Keeping aside the fact whether the New Pension System (NPS) has reached the masses as intended, we shall discuss and examine its various facets and how it is an important and beneficial savings and retirement tool.
Why you also need NPS?
With the setting up of the PFRDA and the new pension system, the long-awaited pension reforms have now become a reality. For the most part, the Indian pension scenario has been dominated by employer sponsored plans with contribution from the employee to a certain extent. The conventional retirement options like the employee provident fund (EPF) and the employee pension scheme (EPS) give fixed or defined benefits which may not be adequate to meet post employment expenses. NPS primarily aims to bring into the pension fold a huge population which is part of the unorganized/non-government sector.
NPS Structure
The unique option that the NPS gives to subscribers is a selection of fund managers with whom they wish to entrust their funds` management.
Pension fund managers currently offering services under the NPS:
> ICICI Prudential Pension Funds Management Company
> IDFC Pension Fund Management Company
> Kotak Mahindra Pension Fund
> Reliance Capital Pension Fund
> SBI Pension Funds Private
> UTI Retirement Solutions
Subscription Types:
To apply for the voluntary pension scheme, there are two types of accounts:
Non-withdraw-able account: The tier 1 account is the basic NPS account which is non-withdraw-able till retirement or in the case of death of the subscriber.
Withdraw-able account: A tier 2 account is available to only those who are existing subscribers of the tier 1 account. The unique selling point (USP) of the tier 2 account is that money contributed into this account can be freely withdrawn as and when the subscriber wishes except for a minimum balance that needs to be maintained at the end of each financial year.
Asset Allocation Class Options:
> Asset Class E - Most aggressive option where the cap for equity investment is 50% of the investment corpus.
> Asset Class C - Medium risk option
> Asset Class G - Low risk option
Investment Options
Auto Choice - Lifecycle fund: Your contributions are pooled into a lifecycle fund and then invested as per pre-defined asset allocations that change over the life cycle of the subscriber. For example, up to 35 years, 50% goes into the aggressive class E with 30% and 20% in asset class C and G respectively. As retirement nears at age 55, only 10% is invested in class E and C but 80% is transferred in less risky class E.
Active Choice: You can choose not only which fund manager to use but also what asset allocation to go with. Once subscribed, there is also a switch window available every year in May.
NPS - The Cheaper Option
Shown below is a projection of how an investment of Rs 1 lakh per annum (p.a.) would behave over a period of 30 years. This is considering that all three options give similar returns at the rate of 10% p.a. For the sake of this projection we have considered funds that would match the asset allocation pattern followed by the aggressive portfolio under NPS.
Why you also need NPS?
With the setting up of the PFRDA and the new pension system, the long-awaited pension reforms have now become a reality. For the most part, the Indian pension scenario has been dominated by employer sponsored plans with contribution from the employee to a certain extent. The conventional retirement options like the employee provident fund (EPF) and the employee pension scheme (EPS) give fixed or defined benefits which may not be adequate to meet post employment expenses. NPS primarily aims to bring into the pension fold a huge population which is part of the unorganized/non-government sector.
NPS Structure
The unique option that the NPS gives to subscribers is a selection of fund managers with whom they wish to entrust their funds` management.
Pension fund managers currently offering services under the NPS:
> ICICI Prudential Pension Funds Management Company
> IDFC Pension Fund Management Company
> Kotak Mahindra Pension Fund
> Reliance Capital Pension Fund
> SBI Pension Funds Private
> UTI Retirement Solutions
Subscription Types:
To apply for the voluntary pension scheme, there are two types of accounts:
Non-withdraw-able account: The tier 1 account is the basic NPS account which is non-withdraw-able till retirement or in the case of death of the subscriber.
Withdraw-able account: A tier 2 account is available to only those who are existing subscribers of the tier 1 account. The unique selling point (USP) of the tier 2 account is that money contributed into this account can be freely withdrawn as and when the subscriber wishes except for a minimum balance that needs to be maintained at the end of each financial year.
Asset Allocation Class Options:
> Asset Class E - Most aggressive option where the cap for equity investment is 50% of the investment corpus.
> Asset Class C - Medium risk option
> Asset Class G - Low risk option
Investment Options
Auto Choice - Lifecycle fund: Your contributions are pooled into a lifecycle fund and then invested as per pre-defined asset allocations that change over the life cycle of the subscriber. For example, up to 35 years, 50% goes into the aggressive class E with 30% and 20% in asset class C and G respectively. As retirement nears at age 55, only 10% is invested in class E and C but 80% is transferred in less risky class E.
