Defined benefit pension

Indian Economy glossary

Also called: Old Pension Scheme, OPS · Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

A defined benefit pension is a pension where the amount you get after retirement is fixed in advance by a formula, such as a share of your last pay. The payer, not the worker, carries the risk of paying it.

India's Old Pension Scheme (OPS) is a defined benefit pension. It pays 50% of last pay, and this amount rises with Dearness Allowance (DA).
It matters because the promise is certain for the employee. But in India it is paid from the budget, so it creates a large and growing bill for future governments.

Formula (OPS): Monthly pension = 50% × last pay, then raised over time with DA.

Explanation

How it works

The benefit is promised first. The worker knows the pension amount before retiring. It does not depend on how any investment performs.
Indexed to DA: the pension goes up whenever Dearness Allowance goes up. DA is linked to inflation (the general rise in prices). So the pension keeps its buying power.
Who carries the risk: the employer, which for OPS is the government. This is a fiscal risk, a risk to the government's budget.
Longevity risk: the risk that pensioners live longer than expected. Under OPS the government keeps paying for as long as the pensioner lives.
Inflation risk: every DA increase raises the pension bill.
Investment risk: in a DB plan with a fund, poor returns must be made up by the employer. OPS has no fund, so here the risk shows up directly in the budget.

Funded vs unfunded (pay-as-you-go)

A DB pension can be funded, where money is set aside in a fund during the working years. It can also be unfunded.
India's OPS is unfunded and pay-as-you-go.
Pay-as-you-go means today's taxes pay today's pensioners.
No fund is built up while the employee works.
So every rupee of future pension is a claim on a future budget. This claim is called an unfunded future liability.

What makes the burden rise

Longer lives: pensions are paid for more years.
DA increases: each pension grows over time.
More retirees compared with working taxpayers: fewer people pay for more pensioners.
Pay revisions: a higher last pay means a higher pension, because the pension is a share of last pay.

Worked example

An employee's last pay is Rs 80,000 a month.
OPS pension = 50% × 80,000 = Rs 40,000 a month, plus DA increases for life.
The employee made no investment choices and carries no market risk. The government must find this money from each year's budget.
Compare with a defined contribution pension: the employee and employer put in fixed amounts. The final pension depends on how much the fund grows, so a market fall lowers the pension. The employee carries that risk.

In India

OPS was the pension for government employees before the National Pension System (NPS).
The switch to NPS: central government recruits joining from 1 January 2004 moved to NPS, a defined contribution scheme. The armed forces were left out. States opted in.
Regulator: NPS is regulated by PFRDA (Pension Fund Regulatory and Development Authority) under the PFRDA Act 2013. OPS is paid directly from the government budget, so it has no fund regulator.
OPS revival in some states:
Some states have moved back to OPS.
Why: it saves money now. The state stops paying its employer share into NPS, so its current spending falls.
The RBI's warning: OPS is fiscally unsustainable. It creates large unfunded future liabilities that grow with longer lives and DA increases. The cost moves onto future taxpayers.
Unified Pension Scheme (UPS), a middle path:
The Cabinet approved it on 24 August 2024. It covers about 23 lakh central government employees [1].
It was notified on 24 January 2025 as an option within NPS and has run since 1 April 2025 [2].
It assures 50% of the average basic pay of the last 12 months after 25 years' service. The minimum pension is Rs 10,000 a month after 10 years, and the family pension is 60% of the employee's pension [1].
Like OPS, it promises a fixed pension. Unlike OPS, it stays contributory and funded, because the employee also pays in.
Atal Pension Yojana (2015) also has a defined benefit feature. It guarantees unorganised workers a pension of Rs 1,000-5,000 a month.

Don't confuse with

Defined contribution pension (NPS): only the contributions are fixed. The final pension depends on market returns, and the employee carries the risk. Under DB (OPS), the benefit is fixed and the government carries the risk.
Unified Pension Scheme (UPS): it assures a pension like OPS, but it is funded and contributory. It is based on the average basic pay of the last 12 months, not the last pay drawn [1].
Annuity: a regular income, usually for life, bought from an insurer with a lump sum, as NPS requires for at least 40% of the corpus. It covers longevity risk through insurance. OPS covers the same risk through the government budget.
Pay-as-you-go vs funded: these words describe how a scheme is financed, not what it promises. OPS is both defined benefit and pay-as-you-go. UPS gives an assured benefit but is funded.

Prelims Hooks

OPS = defined benefit: 50% of last pay, indexed to DA, unfunded, pay-as-you-go. The risk is fiscal, carried by the government.
NPS = defined contribution: funded and market-linked. The risk is carried by the employee. It applies to central government recruits from 1 January 2004, excluding the armed forces.
NPS is regulated by PFRDA (PFRDA Act 2013), not IRDAI. OPS is paid from the budget and has no fund.
Trap: UPS pays 50% of the average basic pay of the last 12 months after 25 years, not 50% of the last pay drawn. The minimum is Rs 10,000 and the family pension is 60% [1].
UPS has been in effect from 1 April 2025 as an option within NPS [2].
Trap: "OPS reduces a state's current spending but raises its future liabilities" is correct. The saving comes from stopping the employer's NPS contribution.

Mains Points

Fiscal sustainability vs employee security:
OPS gives retirees a certain, inflation-protected income.
But its unfunded liabilities grow with longer lives and DA increases, and they crowd future budgets.
The RBI's warning on OPS revival ties the debate to state finances (GS-III).
Intergenerational equity (fairness between today's and tomorrow's taxpayers):
Returning to OPS lowers spending now by pushing costs onto future taxpayers.
This is a short-term political gain paid for with a long-term fiscal cost.
Policy design, from OPS to NPS to UPS:
OPS puts all the risk on the government. NPS puts market risk on employees.
UPS keeps an assured pension inside a funded, contributory system [1].
This mix is a possible model for sharing risk between the government and employees in an ageing society.

Related concepts

Insurance and pensions

Sources

1PIB — Cabinet approves Unified Pension Schemepib.gov.in · tier 1
2PIB — DFS releases detailed FAQs on the tax treatment under UPSpib.gov.in · tier 1