National Pension System gets more attractive for investors
New rules, plus a proposed law giving statutory powers to the Pension Fund Regulatory and Development Authority,
promise to revamp NPS and popularise what many say is the only genuine
pension product in the country.
Not long ago, if you went to a bank to open a National Pension System (NPS) account, you would have got a frown from the banker. Not surprising, as the account would have earned the bank a mere Rs 20, no matter how big your investment was, and attending to you was not worth it.
You were lucky to not deal with those who manage NPS funds. Just imagine their reaction, for all they would have got is Rs 9 for managing Rs 10 lakh.
No wonder you did not get calls from banks hard-selling NPS, a long-term retirement savings plan with provision for regular pension at the end of the tenure.
SEVEN
If you haven't even heard of NPS, it's not surprising. Even Yogesh Agarwal, the chairman of the Pension Fund Regulatory and Development Authority (PFRDA), the sector regulator, admits that "for the three years since its launch, NPS failed to take off in the voluntary segment because of no incentive to intermediaries."
This is about to change. New rules, plus a proposed law giving statutory powers to the PFRDA, promise to revamp and popularise what many say is the only genuine pension product in the country.
We take you through the changes made in the scheme over the past one year and try to evaluate if these have made NPS a better retirement product in terms of access, cost, liquidity and tax benefits.
NPS IN SHORT
NPS, India's answer to the US' retirement scheme- 401(K)-is a government-approved pension scheme for Indian citizens in the 18-60 age group. While central and state government employees have to subscribe mandatorily, it's optional for others.
The minimum annual contribution is Rs 6,000, which can be paid at once or in instalments of at least Rs 500.
The scheme offers two kinds of accounts-a compulsory Tier-I account and a voluntary Tier-II account. One can open a Tier-II account only if one has an active Tier-I account.
While Tier-I is a basic pension account with restrictions on withdrawal, Tier-II is a voluntary savings option from which a person can withdraw money freely.
Two things that make NPS a genuine pension scheme are restrictions on withdrawal from Tier-I account and the rule that a part of the Tier-I corpus at the end of the tenure has to be used to buy annuity, which gives regular payments in lieu of a lump sum.
Tier-I comes with partial withdrawal options, subject to conditions. The nominee can withdraw the full amount only after the death of the subscriber. Even after retirement at 60, one can withdraw only up to 60 per cent of the corpus; the rest has to be annuitised.
While the lock-in ensures the subscriber does not use the funds during his working life, annuity makes sure the money is paid in instalments over a long period.
31 LAKH
"The rigidity in NPS is understandable as its primary objective is to build a retirement fund," says Lovaii Navlakhi, chief executive and founder of International Money Matters, an investment advisory company.
Annuity can be bought only from the PFRDA-appointed insurers, which are Life Insurance Corporation of India (LIC), SBI Life Insurance, ICICI Prudential Life Insurance, Bajaj Allianz Life Insurance, Star Union Dai-ichi and Reliance Life Insurance.
Insurance pension schemes, regulated by the Insurance Regulatory and Development Authority, have similar features-restrictions on premature withdrawal and compulsory annuity. Mutual funds do not offer such longterm schemes.
FUND MANAGERS & ASSET CLASS
The contributions are invested in a combination of asset classes-equity (Asset Class E), government bonds (Asset Class G) and a mix of liquid funds, corporate debt, fixed deposits, etc (Asset Class C). Exposure to equity cannot exceed 50 per cent.
If you are not confident about deciding the asset allocation yourself, your money will be invested in a Life Cycle Fund, a combination of the above three asset classes. In this, as you age, exposure to equity falls while that to government securities rises.
The money is managed by seven fund managers appointed by the PFRDA. While the accounts of government employees are managed by one of the three government fund managers, LIC Pension Plan, SBI Pension Plan and UTI Retirement Solutions, the money invested by others is managed by one of the six fund managers, ICICI Prudential Pension, IDFC Pension, Kotak Mahindra Pension, Reliance Capital Pension, SBI Pension Funds and UTI Retirement Solutions. You have to opt for a fund manager while opening the account.
