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Equitable and Sustainable Pensions

Chapter 16. India’s Pension Reform Initiative

Benedict Clements, Frank Eich, and Sanjeev Gupta
Published Date:
March 2014
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Dhirendra Swarup


Nearly one-eighth of world’s elderly population lives in India. The vast majority of this population is not covered by any formal pension scheme. Instead, they are dependent on their own lifetime savings and transfers from their children or extended families. These informal systems of old-age income security are imperfect and are becoming increasingly strained, especially in light of increasing labor mobility, improving life expectancy, and an increasing old-age dependency ratio.1 The population older than 60 grew at an annual rate of 3.8 percent between 1991 and 2001, from 55.3 million to 75.9 million, as compared with annual growth of 1.8 percent for the general population. By 2015, India’s elderly population is estimated to be more than 113 million, and it is likely to nearly double during the following two decades.2

Pension policy in India has traditionally been based on financing through employer and employee participation. As a result, coverage has been restricted to the organized sector, and the vast majority of the workforce in the unorganized sector has no access to formal channels of old-age financial support. Of the more than 300 million employed Indians in the working-age population, fewer than 12 percent are covered by some form of retirement benefit scheme (OECD, 2009). Besides the problem of limited coverage, the existing mandatory and voluntary private pension system is characterized by limitations such as a fragmented regulatory framework and lack of individual choice and portability. High incidence of administrative costs and low real rates of return are endemic in the existing system, which has become unsustainable.

Unsustainability of the existing pension system is accentuated by the sharp increase in the financial burden on the government and other employers on account of pension liabilities. The total pension expenditure for central government employees rose from 3.6 percent of GDP in 1994/95 to 7.3 percent of GDP in 2010/11.3

Description of the Current Indian Pension System

National Pension Scheme

Since the early 2000s, a marked shift has taken place in pension policy in India through the introduction of a new pension system. The government’s objective was to design a defined-contribution (DC) scheme for new entrants in central government services without the need for extra pension infrastructure. The scheme was also intended to serve other groups such as state government employees, middle-class self-employed people, and low-income workers in the unorganized sectors.

The National Pension Scheme (NPS) became operational in late 2003. Participation has been mandatory for new central government employees (except the armed forces) since 2004. The NPS marked a radical shift from the defined-benefit (DB) system to a DC regime. More than 2 million central and state government employees are already covered under the NPS and contribute 10 percent of their salary and so-called dearness allowance4 toward their pensions with a matching contribution from the relevant governments. Since 2004, 26 states have also established DC pension systems for their own new employees. The NPS holds a corpus of nearly US$4 billion and has more than US$5.40 billion in assets under management.5 See Table 16.1 for the number of subscribers registered under the NPS.

Table 16.1Total Subscribers Registered Under the NPS, 2012
Category or SectorNumber of Subscribers
Central government1,037,017
State governments1,421,281
NPS Lite1,254,860
Private sector151,783
Total coverage3,864,941
Source: The NPS status report as of October, 7, 2012, available at NPS Lite is a targeted scheme designed for providing old-age income security to the economically disadvantaged sectors of society. It operates through the use of “aggregators” who are responsible for the enrollment of subscribers into the scheme and for servicing their needs.
Source: The NPS status report as of October, 7, 2012, available at NPS Lite is a targeted scheme designed for providing old-age income security to the economically disadvantaged sectors of society. It operates through the use of “aggregators” who are responsible for the enrollment of subscribers into the scheme and for servicing their needs.

The NPS, which began as a pension scheme for government employees, was opened to all citizens on a voluntary basis in 2009. The government also launched the Swavalamban Scheme under the NPS, which focuses on providing pension coverage to the informal sector. In this scheme the government contributes Rs 1,0006 annually toward those subscribers who contribute Rs 1,000 to Rs 12,000 in one financial year. The co-contributions will continue until 2016–17, during which period it is expected to benefit about 7 million NPS subscribers from the unorganized sector.7

