupation for re-introduction of the old pension scheme, we are missing very important aspects of NPS especially from Millennial’s perspective which we shall be discussing in this article.
Need for National Pension Scheme (NPS) – Government’s Perspective
The primary difference between NPS and OPS is that NPS is contribution defined while OPS is benefit defined. In the case of OPS, the employee’s pension is linked to the salary drawn during the final year of service while in the case of NPS pension is linked to the contribution made by the employee during the length of service.
In the case of OPS employers (i.e. PSUs, State governments, and central government) deducts 10% of basic pay from the salary of employees and makes a matching contribution. On retirement employee contribution with specific interest is paid to an employee while employer contribution is used to discharge pension liability.
Since the pension liability depends upon the last drawn salary but is to be paid from the defined contribution by an employee during the length of service there could be a mismatch between the two. In the case of high life expectancy, it may lead to an increased burden on employers, taxpayers, and may distort government finances. So with the introduction of NPS employer is shielded from the potential cost of the pension.
Issues with National Pension Scheme (NPS) – Employee Perspective
- The NPS corpus is not allowed to withdraw till the age of 60 except for certain specified purposes like higher education/marriage of children, construction of house & treatment of certain kinds of illness.
- The NPS fund is managed by approved fund managers who invest the same in Government/Corporate bonds & equity markets. Due to volatility in equity/bond markets, the return on the NPS fund is not certain.
- Unlike in OPS, the pension amount is not certain. Further, under the OPS scheme, the pensioner gets the benefit of revision of pension over time with an increase in DA, implementation of the pay commission, etc.
- In cases where the length of service is relatively small, the pension under NPS is substantially less in comparison to the same under OPS.
Benefits of National Pension Scheme (NPS) – A Millennial’s Perspective
Now we shall be discussing some of the benefits of NPS from the Millennial’s perspective. These aspects have not been discussed in greater detail in most of the articles on the subject.
Freedom to Shift Job
Under OPS the employee gets pension only after serving for a minimum specified number of years i.e. approximately 20+ years. In case one decides to quit early he’ll only get his contribution towards PF and not the matching contribution made by the employer.
While under NPS contributions made by both employee and employer are managed by approved fund managers. The subscribers (i.e. employees in the present case) are issued specific PRAN (Permanent retirement account number) and the contributions are credited against the PRAN. In case someone decides to shift his job, he/she can continue with the same PRAN account and with the entire contribution of employee & employer. So if someone under NPS working for SBI wants to shift to RBI, he/she may continue with the total amount which is not the case under OPS.
With increased job opportunities, both in the public as well as a private sector it helps in building a large corpus along with progression in career.
Additional contribution by Employer
Under OPS an employer deducts 10% of basic pay and makes a matching contribution while in the case of NPS 10% of basic pay + DA is deducted from salary with 14% contribution made by the employer.
In other words, an employee gets a 140% return on an additional 10% of DA which is then again invested in Government/Corporate bonds & equities.
Albert Einstein famously said
“Compound interest is the eighth wonder of the world. He who understands it earns it he who doesn’t pay it“
Let us understand the impact of additional employer contribution with an example:
|Additional amount of employer contribution(@14% of DA)||Rs. 3000|
|Average Annual increase||5%|
(Discussed in detail in ensuing paras)
|Present Age||25 years|
|Corpus at the age of 60 years||Rs. 1.03 crore|
(Only with an additional 14% additional contribution by an employer against the deduction of 10% of DA from salary under NPS)
National Pension Scheme (NPS) fund managers have more flexibility to invest the funds in various asset classes like government bonds, corporate bonds & equity, etc. It is well known that in longer time frames equity mostly beats the return of other asset classes.
Interest rates have come down significantly in recent years and the rate offered on EPF (under OPS) is also on a declining trend. On the other hand, NPS funds have earned good returns. The returns of SBI Pension Fund Scheme- Corporate CG over various tenures are as under:
|Period of Investment||Annualised Returns (As of 13.11 2020)|
While it is very difficult to know the final pension amount under NPS but it is not that if something is not certain means that it’ll only be inferior.
Charlie Munger has famously said:-
“The first $100,000 is a b*tch, but you gotta do it”
It shows the power of compounding and the advantages of an increase in corpus over time. The effects of compounding are always felt towards the later part. As NPS is relatively new and no one has retired after completing a normal job period of approximately 30-35 years under NPS yet, hence we are not able to know the effect of compounding on the NPS corpus.
Let us understand this with an example
Let us estimate the value of the National Pension Scheme (NPS) corpus with the following assumptions:
- Monthly contribution to NPS at the joining (Age 24 years): Rs.5000
- Average per year increase in salary: 8%
(Assuming 8% growth in simple terms means that your salary doubles every 9 years)
Employer contribution shall be 140% of your monthly contribution. The average return on the NPS corpus is expected at 8% to 10%. As per the annual report of the largest NPS fund manager SBI pension fund for FY 2019, the annualized return on major schemes is as under:
|Sr. No||Scheme||Return Since Inception( app * -12 years)|
|1||SBI Pension funds (p) ltd- State Govt||9.47%|
|2||SBI Pension funds (p) ltd- Central Govt||9.82%|
|3||SBI Pension funds (p) ltd- Corporate CG||9.55%|
In the case of above, the value of National Pension Scheme (NPS) corpus during a period of employment and at the time of retirement shall be as under:
|Age||NPS fund (Rs. Cr)||NPS fund (Rs. Cr)||NPS fund (Rs. Cr)|
|Annualised return @ 7%||Annualised return @ 8%||Annualised return @9%||Annualised Return @10%|
The table above also explains why those who have retired under NPS in recent years are getting paltry pensions as the fund doesn’t get enough time for compounding. The more the time fund gets for compounding better are the chances of earning a handsome pension after retirement.
You can check pension quotes by various annuity service providers using the expected NPS fund value as above using the link under “Sources”. A minimum corpus of 40% is to be used mandatorily to buy an annuity.
The Bottom Line
Only time will tell whether National Pension Scheme (NPS) or Old Pension Scheme (OPS) is better it is beneficial to millennials who got better job opportunities and want to shift jobs without any financial loss. Further considering better returns, extra employer contribution & with long-term compounding, it is expected to earn a good annuity to support post-retirement life.
Related Article: Where My National Pension System, NPS money is invested?