Overview of NPS (National Pension System)

All those who are risk averse & prefer to invest in safe instruments, NPS is a better option than plain vanilla FDs / RDs / Post Office savings / PPF.

Obviously this may not be as attractive for investors who are already investing in Mutual Funds / Equities & benefit from superior returns over long term.

It has an element of equities & depending on one’s comfort level, one can opt for 0-75% allocation.

The NDA government is a big advocate of NPS. They have been constantly making tweaks to make this attractive & includes trying to bring it at par with other  instruments from a tax standpoint (PPF / EPF).

Here are some good to know things about NPS:

Account Opening:

This can be done online if you have an AADHAR Card. The process is simple and takes not more than an hour. Your “PRAN- Permanent Retirement Account Number” & a card will be dispatched within 3-5 working days.

Check out this link: https://enps.nsdl.com/eNPS/NationalPensionSystem.html

Account Types:

There are 2 types of accounts:

  1. Tier 1 –  This your retirement account. Investments made here can only be withdrawn at retirement (before retirement with some caveats). Minimum investment is Rs.1000/- per year (reduced from Rs.6000/- earlier)
  2. Tier 2 – is Optional. This is like a savings account & one can invest or withdraw any number of times from this account. This is a good option to park liquid funds / emergency funds.

Investment Options:

At a high level there are 4 broad categories:

  1. “A” – Alternate Investments (REITS, Mortgage based securities, Infrastructure investment Trusts)
  2. “E” – Equity
  3. “C” – Corporate Bonds
  4. “G” – Government securities

Allocation between these asset class can be made through these 2 options:

  1. Active Choice –  here the member can allocate the amount as he / she desires. However, the cap for A is 5% & Equity is 50%
  2. Auto Choice – allocation is pre-determined and linked to the age of the member
Choice Category – starting age 35 years Equity Allocation Corporate Bonds Govt Securities
LC 75 75% 10% 15% From age 36, equity allocation reduces by 4% each year – 3% “G” & 1% “C”
LC 50 50% 30% 20% From age 36, “E” reduces by 2% & “C” by 1 % each year & allocated to “G”
LC 25 25% 45% 30% From age 36, “E” reduces by 1% & “C” by 2% each year & allocated to “G”

Fund Managers

There are 7 Pension Fund Managers who are currently registered with PFRDA & belong to the top Mutual Fund Houses of India. You can choose any one to manage your investments.

Switches

One can switch allocation twice a year for free & fund manager’s once a year without charges.

When can one withdraw & how much?

Ideally on retirement & the amounts are as below:

  1. 60% can be withdrawn as lumpsum
  2. 40% has to be converted into annuity i.e. pension

However, there is a provision to withdraw earlier (50-60 years) & for special situations.

Annuity Service Providers (Pension Providers)

There are 5 Insurance companies to choose from at this point of time (LIC, HDFC Life Insurance, ICICI Pru Life Insurance, SBI & Star Dai-ichi)

Tax Treatment of NPS:

When Investing

  • Up to Rs.2 lacs can be claimed as tax benefit or Rs.50000/- over & above one’s 80C limit of Rs.1.5 Lacs

When withdrawing:

  • Lumpsum – 40% is tax free & 20% is taxed at marginal rates
  • Annuity / Pension is taxed at marginal rates

Charges

This is the key benefit of NPS. Even with new revised Fund Mgmt charges of 0.1%, these are anywhere from 1/10th to 1/25th  of typical mutual fund charges. Hence this is a great product to park one’s liquid / emergency cash.

Additionally, there are nominal charges for record keeping, annual maintenance & transaction charges.

One big call out is that ensure you use a registered bank with NPS to invest as otherwise there are charges of 2-2.5% which will wipe off all the benefits of lower costs. Typically, all PSU & major private banks are in approved list (surprisingly ICICI Bank is not).

Returns

Are comparable to those of leading funds from pure play Mutual Funds.

My Verdict:

NPS is a good investment avenue for the uninitiated and defensive investors (actually savers). It at least provides infltion beating returns if one opts for fair portion of equity.

The product is not as simple & straight forward and moreover not as tax efficient as an Equity Mutual Fund. What’s really bad about NPS is buying annuity where return rates are very poor (currently 6-7%) which is not inflation beating.

