Understanding Pension Schemes

GS 3 - Economy

What is the Old Pension Scheme (OPS)?

The Old Pension Scheme (OPS) is a government-approved retirement plan that provides monthly pensions to government employees upon their retirement. 

Eligibility: Ensures a guaranteed pension for those employees who have completed a minimum of ten years of service, calculated based on their final basic salary and years of service.

  • In the OPS, the government covers the entire pension amount for retired employees. Therefore, during their service, no deductions are made from employees' salaries for this purpose.
  • Upon retirement, individuals under the OPS receive their pension along with the benefits of revised Dearness Allowance (DA) twice a year. Since their pension is linked to their last salary and DA, it increases when DA is revised biannually. It's important to note that the OPS exclusively pertains to government employees.
  • States that have restored the OPS are Himachal Pradesh, Rajasthan, Chattisgarh, Jharkhand and Punjab

Advantages and Disadvantages of the Old Pension Scheme (OPS)


  1. Assured Lifelong Income: The OPS offers retirees a reliable and consistent income stream throughout their post-retirement life.

  2. Predetermined Pension Formula: The scheme calculates pension based on a fixed formula, either 50% of the last drawn basic salary plus Dearness Allowance (DA), or the average earnings in the last ten months of service, whichever is higher.

  3. Incremental Pension: Pension payments increase with the biannual revision of Dearness Allowance, providing pensioners with an adjusted income to cope with inflation.

  4. No Salary Deductions: Employees are not subject to any deductions from their salaries for pension contributions, as the government covers pension expenses.

  5. Government-Funded: The government shoulders the financial burden associated with pension payments, ensuring financial security for retirees and their spouses.

  6. Indexed to Inflation and Pay Commissions: The OPS guarantees pension payments indexed to inflation and pay commissions, safeguarding retirees against rising costs of living.


  1. Fiscal Burden: The OPS places a substantial financial strain on both the Central and State governments due to the continuous and increasing pension liabilities.

  2. Absence of Pension Corpus: Unlike modern pension schemes, the OPS lacks a dedicated pension corpus that could accumulate and alleviate the government's pension obligations over time.

  3. Unsustainability: The scheme's design makes it unsustainable, with pension liabilities growing annually, leading to potential fiscal challenges.

  4. Extended Pension Payouts: Increased life expectancy due to improved healthcare facilities means the government has to sustain pension payouts for longer durations, amplifying its financial responsibilities.

What is the National Pension Scheme (NPS)

In 2004, the National Democratic Alliance (NDA) government took a significant step by discontinuing the Old Pension Scheme (OPS) and introducing the National Pension Scheme (NPS) for government employees. This transformation marked a broader shift that eventually extended the NPS's reach to encompass all citizens, including those who are self-employed and working in unorganized sectors. The NPS was officially opened up to citizens in 2009, ushering in a new era of pension planning.

  • Unlike its predecessor, the OPS, which provided government employees with a defined pension based on their years of service and last drawn salary, the NPS operates as a contributory pension system. It encourages contributors to deposit a fixed amount every month until they reach the age of 60. Subsequently, they receive a regular pension post-retirement.
  • The primary motivation behind introducing the NPS was to offer a secure and stable post-retirement income solution to citizens. Managed by the Pension Fund Regulatory and Development Authority (PFRDA).
  • Under the NPS framework, government employees allocate 10% of their basic salary plus Dearness Allowance (DA) towards their pension contributions, which is then matched by a 14% government contribution. For non-government citizens, the NPS offers the flexibility to invest a minimum of Rs. 500 per month.
  • Operating as a market-linked annuity program, the NPS allows individuals to systematically invest during their active working years, with the accumulated corpus being converted into an annuity upon retirement. This annuity provides regular pension payments to retirees, ensuring financial stability in their golden years.
  • The investment portfolio of the NPS is meticulously managed by prominent entities like SBI, LIC, and UTI, all of which operate under the regulatory oversight of PFRDA. When individuals retire, they have the option to withdraw up to 60% of their NPS corpus and invest the remaining 40% with one of the ten designated professional fund managers. This choice empowers retirees to receive pension annuities as a dependable monthly income stream.

