From colonial era to post-independence the pension system in India has undergone massive transformation. During British Raj, the pension system was relatively elitist, catering to the whims of British civil servants, government officials and military personnel.
In the initial stages, there was no uniform pension system for the Indian population. After the first war of independence in 1857, the British felt the need to ensure loyalty of Indian civil servants and military officers. Hence a formal pension system was introduced, mainly for those employed in the British administration.
Pension schemes were administered under the Pension Rules of 1871 for military personnel and the Indian Civil Services (Retirement) Rules of 1930 for civil servants. Both systems provided some financial security for employees, but with very little scope for an equitable distribution of pension benefits.
Under the British, the pensions were largely tied to length of service and rank. Higher-ranking British officers were entitled to generous pensions, while lower-level employees were offered little or no retirement benefits. Pension were based on the last drawn salary, and the amount was determined by the pensionable service.
The aim of the colonial pension system was to protect the interests of British officers. It was structured to provide only the bare minimum for Indian employees. The pension benefits for Indian civil servants were comparatively modest and linked to their length of service. This disparity reflected the broader colonial ethos of treating Indian workers as secondary to British officers.
Post-independence (1947 – 1970s):
After India gained independence in 1947, the government of India started building a more inclusive and systematic pension framework and expanded to include a broader section of society, especially government employees.
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The Indian Civil Services (ICS) officers, were among the first to receive pensions after retirement based on their length of service and salary. The military Pensions also received pensions based on their years of service and ranks.
The Indian Constitution (adopted in 1950) allowed the government to design social security schemes for the welfare of the people, including pensions for public servants. The Pension Rules of 1950 were introduced in 1950, to replace the British colonial-era pension regulations for fair treatment of employees who served the government, regardless of rank or status. The Pension Rules of 1950 was designed to provide uniform, fair, and anticipated pension and retirement benefits to central government employees.
The Pension Rules of 1950 and subsequent reforms proved to be a major turning point in providing financial security for government employees after retirement. Its key features included:
- Pension – on the basis of length of service and last drawn salary. This made the system more transparent and equitable.
- For the first time, a provision was made to provide family pension to the dependents of deceased employees
- The age for superannuation was set at 58 years
- Employees who wished to retire voluntarily before this age were still eligible for pension if they met certain service criteria.
The system was designed to ensure that government employees, regardless of their job or position were entitled to fair pension benefits after retirement. But this transition wasn’t easy and on the contrary was quite challenging. The Indian civil servants who were accustomed to the colonial pension system, were among the first to resist the shift towards a new, more democratic framework. The post-independence government had to balance the systems limitations with the needs of the newly independent nation’s growing administrative workforce.
One of the first reforms during this period was the Central Civil Services (Pension) Rules, 1972, which defined the pension and post-retirement benefits for Indian government employees.
After independence, military pension schemes were also extended. The Defence Pension Scheme continued to provide pension benefits to soldiers based on their service records.
In the 1950s, the EPF (Employees’ Provident Fund) was introduced for employees working in the private sector but it was more of a provident fund than a full-fledged pension system.
1980s – 1990s: structural reforms and challenges
This period saw significant changes in the economy, which led to various reforms in the pension system.
In 1988, the National Social Assistance Programme (NSAP) was launched to provide pensions to the elderly, widows, and disabled persons. This was a significant move towards providing social security for those outside the formal government employment system.
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The fiscal pressure caused by an aging population and the expanding government workforce, along with the growth of informal and private sectors, highlighted the need for pension reform. The government was increasingly concerned about the sustainability of pension obligations, especially the unfunded pension liabilities.
2000s – Present: reforms and expanding coverage
In the early 1990s, the government began to move away from traditional pension structures and started focusing more on market-linked systems. A major shift occurred in the early 21st century as the Indian government introduced reforms to modernize the pension system. The National Pension Scheme (NPS), 2004 was one such step in this direction. The NPS was designed to be a market-linked, contributory pension scheme that allowed the beneficiaries to invest in a variety of funds (equity, debt, government bonds). Over time the NPS was extended to other sectors, including state governments and the unorganized sector to make pensions more sustainable by relying on personal contributions and market-based returns instead of unfunded government contributions.
