Pension: The Forms It Takes in India, and How Each Pays

A pension is an income paid after work stops. In India it takes several forms: an employer's own arrangement, a government scheme for its own employees, a contributory scheme where the money accumulates in an account, and an income bought from an insurer. The four differ in who funds them, who carries the risk, and whether the amount is promised or produced.

Underneath those forms sits one distinction that decides everything else. In some arrangements somebody has undertaken to pay a stated amount; in others an amount will simply be produced by whatever the money grew into. Every other property of a pension follows from which of those two it is: who funds it, who is exposed when things go badly, and whether the figure rises as prices rise. One word covers both. A household can hold two completely different things and describe them with the same sentence. Rates, rules and tax treatments all change, so the authority for each is named instead.

What is a pension, underneath the word?

Strip the word back and it describes one thing only: money arriving after the work that used to bring money in has stopped. A pensionAn income paid after work stops, whatever the arrangement behind it happens to be called. is defined by its purpose and not by its machinery. A definition made of purpose stretches easily, so the word ends up across arrangements that behave nothing alike.

Think about the day the earning stops. Until then a household has a repeating inflow: a salary on a date, a counter that takes money six days a week, or work that pays when it pays. Spending does not stop on that day. Spending changes shape and continues, every month, for as long as the household lasts. So the day the inflow ends leaves a gap between what leaves and what arrives, and something has to stand in it.

Only four things can stand there, and everything that follows is a variation of it. Somebody has promised to pay. Or money was set aside over the years and is now being drawn down. Or a sum was handed to an institution in exchange for an income. Or nothing was arranged, and the household lives on what it holds and what it can still earn. A promise, an accumulation, a purchase and nothing at all are not four flavours of one thing but four structures, and they put risk in different places.

The word pension names the gap it fills and not the machinery that fills it, and that single fact is the source of almost every misunderstanding in this subject. Two neighbours can each say they have a pension and mean arrangements with nothing structural in common: one a promise from an employer that arrives whatever happens, the other a balance that still has to be turned into an income by means not yet decided. Both sentences are true. Only one describes a promise.

Why does one word cover arrangements that behave nothing alike?

Because the word describes the purpose, and the purpose is genuinely shared. Every one of the four structures exists to put money in a household's hands after the earning stops. Language settles on the shared purpose because that is what people care about while they are talking, and the machinery only starts to matter when something goes wrong or when a decision has to be made.

Here is an everyday version. Two people say they have a place to stay in Nashik. One has a house registered in her name. The other has a cousin who has said she can come whenever she likes. Both sentences are true, and one of them depends on somebody else still meaning it in fifteen years. Nobody is lying. The word covered the purpose and hid the structure.

Sorting arrangements by their name tells a household almost nothing, and sorting them by who carries the risk tells it almost everything. Once the question stops being what an arrangement is called and becomes who has to find the money when things go badly, four confusing forms become two clear ones with a purchase sitting in between.

What forms does a pension take in India, and how does each one pay?

Four shapes cover almost everything a reader in this country will meet, and it helps to meet them as shapes before names. Names change when rules change. The shapes do not.

The first shape is an arrangement where an employer, or a government acting as an employer, has undertaken to pay a stated income after service ends. The amount is worked out by a formula the arrangement sets, usually from length of service and what the person was paid towards the end. Nobody has an individual pot. There is a promise, and behind it either a fund maintained for the purpose or the promiser's future revenue.

The second shape is a contributory account. Money goes in every month, from the person and from an employer alongside where there is one, and it accumulates. At the end there is a balance, and the balance is whatever the contributions and the credits made it. Nobody has undertaken that it will reach any figure. A provident fund account on a payslip is of this second shape.

The third shape is a purchase. A lump sum, usually the balance from the second shape, is handed to an insurer, and the insurer undertakes to pay an income. The income is stated at the moment of purchase and does not change afterwards unless it was bought in a form that changes. Such a bought income is an annuityAn income bought from an insurer with a lump sum., compared with the other forms separately.

The fourth shape is no arrangement at all. Having no arrangement is neither an oversight nor rare. A person running a tailoring counter, a shop or a cart has no employer, and therefore no second contributor, no formula, no promise and nothing for a scheme to attach to. The fourth shape is the position of a very large part of the working population of this country, and it is a structure like the other three rather than a hole where a structure should be. In its place stands whatever the household has set aside and whatever it can still earn.

Who actually funds each arrangement?