Advantages and Disadvantages of the National Pension Scheme (NPS)


  1. Tax-Free Corpus Withdrawal: Upon retirement, individuals can withdraw 60% of their NPS corpus tax-free, offering financial flexibility.

  2. Investment Control: NPS participants have autonomy over investment decisions, selecting professional fund managers to achieve optimal returns.

  3. Professional Fund Management: Qualified fund managers handle NPS investments, ensuring potentially higher returns irrespective of equity or debt investments.

  4. Tax Deduction: Regular NPS contributions during employment offer tax deductions, reducing the overall tax liability.

  5. Transparent Regulation: NPS is overseen by the PFRDA, enforcing clear investment rules, consistent performance evaluations, and fund manager oversight, enhancing safety.

  6. Online Management: NPS accounts are easily operated and managed online, offering convenience to participants.

  7. Partial Withdrawal: Participants can withdraw from their NPS account before retirement, with a limited number of withdrawals available after ten years of account opening.


  1. Mandatory Contribution: A compulsory contribution of 10% of the basic salary plus Dearness Allowance is required, impacting take-home pay.

  2. Variable Pension Amount: Pension payments vary depending on investment returns from market-linked instruments managed by fund managers.

  3. Limited Financial Literacy: Lack of familiarity with financial concepts may hinder the ability to select the most suitable fund manager for NPS investments.

Comparison between OPS and NPS


Old Pension Scheme (OPS)

New Pension Scheme (NPS)

Eligibility of the employees

Only Government employees

Government Employees

Payment of Pension

Provides pensions to government employees based on their last drawn salary plus DA

Provides pension based on the investments made in the NPS scheme during their employment

Amount of pension

Provides pensions to government employees based on their last drawn salary plus DA

60% lump sum after retirement and 40% invested in annuities for getting a pension


Employees don't contribute any amount

Government employees contribute 10% of their salary (basic + dearness allowance), and the government contributes 14% 

Income Tax Benefits 

No Tax Benefits 

Employees can claim tax deductions of up to 1.5 lakh under Section 80C of income tax and up to Rs.50,000 on other investments under 80CCD (1b).

Tax in Pension Amount

The pension amount is tax-free.

60% of the NPS corpus is tax-free, while the remaining 40% is taxable.

NPS Over Old Pension Scheme: Advantages 

  1. Flexibility in Pension Amount: NPS provides flexibility in determining pension amounts based on factors like contribution, investment type, and age of joining, allowing individuals to customize their retirement benefits.

  2. Long-Term Market Gains: NPS benefits from the potential growth of equity markets over time, leading to potentially higher returns compared to fixed pension amounts under OPS.

  3. Dual Benefit: NPS offers a combination of a monthly pension and a lump sum amount upon retirement, providing individuals with more options to manage their funds.

  4. Reduced Government Liability: NPS shifts the risk of inflation and longevity away from the government, as it's based on contributions and investments, reducing the burden on the government to ensure fixed pension payouts.

  5. Economic Sustainability: NPS is considered more sustainable for the economy, as market-linked investments and employee contributions reduce the government's responsibility for pension payments.

10 Reasons why India needs an Efficient Pension System 

1. Financial Security  : Pension schemes ensure retirees have a dependable income source in retirement.

2. Reducing Dependency : They reduce seniors' reliance on their children for financial support.

3. Social Safety Net : Pension plans act as a safety net for those without other retirement savings.

4. Savings Incentive : Encourage long-term savings, fostering financial responsibility.

5. Talent Attraction : A robust pension system attracts and retains a skilled workforce.

6. Economic Growth : Pension funds can be invested in economic development.

7. Government Relief  : Thus Alleviating the financial burden on government-funded pension systems.

8. Financial Inclusion  : Extends coverage to underserved populations, promoting financial inclusion.

9. Risk Mitigation : Protects retirees from market volatility through risk-sharing mechanisms.

10. Competitiveness : Enhances India's global competitiveness by offering secure retirement options.


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