NPS or UPS: Which matters more in an employee's retirement planning?

A Unified Pension Scheme (UPS) is a shift back to a defined benefit plan from a defined contribution plan. In essence, it guarantees government employees a specified pension amount, which will be equivalent to half of their last drawn basic salary (under specific conditions of tenure served).

Guaranteed pension was also the primary demand under the OPS agitation. So, in a way, it addresses the concern, albeit only for government employees and not for private sector employees.

Mohit Gang, CEO of MoneyFront, said, “NPS is completely market-linked, and in that sense, has higher uncertainty. UPS is guaranteed, so it removes the element of uncertainty and, more importantly, it is inflation-indexed, which makes it a much better alternative.”

There could be a scenario where if NPS contributions are high every month, market returns are over 12%, and annuity rates at withdrawal are favorable, NPS could also generate a reasonable corpus. However, there are still too many variables, and the biggest drawback is the lack of protection against inflation under NPS.

So, it’s a clear advantage to UPS, though it will put a hefty burden on the exchequer and is considered a regressive step from an economic perspective.

Let's consider the scenario of two individuals, one aged 35 and another aged 55. Which retirement scheme would be more advantageous for each person: NPS or UPS?

At age 35: For a 35-year-old, NPS could be a better option, especially if they are not in government service. Assuming they contribute Rs 1 lakh annually and the average rate of return is 8%, they could amass a sizable corpus by the time they turn 60. The power of compounding and equity exposure can create significant wealth, which can be used for lump-sum withdrawals and annuities to provide regular income in retirement.

The calculation for NPS:

• Contribution: Rs 1 lakh annually from age 35 to 60 (25 years)
• Expected return: 8%
• Corpus at 60: Rs 79.2 lakh (approx)
• Withdrawal: 60% lump sum = Rs 47.5 lakh (tax-free)
• Annuity purchase (40%): Rs 31.7 lakh, generating a monthly pension based on the annuity rate.

However, if the individual continues contributing at the same rate until the retirement age of 60, their corpus could grow beyond Rs 1 crore or more, depending on market conditions. This highlights the wealth-building potential of NPS over the long term.

At age 55: For someone aged 55, UPS might be a safer bet if they qualify, as the investment horizon for NPS is much shorter, reducing the benefits of compounding and exposing them to higher market risk. "A 55-year-old under UPS could look forward to a stable, inflation-indexed pension based on 50% of their last drawn salary, which can be a more secure and predictable source of retirement income," says Gang.

Example for UPS:

• Last drawn salary: Rs 1 lakh/month
• Pension (50% of the last salary): Rs 50,000/month
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The choice between NPS and UPS depends on individual circumstances and preferences. While NPS offers the potential for higher returns, it also involves investment risks. UPS provides a guaranteed pension but may not offer as high a retirement corpus. Therefore, before making a decision, it's essential to carefully consider your financial goals and risk tolerance.

Disclaimer: This is a simplified example. Actual returns and pension amounts may vary based on various factors, including market performance, government policies, and individual contributions. It is advisable to consult a financial advisor for personalized advice.