In 2015, the government launched the Atal Pension Yojana (APY) to provide a pension to workers in the unorganized sector. The APY encouraged individuals to make regular contributions to a pension fund, starting from as low as Rs 42 per month. The government contributes a part of the amount for eligible individuals.
Likewise the Indira Gandhi National Old Age Pension Scheme (IGNOAPS) was introduced to provide financial assistance to elderly individuals below the poverty line.
Despite these reforms, a significant proportion of India’s population, especially those in the informal sector, remained outside the formal pension system. Due to aging population, the need for equitable and effective pension especially for government employees continued to grow. Hence the government was under pressure to manage the pension liabilities which were becoming a growing concern.
Pay Commissions and their impact on pension policies
After independence as India progressed, the pension system continued to evolve and adapt itself to suit the country’s changing economic conditions. This is where the Pay Commissions made their impact on the pension system and helped shape the pension framework for central government employees.
The Pay Commissions set up at regular intervals (usually every 10 years) helped fine-tune the pension system in independent India by reviewing and recommending revisions to the pay scales of government employees and corresponding pension benefits. The recommendations of the Pay Commissions were instrumental in shaping the pension policies that followed.
The initial Pay Commissions, particularly the 1st Pay Commission, played a critical role in shaping the pension system that we recognize today.
1st Pay Commission
The 1st Pay Commission clearly defined pensions based on the last drawn salary, introduced the concept of family pensions, and gradual alignment of pension policies with inflation. This laid the foundations of a modern pension structure for central government employees in the years to come.
The 1st Pay Commission recommended that pensions should be based on an employee’s last drawn salary and length of service, both of which became standard criteria for pension calculations in subsequent years. The Commission also introduced a clear definition of superannuation pension (for employees retiring at the age of 58) and retiring pension (for those retiring before the prescribed age), ensuring more flexibility for employees who chose early retirement.
The 1st Pay Commission also introduced the concept of family pension for the first time, ensuring that the next of kin or family members of deceased employees continued to receive financial support after their loved one’s death. The 1st Pay Commission’s recommendations ensured that pensions were more predictable and aligned with the employees’ final salary, rather than arbitrary or minimal amounts.
Pay Commissions and Pension Revisions
Each commission sought to adjust pension benefits according to the changing socio-economic landscape and needs of a growing bureaucracy in a rapidly developing nation.
The subsequent commissions after the 1st Pay Commission continued to refine the pension system. The 2nd and 3rd Pay Commission induced the system to cater to the growing needs of the government workforce, and rising economic challenges.
The 2nd Pay Commission recommended improvements in family pensions and sought to bring more parity between pension amounts for employees across various government departments.
3rd Pay Commission introduced the Dearness Relief (DR) as part of the pension system, ensuring that pensions were adjusted for inflation, which had been a growing concern due to the rising cost of living in the country.
The 6th Pay Commission led by Justice B. N. Srikrishna, a former Judge, Supreme Court of India was one of the most comprehensive revisions in the pay and pension system. This Commission suggested several changes to bring parity between serving employees and retired persons. These included:
- Pension of central government employees based on last drawn salary, to ensure that the pension and post-retirement benefits are aligned with the actual earning at the time of retirement.
- To ensure that pensions are aligned to the cost of living and inflation.
- Reinforced the Dearness Relief (DR) mechanism to ensure that pensioners were protected from inflation, and pension adjustments is in line with the rising cost of living.
- Revised the family pension system to support to the families of deceased employees, and ensure that dependents received a reasonable income after the death of the primary breadwinner.
- Revised pension benefits to ensure parity between active employees and those who had retired before the implementation of the 6th Pay Commission
The 6th Pay Commission set a new benchmark and ensured that pensioners received a reasonable income post-retirement, with built-in inflation safeguards. These changes were meant to enhance the standard of living of the pensioners, and ensure that they did not face a financial crisis after the end of their active service.
The 7th Pay Commission chaired by Justice Ashok Kumar Mathur a former Chief Justice of Calcutta High Court, Madhya Pradesh High Court, and Judge of the Supreme Court of India was another watershed moment in the evolution of pension in India. Some of its recommendations included:
- Pension to be calculated on the basis of the last drawn pay.
- Revised the pay scales and pension benefits to ensure that pension was directly linked to the new pay structure. It provided an immediate increase in pension pay-outs for all retired government employees.
