Government employees who opt for the central government’s Unified Pension Scheme (UPS), introduced on August 24, can expect a significant increase in their pension payments.

The government contribution under the UPS will increase to 18.5% from the current 14%, resulting in an expected pension increase of 19% for employees with a starting salary of Rs 50,000, said a TOI report based on calculations by the UTI pension fund.

The UPS, which is set to come into effect on April 1, 2025, guarantees a pension of 50% of the average basic salary of the last 12 months preceding retirement. Employees with 25 years of service will receive this full amount, while employees with at least 10 years of service will receive a pro rata pension with a guaranteed minimum of Rs 10,000.

Under the UPS, the pension capital is divided into two funds:

• An individual pension fund into which the employee contribution of 10% of basic salary and cost-of-living allowance (DA) as well as the corresponding government contribution are credited.
• A separate pool corpus consisting of an additional government contribution of 8.5% based on the basic salary and DA of all employees.

Employees can choose how to invest their individual pension capital, but the guaranteed pension is based on a ‘standard mode’ investment pattern notified by the Pension Fund Regulatory and Development Authority (PFRDA). Employees can withdraw up to 60% of their individual pension capital, which will reduce their guaranteed pension proportionately.

If the investment chosen by the employee generates a higher pension than the insured amount, he or she will receive the higher payout. If, on the other hand, the investment generates a lower pension, the state will make up the difference, but only up to the level of the benchmark pension.

Full pension is available to all employees who have completed 25 years of service. A pro rata pension is available to all employees with at least 10 years of service. Employees have the option to choose between the UPS and the existing New Pension Scheme (NPS).

NPS or UPS, which is better?

Experts are divided on whether workers should switch from NPS to UPS. Dhirendra Kumar, CEO of Value Research, in a Moneycontrol report, has advised those who have many years left before retirement to stick with the existing NPS to earn stock market returns. Suresh Sadagopan, CEO of Ladder7 Wealth Planners, in the same report highlights the great appeal of UPS’s guaranteed income and suggests that eligible NPS subscribers should consider switching to UPS to secure their basic post-retirement lifestyle.

Unlike the Old Pension Scheme (OPS), where employees did not contribute, UPS requires employees to contribute 10% of their basic salary and pension plan, while the government contributes 18.5%. Part of the government contribution (8.5%) goes into a guarantee reserve fund to cover any shortfall.

What about taxation?

The tax implications of UPS are yet to be clarified. Pension income under UPS is expected to be taxed at the income tax rate, similar to NPS, allowing a tax-free lump sum payment of 60% of the capital. UPS also contains a provision for a lump sum payment based on length of service, but the tax treatment of this payment remains unclear.

With the option to choose between UPS and NPS, the government is expected to provide further guidelines to help workers make informed decisions. Piyush Gupta, Director, CRISIL Market Intelligence and Analytics, says younger workers may benefit from staying with NPS due to the potential for higher long-term returns, while older workers who are nearing retirement may find UPS more attractive due to the guaranteed pension benefits.

Difference between UPS, NPS and OPS

UPS: For government employees only. Guarantees a pension of 50% of average basic salary over the last 12 months. Requires employee contributions of 10% of basic salary plus DA, with the government contributing 18.5%. Includes a separate pooled capital funded by an additional government contribution of 8.5%.

NPS: Available to public and private sector employees. No guaranteed pension; pension depends on market returns. Employees contribute 10% of their salary, government contributes 14%. Allows up to 60% tax-free lump sum on retirement.

OPS: Was intended for public sector employees. Provides a guaranteed pension based on 50% of the last basic salary received, without the need for employee contributions. The state fully financed the pension, without the need for investment in market-linked products.