(IDFC Pension Fund has recently opted out of NPS; DSP BlackRock Investment Manager has received approval to manage the corpus.)
PERFORMANCE & COST
NPS has delivered 5-12 per cent annual returns in the past three years. Due to the market downturn, the return from the equity portfolio has been the lowest (around 5 per cent), while the Asset Class C has returned up to 12 per cent a year.
"Though the returns are in line with the overall performance of equity and debt markets, they have been volatile," says Manikaran Singhal, a Chandigarh-based certified financial planner.
However, as NPS is a longterm product that has been around for just three years, not much can be read into these figures. A reassuring fact, though, is that the fund managers have a good record in asset management.
A USP of NPS is its low cost. When it was launched, the fund management cost was capped at 0.0009 per cent and points of presence, or PoPs, where investors open the account, were allowed to charge just Rs 20 per account, no matter how large the investment was. Then there was an account opening fee of Rs 50 for the central record-keeping agency, or CRA, plus an annual CRA fee of Rs 225.
CHANGES: FOR BETTER OR WORSE
Despite scoring well on performance and cost, NPS failed on the awareness front. The fault lay with the incentive structure. As we mentioned earlier, PoPs got just Rs 20 per account; worse, fund managers got just 0.0009 per cent of the corpus as yearly fee.
This was not enough to pay even the brokerage for buying securities, let alone make a profit. So, none of the intermediaries-fund managers/PoPs-pushed the product.
The PFRDA, acting on a report of the GN Bajpai committee, has now overhauled the incentive structure.
>> Higher fee to intermediaries:
The fund management fee for non-government funds has been increased from 0.0009 per cent of assets under management to 0.25 per cent with effect from November 1. The fee for government funds has been revised to 0.0102 per cent from April this year
PoPs can now charge Rs 100 plus 0.25 per cent of the investment, as against a flat fee of Rs 20 earlier.
The changes have been made to encourage promotion and marketing of the product.
"The move will popularise NPS by giving incentives to distributors and fund managers to push the scheme. The fund management fee of 0.25 per cent is less even now when compared to other products. Given the recent performance of NPS, even with 0.25 per cent, it is likely to beat competitors," says Amit Kukreja, a Gurgaon-based certified financial planner.
>> Removal of three-year fixed tenure:
The PFRDA has also done away with the three-year fixed tenure for fund managers, removing uncertainty for them.
"Three years is too short a period for fund managers to establish themselves. Who will enter a business if there is no certainty he will continue after three years?" says PFRDA chairman Agarwal.
Now, once a fund manager is appointed, it can continue for as long as it wants, subject to yearly performance review, says Agarwal.
>> Additional tax benefit:
The Finance Bill 2011-12 allows tax deduction on contribution up to 10 per cent of basic salary and dearness allowance (DA) made by an employer towards the NPS account of an employee under Section 80CCE. This is over and above the Rs 1 lakh limit and is available if the contribution comes through the employer. This is exclusive to NPS and, according to the PFRDA chairman, has already attracted corporate houses.
"Over 250 companies have registered with the PFRDA for this," says CR Chandrasekar, chief executive officer, FundsIndia.com, which has been promoting NPS among companies for the last two years.
"There has been a rise in enquiries about NPS mainly because of the tax benefit under Section 80CCE. The increase in intermediaries' fee is yet to show result," says Vineet Arora, head of products and distribution, ICICI Securities, a PoP.
>> Minimum guaranteed returns:
The Union Cabinet recently passed a Bill that seeks to ask pension fund managers to offer minimum assured return options to investors. This will come into force only after Parliament passes the PFRDA Bill. Many people oppose this. Minimum guarantee, they say, will force pension fund managers to build a more conservative portfolio with little or no equity and thus deprive investors of good returns in the long run.