For the initiated, Equity Mutual Funds are the best bet. Mutual Funds are tax efficient (zero tax on profits after 1 year) & not as cumbersome and complicated.

Moreover “SIP” while you accumulate & “SWP” while you withdraw during retirement is a great approach. This not only ensures zero tax liability on withdrawal but also superior returns on the accumulated corpus even during retirement days.

Advertisements

Fund your own Retirement Pension

Can you fund your own pension? Yes. You can actually fund your own retirement pension.

Many salaried employees think that this is only possible for Govt or PSU employees. They aren’t sure how they would meet their retirement needs.

Well you have a few choices to build your egg nest which will provide for your monthly income in sunset years.

Option 1  – SIP & SWP through Mutual Funds

SIP – Here one can contribute a  predetermined amount each month over a period of time.

SWP – This starts when one retires. One withdraws a pre-determined amount monthly / quarterly or at regular intervals to cover for expenses in retirement.

Let’s take an example of Mr. A who is 35 years old with monthly expense of Rs.35000/-. He will retire at age of 60 years.

Assuming inflation of 7% each year, his monthly expense of Rs.35000/- today will increase to Rs.1.9 lacs (35000*1.07^25) at retirement.

He plans to start a monthly SIP to support his retirement needs & shall continue to invest each month for next 25 years. This monthly SIP is effectively creating a cycle for monthly withdrawal in his sunset years.

Assuming his monthly investment will generate  12% annualised return over 25 years, all he needs to invest each month is 12000/- in first year. The investment amount must be increased by 7% each year to factor for inflation. i.e 12840/- each month in year 2, an additional 7% over 12840 in year 3 & stepping up each year.

This should continue over 25 years. when he retires he is ready to do his first SWP – “Systematic Withdrawal Plan”.

Since the money has been invested over 25 years there is zero tax liability (any equity MF investment over 1 year has zero tax liability). Since the corpus continues to stay invested in MF during retirement it continues to earn superior tax free returns.

Compare this to a MF Dividend Plan which is not a great idea as though the dividend is tax free in your hands, the MF House has to pay Dividend Distribution Tax of 30%+. This money obviously goes from your investment effectively reducing your corpus.

Option 2 – NPS – National Pension System which is over seen by Govt appointed PFRDA (Pension Fund Regulatory & Development Authority)

https://india.gov.in/spotlight/national-pension-system-retirement-plan-all

or

http://www.enps.nsdl.com

Here an Indian National between the age 18-60 can contribute a minimum of Rs.6000/- each year or more until age of 60. On retirement he has the option to buy a Pension Plan with the entire corpus or buy a Pension Plan with 40% of the corpus & withdraw the remaining amount.

During the accumualtion phase one can choose the investment options for his / her corpus. This can either be E – Equity MF (max 50%), C- Corporate Bonds or G – Govt Securities. One can also choose the automatic allocation option where the money is invested in pre-determined ratios linked to your age.

The disadvantages of NPS are:

  1. You can’t withdraw any money until 60 years
  2. On retirement one can with draw 60% of which 40% is tax free. 20% is taxable at marginal rates
  3. 40% of balance on retirement has to be invested in an annuity i.e. purchase a pension plan. Returns from Pension Plans are pretty low & aren’t tax free. Effectively reducing one’s returns.

For people who aren’t financially savvy, this is a good option. Also, the charges on NPS are very ver low & hence it bumps up your returns by that margin.

Option 3 – Rent from Properties

Many believe buying properties for rent is a good option for retirement. Not really since returns are a pittiance 2-2.5%. The rent is taxable & flat maintenance takes away some of your rent.

eg. someone owning a flat costing 1 Cr. today can expect annual rent of Rs.2.4 lacs (2.4%). Maintennace would be in range of Rs.30000-36000/- & tax liability would be about Rs. 24000/-. Effectively one only makes 1.8 Lacs which is very low. Compare this with a MF which at 10% will generate Rs.10 Lacs tax free. In sunset years you shouldn’t be much worried of property appreciation unless you want to leave an inheritance for your children.

I would always recommend a “SIP-SWP” for Retirement Planning – your own Pension Plan!!