Active Choice: You can choose not only which fund manager to use but also what asset allocation to go with. Once subscribed, there is also a switch window available every year in May.
NPS - The Cheaper Option
Shown below is a projection of how an investment of Rs 1 lakh per annum (p.a.) would behave over a period of 30 years. This is considering that all three options give similar returns at the rate of 10% p.a. For the sake of this projection we have considered funds that would match the asset allocation pattern followed by the aggressive portfolio under NPS.
NPS | Insurance Pension Plans (ULIP Based) | Mutual Fund Pension Plan | |
Investment amount per year | 100000 | 100000 | 100000 |
Charges per year (Initial period)* | 925 | 13200 | 1250 |
Charges per year (5 years to 10 years)* | 388 | 6000 | 1250 |
Charges per year (11 years to 15 years)* | 455 | 3000 | 1250 |
Charges per year (16 years+)* | 455 | 0 | 1250 |
Fund Management | 0.0009% | 1.25% | 1.25% |
Age limit for annuity | 60 | Flexible | 58 |
Assume CAGR | 10% | 10% | 10% |
Maturity proceeds after 30 years | 1.8 Crore | 1.3 Crore | 1.39 Crore |
Lump sum (Maximum) | 60% | 33% | 0 - 100% |
Pension Corpus (Minimum) | 40% | 67% | 0 - 100% |
*Premium allocation charge and policy administration charges are calculated at the end of the year. Typically, these charges are computed on premium at the beginning of the year/month.
NPS being the option with the lowest costs eats into the investments the least and hence delivers the highest returns.
Chart 1: Increase in retirement corpus over 30 years
NPS being the option with the lowest costs eats into the investments the least and hence delivers the highest returns.
Chart 1: Increase in retirement corpus over 30 years
Important Note: The projection shown above takes an investment of Rs 1 lakh every year because this is where the charges under ULIPs based pension policies and MF pension plans are at the lowest.
Chart 1 shows how the progression of the invested amount happens over 30 years. An important fact to remember is that as of today, NPS is taxed under the EET regime. This however may change or could be amended to bring all other retirement instruments at parity when the Direct Tax Code is introduced.
Tax Advantage
Investment vehicles are taxed in two ways currently; one is the EET (Exempt-Exempt-Tax) and the other being the EEE (Exempt-Exempt-Exempt) framework.
Under the EET method, the first E in EET means that the contributions towards certain savings products are deductible from taxable income, the second E represents that the accumulation from the investment are exempt, and also, all withdrawals at any time are exempt from tax in case of the third E.
The draft of the much awaited Direct Tax Code, which is expected to bring about a consolidation of the current tax laws and also effect some changes in the tax laws, has recently been made public.
With the drafts of the Direct Tax Code, there seems to be a decided push for making the NPS product more attractive to investors. The major change that the DTC will bring about in the retirement products scenario is that ULIPs will now also be taxed under the EET (Exempt-Exempt-Tax) Regime. This means that unlike in the current scenario, withdrawals from ULIPs will not be tax exempted.
It has long been seen in the Indian investments market that the behavior of the retail investors is largely guided by tax concerns. There is always a rush to invest in order to save on tax. ULIPs had an advantage over the NPS and mutual funds because it was taxed as EEE. This means that the withdrawal and is tax free too. Surely this is a major plus, but with the provisions in the new Direct Tax Code, the NPS will also be taxed in the EEE framework. This will invert the tax situation among retirement products with investment benefits.
NPS will be the only product to be taxed under EEE out of the three (Mutual Funds, ULIPs and NPS). As a result, its major handicap will now be removed. The government has designed the NPS to benefit the investor to the maximum and the new taxation vis-a-vis the NPS will only add to the attractiveness of NPS.
Conclusion:
NPS remains a very good product for its purpose and by aligning the distributors` interests with the PFMs would greatly help the NPS increase its strike rate. Re-iterating that NPS is a post-retirement safety tool, it is a very effective tool that covers capital protection and also provides growth. With its lowest charges, it also is the cheapest way to get an exposure to the market. For the thousands and lakhs of employees in the unorganized sector who have negligible or no post-retirement social security benefits, NPS is a boon.
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