For all subscribers to the NPS, including civil servants covered on a mandatory basis, as well as all other citizens who choose to open NPS accounts, annuitization of at least 40 percent of accumulated pension wealth upon attaining the age of 60 is compulsory. The balance is payable as a lump sum or through phased withdrawals between ages 60 and 70, at the option of the subscriber. There are seven private pension fund managers licensed by the Pension Fund Regulatory and Development Authority (PFRDA) to manage voluntary NPS assets, and individual subscribers are free to choose the fund manager they wish to use for managing their retirement savings. There are four broad categories of pension schemes, including a life-cycle, investment-based “default” scheme that offers investment options with varying ratios of equity and fixed-income instruments. Subscribers may choose their schemes. Full transparency and disclosure of information regarding investments is required to be provided by the intermediaries. Portability is provided to the participants along with the ability to transfer accumulations from one fund manager to another.

Occupational Pension Schemes

In addition to the NPS, several other categories of occupational pension schemes are in operation in India. These include the DB civil services pension schemes that cover 22 million central and state government employees, and employees’ provident and pension funds managed by the Employees’ Provident Fund Organization and other employer-managed funds under which another 15 million workers are estimated to be covered (OECD, 2009).

Civil service pensions

The Civil Servants’ Pension (CSP) is a pay-as-you-go, DB scheme for employees of the central government who were hired up to December 31, 2003, and for employees of state governments hired up to the effective date mentioned in notifications issued by those governments. A modified one rank–one wage principle applies wherein all retired employees of a certain rank receive the same pension. Pension payments are revised periodically to reflect growth in wages and the consumer price index. Growth in pension benefits in old age is typically higher than inflation.

The central government provides information on its annual pension payouts, as well as payouts by the state governments, in budget documents (Table 16.2). Estimates of the unfunded liability associated with the benefits under the CSP are, however, neither computed nor disseminated.

Table 16.2Civil Service Pension Expenditure of the Central Government
Fiscal YearExpenditure

(Rs billions)
Percent of GDP
Sources: Central government: Statement 1, Consolidated fund of India, Revenue Account–Disbursements, Budget Documents; Table 2, Macroeconomic aggregates (at constant prices), Handbook of Statistics on the Indian Economy, 2010–11, Reserve Bank of India.
Sources: Central government: Statement 1, Consolidated fund of India, Revenue Account–Disbursements, Budget Documents; Table 2, Macroeconomic aggregates (at constant prices), Handbook of Statistics on the Indian Economy, 2010–11, Reserve Bank of India.

Fiscal stress is the main problem for CSP: it was designed at a time when most of the employees who retired at age 60 were expected to live to 68. The value of the annuity embedded in the CSP has risen as the result of improvements in longevity. The mortality characteristics of government employees, who belong to a relatively higher income group than the average, are more or less in line with populations in the Organization for Economic Cooperation and Development countries. The fiscal stress at the subnational level has been even more acute, partly for demographic reasons, and has led to noncompliance on the part of scheme underwriters. Some of the state governments have not made timely payment of pension benefits.

Private sector employees’ mandatory schemes

Pension benefits of other employees in the organized sector are governed by the Employees’ Provident Funds and Miscellaneous Provisions Act, 1952, under which the Employees’ Provident Fund (EPF) and the Employees’ Pension Scheme (EPS) were established. The provisions of this act are applicable to all businesses employing more than 20 workers. The schemes are administered by the Employees Provident Fund Organization (EPFO): all functions and processes of the EPF and the EPS are handled by the EPFO, except fund management, which has been outsourced to four professional asset management companies. However, some schemes under the purview of EPFO are allowed to manage their own funds. EPFO treats them as exempted funds. These exempted funds are required to follow the EPFO’s investment guidelines and are required to match the EPFO’s returns.

The EPF is an individual account, DC scheme wherein the employee and employer each contribute to the fund at the rate of 12 percent of the employee’s pay. In 2012, the total assets under EPFO’s control was more than Rs 3 trillion (US$54.5 billion). There are a number of provisions under the scheme for preretirement withdrawal of accumulated balances. These provisions are frequently used by scheme members, which leads to reduced balances at the time of their retirement. These depleted balances lead to negligible old-age income benefits. The EPFO scheme enjoys an “EEE” (exempt, exempt, exempt) tax structure, which constitutes a major tax subsidy.8

The EPS is a DB scheme based on a contribution rate of 8.33 percent from the employee and an additional 1.16 percent from the government. The EPS was introduced in 1995 to replace the Family Pension Scheme of 1971, and is applicable to workers who entered into employment after 1995 and those who were covered under the previous scheme.