Even the fund managers say this will add complexity. We will be "required to back the guarantee with net worth, increasing the need for capital", says Vikas Raj, CEO, IFDC Pension Fund.
A similar provision for pension plans of insurance companies has led to closure of most such schemes.
However, going by the text of the initial finance ministry press release, it seems the guarantee will be optional. More clarity is awaited.
>> Premature Withdrawal:
A clause in the PFRDA Bill proposes to allow up to 25 per cent withdrawal in Tier-I account before maturity subject to conditions such as purpose and frequency.
At present, any withdrawal before the person turns 60 leads to closure of the account. One can withdraw only up to 20 per cent contribution made before one turns 60. The rest, 80 per cent, has to be invested in an insurance annuity scheme.
The proposal will address a major worry of investors, that is, lack of liquidity.
Vineet Arora of ICICI Securities says too many windows of withdrawal will defeat the purpose of NPS, which is building a retirement fund.
Employee Provident Fund (EPF) allows partial withdrawal for specific expenses such as medical emergencies, house construction, higher education of children, marriage, etc.
DISADVANTAGE NPS
The changes, say critics, have largely addressed marketing and distribution issues. Core issues that directly impact investors are yet to be resolved, they say.
>> Tax on maturity proceeds:
The most key concern is the lack of clarity on taxation at withdrawal. Present laws say the funds will be taxed at withdrawal.
Under the existing laws, up to 60 per cent corpus on maturity can be withdrawn while at least 40 per cent has to be used to buy annuity. At present, returns from annuity insurance plans are not tax-free.
The proposed Direct Taxes Code (DTC) seeks to exempt NPS funds from tax at withdrawal. However, it is not clear if the DTC provides for tax exemption on returns from annuity plans as well. Further, there is uncertainty over the DTC itself with Finance Minister P Chidambaram calling for a review.
Most financial planners say tax at withdrawal is a big impediment to NPS becoming the best pension scheme.
Taxability of maturity proceeds is the major concern, says Manikaran Singhal, while Sumeet Vaid, CEO, Ffreedom Financial, says making withdrawal tax-free will give the product a big boost.
>> Compulsory annuity:
Another drag is restrictions on withdrawal from Tier-I account, the primary account for pension savings. Even on maturity, one can withdraw only up to 60 per cent funds; the rest has to be used to buy annuity, the returns from which are not tax-free.
Also, the annuity has to be bought from one of the six PFRDA-approved insurers. Options in terms of the number of annuity providers are anyway few with LIC commanding a 70 per cent market share.
"Annuity and pension is a long-term business and requires a degree of stability and financial size. In the present market, 12 companies have premium income of less than Rs 3,000 crore. How do you expect them to get into the annuity business? They do not even qualify for grant of annuity by NPS," says SB Mathur, former Life Insurance Council secretary general.
Pension plans by insurance companies have similar restrictions on withdrawal. In fact, in these, the annuity can be bought only from the pension plan provider.
>> Low on equity:
NPS portfolios cannot have more than 50 per cent exposure to equity. For those who start in their 20s or early 30s, this can mean a loss of opportunity, as equity has given 12-15 per cent returns a year over long periods.
The PFRDA chairman, while rejecting any possibility of an increase in equity exposure, said 50 per cent equity exposure was good enough for pension plans.
Compared to traditional retirement schemes such as EPF and Public Provident Fund, which do not invest in stocks at all, NPS is far more flexible in terms of equity exposure.
Nonetheless, investors looking for higher equity exposure can opt for equity mutual fund schemes such as large-cap funds and equity exchange-traded funds.
>> Competition from traditional schemes:
For long, EPF has been the main retirement savings instrument. It is a major competitor for NPS as the government has made it mandatory for 'establishments with 20 or more employees' to subscribe to it.