Follow the money backwards. Every rupee reaching a household after work stops came from one of three places: an employer, the state, or the household itself. Naming the funderWhoever actually puts the money in, as distinct from whoever pays it out at the end. is the fastest way to see what kind of arrangement a household is standing in.

In a promised arrangement the promiser funds it, either by setting money aside year by year into a fund kept for the purpose, or by paying out of whatever revenue it has in the year the payment falls due. The second kind is described as unfundedA promise paid out of current revenue rather than out of a pot of money accumulated in advance for the purpose., and the word matters. An unfunded promise depends on the promiser still having revenue decades from now. Either way the household did not fund it, and not funding it is the defining feature of the first form.

In a contributory account the household funds it, and where there is an employer, that employer funds part of it alongside. Nothing arrives that somebody did not put in, and there is no promise being funded from elsewhere. A produced arrangement is funded entirely by the people contributing to it, so nobody outside it has any reason to carry risk on its behalf.

In a purchased income the household funds it completely and then hands the money over. The purchase confuses people. At the end an insurer is paying, and it feels as though the insurer is funding it. The insurer is not funding it. The insurer sold the conversion of that money into an income, not the money itself.

Where nothing is arranged, the household funds everything and there is nobody else in the picture. Ashok Bhosale, who runs a tailoring counter in this invented household, has no employer, so there is no second contributor and nothing for a scheme to attach to. The absence is not an omission on his part. It is what self-employment structurally is, for a very large share of the people working in this country.

What does promised against produced actually mean?

The distinction everything else turns on is worth stating plainly. In a promised arrangementOne where somebody has undertaken to pay a stated amount, so a figure exists before the money does. somebody has undertaken to pay an amount, and that amount can be written down before anybody knows what the money will do. In a produced arrangementOne where the amount is simply whatever the accumulation turns out to be, so no figure exists until the end. nobody has undertaken anything, and the amount is whatever the accumulation turns out to be when the day arrives.

Notice what that does to the order of events. Under a promise the figure comes first and the funding is arranged to meet it. Under a produced arrangement the funding comes first and the figure arrives last. A promise fixes the outcome and leaves the funding to be solved, and an accumulation fixes the funding and leaves the outcome to be discovered.

Here is the everyday version. A contractor quotes Rs 4,00,000/- to build two rooms. The quote is a promise: the price is fixed and every problem on site is his to solve. The alternative is buying the cement, the steel and the labour directly, week by week, as money comes in. Buying materials week by week is production: the spending is fixed by what the household can afford, and the number of rooms is whatever the material bought. Nobody confuses those two on a building site, and people confuse them constantly when the subject is money after sixty.

One more thing follows immediately. A promise can be stated as a number today for a date thirty years away. An accumulation cannot, and any figure attached to one is somebody's arithmetic on somebody's assumption rather than a commitment. None of that criticises accumulations, the ordinary arrangement for most people. Such a number is worth exactly as much as the assumption underneath it and no more.

Who carries the risk when an amount has been promised?

Three things can go wrong between now and the last payment of somebody's life, and only three. Markets can do badly, so the money set aside grows less than hoped. The person can live a long time, so payments run on far longer than anybody planned for. And prices can rise, so each payment buys less than when the amount was set.

In a promised arrangement all three belong to the promiser, completely. If markets disappoint, the promise does not shrink and the promiser finds the difference. If the person lives to ninety four, the promise does not stop at eighty. Outliving the money is longevity riskThe risk of living longer than the money set aside was expected to last., and it is the one people notice last and feel most.

The third one, prices rising, depends on the wording. Where the arrangement is written to rise, either by a stated formula or by a linked allowance, indexationAn amount written to rise over time, which some arrangements carry and others simply do not. is part of the promise and the price risk sits with the promiser as well. Where the arrangement states a flat amount for life, the promise was only ever a promise of that figure, and what happens to what the figure buys is the household's problem entirely. An arrangement that rises and an arrangement that does not are two different promises, however similar the paperwork looks on the day it is signed.

So the promised form, at its strongest, takes all three risks away from the household. Arrangements of this kind are increasingly rare for exactly that reason: somebody has to carry all three for decades, and carrying them is not free.

And who carries the risk when the amount is only produced?

All three sit with the household. Not most of them, and not the important ones. All three.

If markets do badly across the accumulating years, the balance is smaller and nobody makes it up. If the person lives a long time, the balance runs out and nobody has undertaken to keep paying. If prices rise, nothing in the arrangement rises to meet it. There is no promiser in a produced arrangement, so there is nobody for any of these to be handed to.