The Family Pension Scheme (framed under the Employees Provident Fund Act) remained unquestioned and there were virtually no changes in contribution rates, administration, and benefits for almost four decades. The first major change occurred in 1995, with the conversion of part of the DC EPF scheme into the DB EPS. This change marked an important break from the existing policy of the EPFO in two ways: (1) a mandated annuity to private sector employees was introduced for the first time; and (2) it added a new pension liability (the scheme is not fully funded) to the government’s existing liability with regard to the civil servants of central and state governments.

Special legislation governs the provident funds set up for employees belonging to particular professions or geographical areas: the Jammu and Kashmir Employees’ Provident Fund Act, 1961; the Coal Mines Provident Fund Act, 1948; the Assam Tea Plantation Provident Fund Act, 1955; and the Seamen’s Provident Fund Act, 1966.

Employers may also choose to set up voluntary provident or superannuation funds to provide retirement benefits to their employees. Such funds are entitled to certain tax benefits if they are approved by the tax authorities.

Social assistance programs for the elderly

The current pension landscape in India includes social assistance programs operated by the government. The following social pensions are covered under the National Social Assistance Program: the Indira Gandhi National Old Age Pension Scheme, the Indira Gandhi National Widow Pension Scheme, and the Indira Gandhi National Disability Pension Scheme. These transfers are targeted to those below the poverty line. Of these, only the Indira Gandhi National Old Age Pension Scheme applies to those older than age 65. The central government finances a monthly pension of Rs 200, which is further supplemented by state governments. Details of the pensioners covered under these schemes are given in Table 16.3.

Table 16.3Membership in Social Assistance Programs
SchemeBeneficiaries (millions)
Indira Gandhi National Old Age Pension Scheme15.6
Indira Gandhi National Widow Pension Scheme2.3
Indira Gandhi National Disability Pension Scheme0.5
Source: NSAP Annual Report, 2009–10. Available at: The data are as of December 14, 2009.
Source: NSAP Annual Report, 2009–10. Available at: The data are as of December 14, 2009.

Future Challenges

Increasing Coverage

The existing pension system, which leaves more than 88 percent of the Indian workforce uncovered, is unlikely to act as a social security umbrella for aging Indians. Even for those covered by the system, the defined benefit is not guaranteed given that the DB schemes are unfunded or underfunded. Improvements in health care leading to increases in life expectancy, the evolution of nuclear family structures, and rising expectations resulting from increases in per capita income, education, and the like are some of the factors likely to compound the problem in the future. The new pension system, based on defined contributions and funded liabilities is a significant step toward addressing this problem. The spread of the NPS is seen by many as the direction in which pension reform needs to move to find a viable and sustainable solution to the problem of old-age income security because it is felt that neither the existing system nor any antipoverty drive by the government is likely to solve the problem.

Introduction of the NPS for new employees of the central and state governments is a positive step for reforming the pension system in India. The road ahead has many challenges that need to be tackled for the system to spread wide enough to cover the unorganized sector, agricultural workers, temporary and casual workers, and the self-employed.

The low level of financial literacy and the high numbers of the rural elderly make the task daunting. The gender ratio of the workforce and economic status of women pose special problems in the design of pension systems. Designing an effective, efficient, and accessible system that meets the requirements of a heterogeneous workforce is the immediate priority of those concerned with the pension reform process in India. The challenges of translating the design into reality will arise thereafter and will take a while to be overcome.