- The family pension scheme was revamped, with a higher percentage of pension paid out to the families of deceased employees.
- Introduced the National Pension Scheme (NPS) for employees appointed after January 1, 2004. Under the new scheme pension was no longer a fixed percentage of salary but based on the contributions made by employees and the government into a pension fund.
- The implementation of Dearness Relief continued under the 7th Pay Commission to ensure that the pension kept pace with inflation.
Pension in Modern India
There are many pension schemes catering to different segments of the population in India. These include the following:
- National Pension System (NPS): A contributory pension scheme which is now mandatory for all central government employees who join after 2004
- Atal Pension Yojana (APY): provides guaranteed minimum pension to people in the unorganized sector.
- Employees’ Provident Fund Organisation (EPFO): A mandatory scheme provided – provident fund, pension, and insurance benefits to private-sector employees.
- Civil Service Pension Scheme – defines benefits for government employees who joined before 2004.
- National Social Assistance Programme (NSAP): A non-contributory pension scheme for the elderly poor and disabled.
Live happily – after retirement
Out of these the NPS was introduced by the Central Government as a pension to help retired government employees and take care of their post-retirement needs. It is a voluntary model regulated by the Pension Fund Regulatory and Development Authority (PFRDA) under the PFRDA Act, 2013. As per the Ministry of Finance notification 5/7/2003-ECB-PR dated 22nd December 2003, NPS is mandatory for Central Government employees, who joined service on or after January 1, 2004, except for those in the armed forces. It is also extended to the employees of Central Autonomous Bodies and all State Government employees/employees of State Autonomous Bodies, if the respective State/UT opted for it. It is available to all the citizens of India including those residing abroad, between the age of 18 and 70 years.
National Social Assistance Programme (NSAP) introduced in 1995 is primarily for the elderly poor and disabled. It is meant for 60 -65 years old people. It is only applicable to people above 60 and below the poverty line. On the other hand the civil servants pension (now open for all) is a contributory pension programs run by the Employees’ Provident Fund Organisation of India (EPFO) for private sector employees and employees of state owned companies.
Eligibility and Benefits:
- Minimum eligibility period for pension in accordance with the Pension Rules is at least 10 years of qualifying service, with a minimum pension of ₹9,000 per month.
- In the case of Family Pension the widow is eligible to receive family pension on death of her spouse after completion of one year of continuous service or even before completion of one year if the Government servant had been examined by the appropriate Medical Authority and declared fit for Government service.
- Employees contribute 10% of their salary to the NPS, with a matching contribution from the employer.
- Pensioners can withdraw 60% of the accumulated amount as a lump sum and use 40% to buy an annuity for a monthly pension.
- Maximum limit on pension is 50% of the highest pay (presently Rs 1, 25,000) per month. Pension is payable up to and including the date of death.
These schemes aim to provide financial security to India’s elderly population, with varying benefits and eligibility criteria.
Comparison: old v/s new pension scheme
The Old Pension Scheme (OPS) and the New Pension Scheme (NPS) in India represent two distinct approaches to retirement benefits for government employees. Here’s a detailed comparison between the two:
Old Pension Scheme (OPS) – A defined Benefit Scheme (DBS)
The OPS provides a fixed monthly pension after retirement based on the employee’s last drawn salary and years of service. The pension is not affected by the market performance or contributions. The pension amount is calculated as a percentage of the last salary drawn (typically 50% to 60% of the last basic salary), with annual increments, and includes a dearness allowance (DA) which adjusts according to inflation.
The employee contributes nothing to the pension fund. The entire pension is paid by the government after retirement. The government bears the cost of the pension payments to retired employees, but these payments are made from the government’s general budget (without a specific pension fund).
The pension is a fixed amount based on the last drawn salary. It is not linked to market performance and continues until the retiree’s death. After the retiree’s death, the spouse continues receiving the pension. There is no lump-sum pay-out; it is paid as monthly instalments based on the pensioner’s salary and tenure.
The OPS is very secure for employees because it offers a fixed pension regardless of market conditions. There is no risk for the employee, but the system creates a huge fiscal burden for the government, especially with an aging population.