Carrying all three is not a fault in produced arrangements but a description of them. A contributory account is a very good machine for accumulating money steadily out of a payslip, and it does that job without pretending to do the other one. The arrangement is honest about itself, so the failure is never in the arrangement. The failure is in reading it as though somebody were standing behind it.

What do all four forms look like with the risks placed in them at once?

The table places all four forms and the three risks at once. The control under it moves the three markers from one side to the other.

What do rising prices do to each of these arrangements?

Nothing happens on any particular day. Rising prices are therefore the quietest of the three risks and do the most damage over a long stretch. A promised amount written flat pays exactly what it promised, every month, for thirty years, and keeps its word while becoming something entirely different.

Take this invented household's own estimate to see the size of it. The Bhosale household reckons it would need about Rs 30,000/- a month in today's money once the earning stops. The school terms will have ended and the two-wheeler loan will be gone, so that is less than the Rs 42,770/- leaving in an ordinary month now, and health spending rises, so it is more in places. The Rs 30,000/- is the household's own estimate rather than a rule.

Now suppose an arrangement paid exactly Rs 30,000/- a month, flat, for twenty years. On an assumed 4 per cent a year of price rises, the last of those payments buys what Rs 13,692/- buys today. On an assumed 6 per cent, Rs 9,354/-. On an assumed 8 per cent, Rs 6,436/-. All three rates are assumptions chosen to show a range rather than readings of any published series, and none of them is typical or expected. The official price series is published by the Reserve Bank of India at rbi.org.in.

Look at the spread between the three end points before anything else. The arrangement is identical in all three cases and so is the promise. The only thing that differs is an assumption about prices, and it more than doubles the answer. Over twenty years the assumption about prices does more to the outcome than most of the decisions a household will agonise over.

Why is an amount that never rises a different arrangement after twenty years?

Because the household is not spending rupees. A household spends groceries, electricity, bus fares, doctor visits and rent. A rupee figure is a stand-in, and the stand-in slips. So an arrangement described once as covering a household's needs becomes, with no event at all, one covering half of them.

Notice what did not happen in that sentence. Nobody defaulted. No institution failed. No rule changed and nobody was misled at signing. The paperwork was honoured to the rupee for twenty years, and the thing the household needed, a month of living covered, was quietly not delivered by year fifteen.

An arrangement that rises with prices and one that does not are two different things wearing the same word, and the difference takes decades to show and cannot be repaired once it has. So the most useful thing to check about any arrangement is not what it pays, but whether what it pays is written to move.

The check itself is small. Ask whether the amount is a fixed figure or whether the arrangement says it rises, and if it rises, ask what it rises with and who decides that. Both are answerable from a document, before anything is signed. Both are also the least likely to come up in the conversation. The figure in front of a household is always the figure for the first year.

What happens to a promised arrangement if the promiser cannot pay?

A promise is only ever as good as the party standing behind it, which is where the promised form gives something back with one hand. Three risks moved away from the household, and a fourth appeared in their place that the produced arrangement does not have at all: the ability of the promiser to pay, decades from now.

The risk of a promiser failing has a shape worth knowing. Where the promiser has been setting money aside year by year into a pot kept for the purpose, the promise is backed by assets that exist and can be counted. Where the promise is unfunded, it depends on the promiser still earning and still being obliged in the year each payment falls due. Governments and very large employers can carry unfunded promises for a long time because their revenue is long lived. Smaller promisers cannot.

A produced arrangement has no promiser, so it cannot be let down by one; a promised arrangement has three fewer risks and one the other does not carry at all. The swap is a trade rather than a free gain, and seeing it as a trade stops the word promise settling everything.

There is a second, less dramatic version of the same thing, and it happens far more often than a failure. Promises get changed. Rules deciding who is covered, on what service and with what formula have been rewritten in many countries including this one, and a person can be inside an arrangement for twenty years and find that the one applying to them is not the one they joined. Rewriting is a property of promises written by parties who can rewrite them.

Where does the Bhosale household actually stand among these forms?

A map nobody stands on teaches very little, so put the Bhosale household against this one. Meghna Bhosale is 36 at 31 March of year two and would reach 60 in 24 years. She works at Sahyadri Freight Services Private Limited, an invented freight company, and her payslip shows a provident fund deduction of Rs 3,120/- a month. Her statement shows an employer amount of Rs 3,120/- alongside it, so Rs 6,240/- a month is going in, or Rs 74,880/- a year. The balance at 31 March of year two is Rs 4,12,000/-, built over eleven years of service.