Fiscal Challenges

The new pension system is an attempt to move away from DB pension plans to DC-based schemes. However, this change is applicable only to new employees in the central and state governments. The problem of financing the pension liability for those already in unfunded or partially funded schemes is likely to cause fiscal stress for the next two or three decades. Parametric changes will, therefore, become necessary for effective and efficient discharge of this liability. Thus, apart from the expansion of NPS, the introduction of parametric changes in the existing DB mandatory pension systems is equally necessary for reducing the fiscal stress. Attempts to estimate the future pension liability arising from the existing unfunded pension plans are at a nascent stage in India. The most recent reliable study of this issue puts the implicit pension debt liability of the central and state governments arising out of civil servants’ pensions and the funding gap of the EPS at Rs 20,034 billion, or 64.5 percent of GDP in 2004/05 (Bhardwaj and Dave, 2005). The study also highlights that the enormity of the problem becomes even more apparent when this liability is compared with the public debt of the government of India, which was 84.9 percent of GDP in 2004/05. Although both the methodology and the results can be questioned, the magnitude of the problem this estimate suggests cannot be ignored.

Empirical evidence collected through a survey commissioned by the Asian Development Bank suggests that India is in transition from old-age support systems based on the family to a new reality in which the balance between family support and self-support in retirement is likely to fall heavily in the latter direction. The survey data show that “of the 363 million earning members of the workforce, less than half have an expectation of financial support in retirement. For younger generation the figure is significantly lower (less than one-third)” (ADB, 2006, p. 109). It is, therefore, essential that policymakers correctly anticipate the course of the transition so that adequate countermeasures are in place at the appropriate time. The ADB data also indicate that without guidance, encouragement, and support, most Indian workers will not save sufficiently for their old age and the capacity of the government and the labor market to face the challenges is likely to become even more limited than it is now. Recognizing the fact that pension reforms are an urgent social priority, policymakers in India are working to transform pension systems so that they are not only capable of meeting the present challenges but are able to adapt and restructure to meet unforeseen future developments.


A major challenge of the National Pension System is to provide the individual subscriber with adequate retirement income. Public sector pension schemes involve policy risk, inasmuch as the government of the day may not be able to pay required pension outlays, leading to delays in pension payments or defaults in some cases. By contrast, private pension schemes are less subject to this policy risk because governments are less prone to confiscate private property, but DC funds do involve capital market risk during the accumulation phase when contributions and returns on investment build up in the fund. The risk is that the pension funds’ performance may be insufficient to give reasonable retirement income to the pension subscribers.

Social Acceptance

Traditionally, coverage in India has been obtained by mandating participation and contributions along with providing tax incentives and guaranteed returns on retirement savings. The voluntary nature of the NPS, along with poor financial literacy and the attitude of households toward financial savings, risk, and retirement planning, poses a challenge to achieving optimum coverage. Creating awareness about these reforms and gaining the confidence of the people is the single most important challenge faced by policymakers.

Even as the PFRDA attempts to increase voluntary coverage of the NPS, a large proportion of unorganized sector workers (perhaps as many as half) may not be in a position in the foreseeable future to self-provide for retirement, and the NPS will, therefore, be an ineffective policy tool for dealing with their old-age poverty challenges. These workers include the lifetime poor, who may not be able to save anything for their old age, and unpaid workers who have no cash incomes with which to make pension contributions. Equally, the NPS will be unable to address the retirement savings needs of informal sector workers who are presently nearing retirement or those who are already age 60 or older. For each of these groups, the government would need to design and implement effective social assistance policies and programs that adequately support them in their old age.

The absence of a meaningful and efficiently delivered old-age pension benefit continues to impose a significant social transfer burden on younger low-income workers. The ability of poorer households to support the elderly is an issue that requires closer analysis and urgent policy attention. The presence of an elderly household member may cause all persons in the household to be in measured poverty, which would, in turn, further depress the capacity of low-income earners to save for their own retirement. In this eventuality, therefore, lifting elderly persons out of poverty through fiscal transfers may offer the possibility of lifting the entire household out of poverty.

Voluntary Contributions

Although the NPS may not be a universal solution to India’s pension coverage gap, its success can dramatically reduce the size of the workforce that must rely on a combination of fiscal and social transfers to combat old-age poverty. Equally, the underlying design considerations that form the basis of the NPS architecture may present a useful benchmark for assessing the efficacy of other existing retirement arrangements, as well as a basis for their reform.