The OPS is unsustainable in the long term due to the heavy financial burden it places on the government. With a growing number of retirees and an aging population, the OPS has led to large fiscal deficits, making it increasingly difficult to maintain. The pension liabilities of OPS are unfunded, meaning the government needs to keep a large amount of public resources to pay pensions to retirees. The OPS is only applicable to employees who joined the government before 2004. It is not applicable to new recruits in central government service after the introduction of the NPS.
There is limited transparency in the OPS, as it is a defined benefit system with no direct involvement of employees in managing or monitoring the pension fund. The government has full control over the pension payments, and employees have little say in the pension’s administration.
The pension received under OPS is taxable as income in the hands of the recipient after retirement.
New Pension Scheme (NPS) – a Defined Contribution Scheme (DCS)
The NPS is a market-linked, contributory pension scheme where both the employee and the government contribute a fixed percentage (currently 10% for employees and 14% for the government) of the employee’s salary to the pension fund. The pension amount depends on the returns generated by the contributions invested in the market. The pension amount can vary based on the corpus accumulated through contributions and the returns on investments made in various asset classes (equity, debt, etc.).
The employee and the government both contribute to the NPS fund. The employee’s contribution is mandatory (10% of basic salary + DA), and the government contributes an equal or higher amount (currently 14%). The government matches the employee’s contribution (up to 14%) and manages the scheme’s regulations, but the contributions are invested in financial markets.
The pay-out varies according to the pension corpus, which depends on the contributions made and the returns on investments. On retirement, 60% of the accumulated corpus can be withdrawn as a lump sum (taxable), and the remaining 40% must be used to purchase an annuity to receive regular monthly pension payments. In case of the employee’s death, the nominee receives the accumulated corpus, which can be used for annuity purchase or withdrawn as a lump sum.
The NPS offers less security than OPS because the pension amount depends on the performance of market-linked investments. There is an element of risk due to the market exposure. The employee bears the risk, as the pension amount can fluctuate depending on the investment returns. However, the risk is mitigated by the option to choose between different asset classes (equity, government bonds, etc.).
The NPS is sustainable because it is a fully funded, market-linked scheme. The contributions made by employees and the government are invested and grow over time, which helps build a corpus to pay pensions. This reduces the fiscal burden on the government. While the government still contributes to the scheme, the overall liability is less since it only matches the employee’s contributions.
The NPS applies to new recruits in the central government (after 2004) and is gradually being extended to state governments and other sectors like the private sector, including the unorganized workforce.
The NPS is more transparent since employees can track their investments and see how their funds are performing in real-time. The system is managed by professional pension fund managers, and individuals can choose between various asset classes. The employee has some level of control over the investment choices, as they can opt for different schemes (equity, government bonds, etc.) depending on their risk preference.
Contributions to the NPS qualify for tax deductions under Section 80C (up to Rs. 1.5 lakh) and additional deductions under Section 80CCD (up to Rs. 50,000). However, the lump sum withdrawal (60%) is taxable, while the annuity (40%) is also taxable at the time of receipt.
Key differences – old & new pension scheme:
| Feature | Old Pension Scheme (OPS) | New Pension Scheme (NPS) |
| Type | Defined Benefit Scheme (DBS) | Defined Contribution Scheme (DCS) |
| Pension Amount | Fixed, based on last salary and years of service | Variable, based on contributions and market returns |
| Contribution | Government bears entire cost | Both employee and government contribute |
| Payout | Fixed monthly pension | Lump sum withdrawal + annuity (variable amount) |
| Risk | No risk to the employee | Employee bears investment risk |
| Sustainability | Unsustainable long-term | More sustainable, due to market-linked structure |
| Eligibility | Government employees before 2004 | New government recruits, private sector employees |
| Taxation | Pension is taxable | Tax benefits on contributions; withdrawals taxable |
Conclusion
The pension system in India has developed from an elitist framework mainly for British officials to a more inclusive system catering to the needs of a wide range of people. The Old Pension Scheme offers security but places a heavy burden on the government’s finances, making it unsustainable. On the other hand, the New Pension Scheme is more sustainable and market-linked but introduces risk to the employees. While NPS gives employees more control and transparency, it requires them to manage market risks for their retirement benefits. However, despite these adjustments, there are challenges in terms of coverage and sustainability of pension scheme for future generations.