Place her. Form two: money goes in, it accumulates, nobody has undertaken that it will reach any figure, and the amount at the end is whatever the balance produces. So all three risks sit with the Bhosale household, and there is no promise anywhere in it.

Ashok Bhosale runs a tailoring counter. There is no employer, so there is no second contributor, no formula, no service record and no promise. Ashok stands in form four. Every risk sits with the household, and so does all of the funding.

The two absences are as informative as what is there. The Bhosale household has no National Pension System account and has bought no income from an insurer. So between two working adults there is exactly one arrangement, it is a produced one, and there is no promise from anybody. On the papers this invented household actually holds there is one produced arrangement and not a single promised amount, and that is the ordinary position outside government employment.

One more thing matters more than it looks. The Rs 4,12,000/- did not appear on the household's balance sheet, and its absence was not an oversight. The sheet recorded what the household could reach, and a provident fund balance is not reachable the way a bank balance is. The balance sits on a different sheet because it answers a different question, and both sheets are correct.

What does a household with no pension of any kind actually have?

The honest answer sounds like nothing and the polite answer sounds like consolation, so the subject usually refuses to answer this question at all. The true answer is neither. A household with no arrangement of any kind has two real things: whatever it has set aside, and its own arithmetic. Both can be counted and written down, and neither depends on anybody keeping a promise.

Start with the counting. Counting is quick, and it is the part people skip. For this invented household the two balances set aside for the long run are Rs 4,12,000/- in the provident fund and Rs 84,000/- in the public provident fund, or Rs 4,96,000/- between them. Rs 6,240/- a month is still going in. Meghna Bhosale reaches 60 in 24 years. The household's own estimate of what it would need is Rs 30,000/- a month in today's money, or Rs 3,60,000/- a year.

The balance set beside the estimate gives a reading rather than a verdict: Rs 4,96,000/- is 16.5 months of Rs 30,000/-. The 16.5 is a plain division of today's balance by today's monthly estimate. The division is not a projection, it ignores the 24 years of contributions still to come, and it says nothing about what anything will be worth later. A reading is a description of a position on a date, and its whole value is that it is checkable, repeatable and owed to nobody.

The arithmetic then gives a household what a scheme does not. The arithmetic is portable: it works the same whether somebody has an employer, a counter, or three kinds of work in a year. The arithmetic updates: run it again in March and it gives a new reading. And it costs nothing and needs nobody's permission.

None of this is a substitute for an arrangement. A counted position exists whether or not an arrangement is ever added, and a household beginning from a counted position begins from a better place than one beginning from a feeling. Not holding a pension is a position rather than an absence, and the first useful act is to write the position down.

How does anybody actually use this sorting in practice?

Three people use it, and none the way a textbook would suggest.

The household uses it on its own statement, once a year, and the exercise takes fifteen minutes. The paper or the screen for each arrangement anybody in the household has is found, and for each one three questions are asked: does anybody state an amount, or is there only a balance; who is putting money in besides the household; and does anything in it say it rises. The answers go into a notebook with the date. The three questions are the whole method. The method needs no adviser and no product, and it produces a written description of what a household holds rather than a word for it.

Somebody assessing a household across a desk uses the same sorting for a different purpose. A person weighing a long dated commitment against a household's future income is not indifferent between an amount somebody has undertaken to pay and a balance that still has to be turned into an income. The two are treated differently because they are different, not because one household is better than another. How any such assessment is made is set by each institution, and none of it is stated here.

The third use belongs to somebody selling an arrangement, who uses the vocabulary either carefully or loosely. When anybody describes an arrangement to a household, the useful question is never how much, and always: is that an amount somebody has undertaken to pay, and does it rise. Two questions, both answerable from a document. A person describing a produced arrangement in the language of a promised one is usually not lying; they are using the word everybody uses. The document still says which it is.

Richard Thaler and the behavioural economists who followed him documented that people discount distant outcomes far more steeply than near ones. Steep discounting explains almost everything about why a goal twenty four years away is the last one any household costs, and why a check that takes an afternoon never gets done. A method that takes an afternoon competes with an afternoon, and loses.

The Bhosale household, Meghna Bhosale, Ashok Bhosale, Ira Bhosale and Sahyadri Freight Services Private Limited are invented.
Educational material. Not advice on any investment, tax, budget or market position.