Though the government allows tax deduction on contribution up to 10 per cent of the basic salary and DA made by an employer towards the NPS account of an employee over and above the Rs 1 lakh limit, mandatory EPF subscription could still be a deterrent for employees to subscribe to NPS. "One of the key changes could be to allow consumers to choose either NPS or EPF," says Nitin Vyakaranam, founder and chief executive officer, Artha Yantra, a provider of retail financial services.
EPF is not the only competition NPS faces. Mutual funds also pose a challenge. In general, most financial planners and advisors recommend mutual fund schemes for achieving all kinds of goals, including retirement.
Even insurers provide pension plans that are similar to NPS, except that the cost is much lower in the latter's case.
NPS: IS IT THE BEST?
The jury is still out. NPS scores over other retirement options in terms of cost and equity exposure (vis-a-vis EPF and PPF), instills discipline and allows additional tax deduction. But some clarity on tax at maturity and liquidity can make it better.
However, if invested in a disciplined manner, mutual funds (large-cap funds, exchange-traded funds and balanced funds) can generate equally decent returns in the long run and that too without taking too much risk.
"As far as structure and cost are concerned, NPS is the best retirement option. But people are reluctant to invest due to taxation and liquidity issues. Mutual funds score over NPS in both these aspects, which is why financial advisors are reluctant to recommend the product," says Singhal.
You were lucky to not deal with those who manage NPS funds. Just imagine their reaction, for all they would have got is Rs 9 for managing Rs 10 lakh.
No wonder you did not get calls from banks hard-selling NPS, a long-term retirement savings plan with provision for regular pension at the end of the tenure.
SEVEN
is the number of PFRDA-approved pension fund managers.
This is about to change. New rules, plus a proposed law giving statutory powers to the PFRDA, promise to revamp and popularise what many say is the only genuine pension product in the country.
We take you through the changes made in the scheme over the past one year and try to evaluate if these have made NPS a better retirement product in terms of access, cost, liquidity and tax benefits.
NPS IN SHORT
NPS, India's answer to the US' retirement scheme- 401(K)-is a government-approved pension scheme for Indian citizens in the 18-60 age group. While central and state government employees have to subscribe mandatorily, it's optional for others.
Premature withdrawal will defeat the purpose of NPS, which is building a retirement fund.
Vineet Arora
Head of Products, ICICI Securities
The scheme offers two kinds of accounts-a compulsory Tier-I account and a voluntary Tier-II account. One can open a Tier-II account only if one has an active Tier-I account.
While Tier-I is a basic pension account with restrictions on withdrawal, Tier-II is a voluntary savings option from which a person can withdraw money freely.
Two things that make NPS a genuine pension scheme are restrictions on withdrawal from Tier-I account and the rule that a part of the Tier-I corpus at the end of the tenure has to be used to buy annuity, which gives regular payments in lieu of a lump sum.
Tier-I comes with partial withdrawal options, subject to conditions. The nominee can withdraw the full amount only after the death of the subscriber. Even after retirement at 60, one can withdraw only up to 60 per cent of the corpus; the rest has to be annuitised.
While the lock-in ensures the subscriber does not use the funds during his working life, annuity makes sure the money is paid in instalments over a long period.
31 LAKH
was the number of subscribers (govt and voluntary) of NPS as on 31 March 2012.
Annuity can be bought only from the PFRDA-appointed insurers, which are Life Insurance Corporation of India (LIC), SBI Life Insurance, ICICI Prudential Life Insurance, Bajaj Allianz Life Insurance, Star Union Dai-ichi and Reliance Life Insurance.
Insurance pension schemes, regulated by the Insurance Regulatory and Development Authority, have similar features-restrictions on premature withdrawal and compulsory annuity. Mutual funds do not offer such longterm schemes.
FUND MANAGERS & ASSET CLASS
The contributions are invested in a combination of asset classes-equity (Asset Class E), government bonds (Asset Class G) and a mix of liquid funds, corporate debt, fixed deposits, etc (Asset Class C). Exposure to equity cannot exceed 50 per cent.
