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    Is NPS the right investment option for you?

    Synopsis

    The structuring of the NPS may not be ideal for some who are looking to save for retirement. Read on to find out more before you plan to invest in it.

    ET Online
    National Pension System (NPS), a voluntary, defined contribution retirement savings scheme designed to enable individuals to save systematically during their earning life, was envisaged in 1999.

    The seeds were sown when the Ministry of Social Justice and Empowerment had commissioned a national project titled OASIS (Old Age Social and Income Security).

    Apart from certain operational changes to the scheme, the broad framework of NPS is still the same. Launched in 2004, it took almost 10 years for the scheme to be introduced as an All Citizen model from May 1, 2009.

    As on July 31, 2016, NPS had a subscriber base and assets under management (AUM) of about 1 crore and Rs 1.38 lakh crore respectively. The figures for corporate and unorganised sectors aren't that impressive (less than 7 lakh subscribers and AUM of about Rs 12,000 crore).

    NPS seeks to inculcate the habit of saving for retirement and provide for regular income during the retired years. And as life expectancy is on the way up, you may need to stack up more wealth than estimated earlier. In fact, recent Union Ministry of Health and Family Welfare statistics show that life expectancy in India has gone up by five years, from 62.3 years for males and 63.9 years for females between 2001 and 2005 to 67.3 years and 69.6 years respectively between 2011 and 2015.

    So is an investment like NPS good enough for post-retirement years? Let's look at its structure and features to find out. As they say: No investment product is good or bad, it's just that the features may not suit all the investors.

    But before we look at NPS in detail, let's consider its suitability and pluses.

    Suitability
    NPS suits those who are looking to save for their retirement but are not very comfortable in making investment decisions on their own. Investing towards retirement not only requires proper asset allocation as one ages but also selecting the right schemes or products to invest in. Not everybody is in a position to cull out the right investment options on a regular basis over 25-30 years of working life. In short, those who don't want to actively manage their retirement portfolio of debt and equity, NPS is, perhaps, the answer.

    Remember, for someone joining NPS at age 30 and investing for retirement for another 30 years with life expectancy of, say, 90, nearly six decades of active investment management is required. NPS helps make equity and debt asset class available in one place with an option to switch between them with varying allocation. The Life stage option in NPS automatically allocates funds between assets as one ages. Even on maturity, NPS takes care of one's pension without much active involvement.

    Pluses
    The single most important advantage that the NPS has had since its very first day is its low cost. Currently, the fund management charge is 0.01 per cent of the funds, just Rs 100 to manage a corpus of Rs 10 lakh! A low fund management goes a long way in creating a big corpus by eating that much less into the returns generated. Here's how NPS fund managers performed in the equity fund category:

    Image article boday


    Recently, the government introduced additional tax benefit for investment in NPS. If the taxpayer contributes more than Rs 1.5 lakh to the NPS in a year, the amount in excess of Rs 1.5 lakh can be claimed as a deduction under the new Section 80CCD(1b). To provide further impetus to NPS, maturity corpus was made partially tax-free by giving tax-exempt status to 40 per cent of the corpus amount.

    Features
    Corpus is only partially tax-free
    At age 60, maximum 60 per cent of the corpus can be withdrawn while annuity is paid on the balance 40 per cent of accumulations. Although, maturity corpus was made partially tax-free by giving tax-exempt status to 40 per cent of the corpus amount, the balance 20 per cent of the corpus that can be withdrawn still remains taxable. One may, however, defer the lump sum withdrawal till age 70, or to avoid paying taxes on this balance, one may club it with 40 per cent annuitisation amount to buy annuity.

    Funds get locked in for long
    NPS is a retirement-focused investment scheme. Typically, there are two stages for someone who wants to accumulate funds for retirement. First is the accumulation phase during which one keeps investing till the vesting age, i.e., the retirement age, and the other is the de-accumulation phase when one starts getting the annuity or the pension.

    Anyone between 18 and 60 can join NPS. Once NPS matures at age 60, payouts happen in two ways: One, a lump sum withdrawal of up to 60 per cent of the corpus can be made, and second, annuity begins on the balance till lifetime. Anyone joining at, say, age 30 will have to continue with NPS during the accumulation phase, i.e. till 60. Also, nearly 40 per cent of the corpus will be unavailable to him for the entire lifetime. It's only the annuity that one receives during the lifetime.