The government and the PFRDA are already using the NPS framework to address the lower levels of the income distribution with conditional cash transfers aimed at encouraging voluntary enrollment and disciplined retirement saving by low-income workers. Such transfers are also useful for increasing the value of their terminal savings. This strategy is expected to improve voluntary NPS enrollment by the working poor. A significant communication and public education effort will also be required to support policy and regulatory efforts to produce optimum, regular savings for old age by a population that faces largely intermittent incomes.

The spread of the NPS would be possible only through the combined efforts of the public and private sectors. The private players, who have hitherto played only a marginal role in the field, are anxious to have a reliable estimate of the likely size of the market before venturing into it.

Reforms and Reform Options

Developing an Inclusive and Equitable National Pension Strategy

A fundamental issue in improving existing retirement programs is the absence of a comprehensive national pension policy. A policy-based benchmark by which the performance of existing occupational schemes can be evaluated needs to be defined. For example, several current occupational schemes fail to deliver an “adequate” retirement income. Yet, subscribers are unable to demand a different outcome simply because there is no clear definition of “adequacy.” The policy objectives of India’s pension system are not clearly stated, nor are the specific responsibilities of administrators and trustees of both compulsory and voluntary programs in targeting or ensuring adequate retirement income security for Indian workers.

Therefore, the government should aim to develop an inclusive and equitable national pension policy that provides equal opportunities and identical rights to all citizens, regardless of their employment status, to achieve a dignified retirement in a secure and well-regulated environment. This policy should enable individual portability across jobs and locations, as well as across a range of pension programs. The design and performance of existing and new pension programs, as well as the underlying actions of regulators, administrators, and trustees, should be guided by this proposed national pension policy. The process of designing this national pension policy should be preceded by a comprehensive review of existing arrangements as well as a broad-based survey of labor markets. Although several regulatory and supervisory deficiencies can be addressed without undertaking such a sweeping review, the effectiveness of the “system” to deliver adequate and sustainable pensions cannot be fully assessed in its absence.

The national pension policy should identify the government’s objectives and goals, including the following:

  • The value of retirement income it seeks to provide and the percentage of income it expects the pension system to generate for individuals in retirement (expressed, for example, as a flat amount relative to the poverty line or as a percentage of salary, or some combination thereof);
  • The level of coverage it seeks to attain (expressed as the percentage of the workforce in the organized and unorganized sectors);
  • The relative extent to which pension provision is to rely on compulsory and voluntary employer-sponsored pension schemes, individual savings and investment, and other government programs; and
  • The means of financing pension provision, including for persons who will be unable to participate in contributory retirement programs.

Extending the Reach of the NPS

An important first step toward a unified and inclusive pension policy framework for formal and informal sector workers was taken in 2004 when the government decided to bring new government employees into the NPS. There is considerable consensus already that the NPS is well suited to serve as a genuinely national pension system because it protects subscriber interests through an incentive-compatible architecture and a dedicated regulator, promotes ease of access, and provides flexible and attractive investment options and low transaction costs. The use of the NPS as a policy tool to implement pension reforms can be broadened and strengthened by extending it to salaried private sector employees covered by legislated pension and provident fund arrangements on a mandatory basis, as well as to salaried workers participating in voluntary, employer-sponsored superannuation and provident fund arrangements.

Increasing Portability

At an institutional level, existing pension and retirement saving programs should be required to outsource scheme administration and the management of individual subscriber records to the Central Recordkeeping Agency regulated by the PFRDA. Similarly, the management of aggregated voluntary and compulsory retirement contributions by salaried workers should be managed by PFRDA-regulated pension fund managers. Salaried workers should be able to use their employers’ or PFRDA-regulated points of presence (primarily banks) to access information on their retirement account balances as well as periodic account statements. Through this strategy, salaried employees in large private or public sector firms would begin to enjoy the same portability rights, as well as product and fund manager choices, that are already available to civil servants and others participating in the NPS. As a result, salaried workers would be able to switch employers or locations, or move from formal to informal or self-employment, without any administrative overhead related to their individual retirement accounts.