    No 100 per cent equity option
    Saving for retirement is a long-term goal. Several studies have shown that equities have delivered high inflation-adjusted return as compared to other assets such as debt, gold, and real estate, over long-term. NPS currently offers a choice to invest 50 per cent of investment into equity under the scheme E fund option. About 50 per cent of one's investment in NPS even in the scheme E fund option is into debt.

    Lack of active fund management
    NPS fund management currently follows a passive approach. Various NPS funds track different indices. Alternatively, one may invest through a mix of actively traded open ended equity and debt mutual funds during the accumulation phase to create a corpus. The Pension Fund Regulatory and Development Authority (PFRDA) is, however, considering active fund management in near future.

    Compulsory annuitisation hampers diversification
    On the vesting age (maturity age) in NPS, minimum 40 per cent of the accumulated corpus has to be compulsorily invested in an Immediate Annuity scheme which has to be purchased from an insurance company. The amount gets locked in for lifetime. Illustratively, if one creates a corpus of Rs 50 lakh in NPS, then Rs 20 lakh (40 per cent, if exiting NPS at age 60, and 80 per cent if exiting before age 60) will be used to buy Immediate Annuity scheme that will fetch pension for lifetime. The amount of Rs 20 lakh will never be returned to the individual.

    NPS does not give an option to deploy the entire corpus in any other investment avenue as per choice. A retiree may want to deploy the amount across investment avenues such as Senior Citizen Savings Scheme (SCSS), post office monthly income scheme, mutual funds, bank fixed deposits, etc., and across maturities for better liquidity. By opening an NPS account, this flexibility is lost.

    Given a choice, one can use a portion of his retirement kitty for the Systematic Withdrawal Plan (SWP), a feature in mutual funds to withdraw and meet regular income needs during retirement. SWP can be used in all MF schemes, including liquid, bond and equity funds. The effective post-tax yield from them could still be higher than annuities.

    Annuity is taxable
    Annuity is entirely taxable in the hands of the individual in the year of receipt. The income in the form of pension, therefore, adds up to the tax liability of the retiree. On the other hand, dividends from mutual funds are either tax-free (equity-oriented) or have lower incidence of taxation (indexation benefit on non-equity funds). A retiree, depending on mutual funds for post-retirement need, may create a stream of regular income through a judicious mix of funds, including SWP. Above all, the corpus remains liquid.

    Portion of principal get taxed
    A portion of the annuity received also includes the investor's own capital, i.e., savings made during the accumulation phase. Taxing the annuity means paying tax on one's own investment and not merely on the income earned. The amount of pension that one gets when adjusted to inflation is almost equal to the amount one saves during accumulation phase. One, therefore, is merely deferring taxes during accumulation phase as annuity is fully taxable.

    Corpus used for annuity is not returned
    By its very nature, an immediate annuity product does not have the provision of return of capital to the investor himself. The corpus or the amount used to purchase annuity is never returned to the individual. There are about seven to 10 different pension options, including pension for lifetime for self, after death to spouse and post that the return of corpus to heirs. The corpus is not returned to the investor under any pension option.

    Low annuity returns
    The annuity returns across various pension options are currently at around 6 per cent per annum. Such low returns will hardly be able to beat inflation. In decreasing interest rate scenario, these may appear fine, unless insurers revise them downwards. The rates are guaranteed for the entire term of the pension option as chosen by investor.

    Conclusion
    It is a very long-term investment product, so make sure you understand the implications and the working of NPS before opening an account. Estimate the amount of monthly savings required to meet your post-retirement expenses, keeping the inflation and your life expectancy in mind. Diversify across various investments, including mutual funds and NPS, but do not bank entirely on the latter.

    Annuities can provide a baseline support to meet household during retired years, but choosing NPS to accumulate a retirement corpus remains a choice which one needs to take now. A corpus created through a mix of mutual funds can still buy you an Immediate Annuity scheme when you are 60, with all your savings at your disposal.

    Listen to the call of your distant retirement and start saving for it now. Remember that delaying and procrastination can be damaging.
    ( Originally published on Aug 18, 2016 )

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