Policy implementation may be phased in by providing such employees with an initial voluntary option for switching their existing retirement savings from publicly or privately managed, DC pension, provident fund, and superannuation plans to NPS products. These employees may also be provided with the right to continue using the existing fund-management services of EPFO or other pension and Provident Fund administrators. The task of enforcing mandatory contributions by both employees and employers should continue to rest with the EPFO and other pension and Provident Fund administrators. This policy option has obvious equity benefits because it would provide India’s formal and informal sector workers with a uniform and well-regulated retirement savings arrangement, and identical rights and choices for maximizing their retirement incomes.

Looking after Stakeholders

The implementation of a larger reform will need to be carefully staged so that the government, the PFRDA, and pension sector stakeholders can adapt effectively. Special attention should be paid to stakeholders upon whom much of the success or failure of the reforms will rest, especially with respect to schemes that are established on a voluntary basis. These stakeholders include financial institutions and other service providers that may assist employers in managing their schemes and scheme assets, as well as the employers themselves and their employees. An effective communication and education campaign would be required to inform and educate salaried workers about new product options, as well as their rights and responsibilities as subscribers to market-linked retirement products with variable returns.

Improving the Governance of Mandatory Occupational Pensions

The mandatory occupational pension programs administered by the EPFO will also need to be reformed: they currently deliver inadequate terminal accumulations as a result of conservative investment policies, suboptimal returns, inefficient administration, liberal preretirement withdrawals, and poor subscriber information and service quality. In parallel, the governance of these schemes needs to be radically improved. In contrast to many countries, India already has a well-established body of financial sector regulations, and many of the key regulatory concepts are already present within its legal framework. As a result, there is sufficient capacity to rapidly build a robust regulatory and supervisory framework for these occupational pension schemes.

The reform process for these schemes will involve a combination of parametric, procedural, and systemic changes. Parametric reforms could aim to increase the types and value of benefits paid to “adequate” levels. Procedural reform would aim to improve administration, operations, governance (including member rights and entitlements), and the manner in which investment decisions are made to strengthen the security and sustainability of the programs. Systemic reform may include issues of regulation as well as fundamental changes in the design of benefit arrangements.


    Asian Development Bank (ADB)2006Pension Reforms for the Unorganised SectorTechnical Assistance Consultant’s Report TA-4226 prepared for Ministry of Finance Department of Economic Affairs India.

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    BhardwajGautam and Surendra A.Dave2005Towards Estimating India’s Implicit Pension Debtpaper prepared for the Second International Workshop onThe Balance Sheet of Social Security PensionsOrganized by PIE and COE/RES, Tokyo, Japan, December 15.

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    Organization for Economic Cooperation and Development (OECD)2009Pensions at a Glance Special Edition: Asia Pacific (Paris: Organization for Economic Cooperation and Development).

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The old-age dependency ratio increased gradually from 6.3 percent in 1980 to 7.6 percent in 2010.


It is estimated that by 2035, more than 217 million persons, constituting 13.7 percent of the country’s population, will be 60 years old and older.


See Table 16.2 for details and sources.


The dearness allowance is a cost-of-living adjustment paid to government employees and pensioners in India.


The total corpus, the aggregate of all subscribers’ funds, being managed under NPS in October 2012 was 219.51 billion rupees (Rs), which amounts to US$3.99 billion. According to the information available on the website of the Pension Fund Regulatory and Development Authority (, total assets under management in March 2013 were Rs 298.52 crores, which amounts to US$5.42 billion. All conversions from Rs to US$ in this chapter are made at the rate of Rs 55 to US$1.00.


In mid-2013, 1 U.S. dollar was approximately 59.5 Indian rupees.


Further information on the Swavalamban Scheme is available at


The “EEE” status of the EPFO-administered schemes indicates that the contributions made to the fund, the returns earned during the accumulation phase, as well as the final withdrawal, are all exempt from taxation. In contrast, the NPS follows an EET tax structure under which the contributions are exempt, accumulations are exempt, but withdrawals (in old age) are taxable income.

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