NPS has some limitations such as lack of liquidity and taxable annuities.
Sumeet Vaid
CEO, Ffreedom Financial Planner
The money is managed by seven fund managers appointed by the PFRDA. While the accounts of government employees are managed by one of the three government fund managers, LIC Pension Plan, SBI Pension Plan and UTI Retirement Solutions, the money invested by others is managed by one of the six fund managers, ICICI Prudential Pension, IDFC Pension, Kotak Mahindra Pension, Reliance Capital Pension, SBI Pension Funds and UTI Retirement Solutions. You have to opt for a fund manager while opening the account.
(IDFC Pension Fund has recently opted out of NPS; DSP BlackRock Investment Manager has received approval to manage the corpus.)
PERFORMANCE & COST
"Though the returns are in line with the overall performance of equity and debt markets, they have been volatile," says Manikaran Singhal, a Chandigarh-based certified financial planner.
However, as NPS is a longterm product that has been around for just three years, not much can be read into these figures. A reassuring fact, though, is that the fund managers have a good record in asset management.
A USP of NPS is its low cost. When it was launched, the fund management cost was capped at 0.0009 per cent and points of presence, or PoPs, where investors open the account, were allowed to charge just Rs 20 per account, no matter how large the investment was. Then there was an account opening fee of Rs 50 for the central record-keeping agency, or CRA, plus an annual CRA fee of Rs 225.
CHANGES: FOR BETTER OR WORSE
Despite scoring well on performance and cost, NPS failed on the awareness front. The fault lay with the incentive structure. As we mentioned earlier, PoPs got just Rs 20 per account; worse, fund managers got just 0.0009 per cent of the corpus as yearly fee.
This was not enough to pay even the brokerage for buying securities, let alone make a profit. So, none of the intermediaries-fund managers/PoPs-pushed the product.
The PFRDA, acting on a report of the GN Bajpai committee, has now overhauled the incentive structure.
>> Higher fee to intermediaries:
The fund management fee for non-government funds has been increased from 0.0009 per cent of assets under management to 0.25 per cent with effect from November 1. The fee for government funds has been revised to 0.0102 per cent from April this year
PoPs can now charge Rs 100 plus 0.25 per cent of the investment, as against a flat fee of Rs 20 earlier.
The changes have been made to encourage promotion and marketing of the product.
"The move will popularise NPS by giving incentives to distributors and fund managers to push the scheme. The fund management fee of 0.25 per cent is less even now when compared to other products. Given the recent performance of NPS, even with 0.25 per cent, it is likely to beat competitors," says Amit Kukreja, a Gurgaon-based certified financial planner.
>> Removal of three-year fixed tenure:
The PFRDA has also done away with the three-year fixed tenure for fund managers, removing uncertainty for them.
"Three years is too short a period for fund managers to establish themselves. Who will enter a business if there is no certainty he will continue after three years?" says PFRDA chairman Agarwal.
Now, once a fund manager is appointed, it can continue for as long as it wants, subject to yearly performance review, says Agarwal.
>> Additional tax benefit:
The Finance Bill 2011-12 allows tax deduction on contribution up to 10 per cent of basic salary and dearness allowance (DA) made by an employer towards the NPS account of an employee under Section 80CCE. This is over and above the Rs 1 lakh limit and is available if the contribution comes through the employer. This is exclusive to NPS and, according to the PFRDA chairman, has already attracted corporate houses.
"Over 250 companies have registered with the PFRDA for this," says CR Chandrasekar, chief executive officer, FundsIndia.com, which has been promoting NPS among companies for the last two years.
"There has been a rise in enquiries about NPS mainly because of the tax benefit under Section 80CCE. The increase in intermediaries' fee is yet to show result," says Vineet Arora, head of products and distribution, ICICI Securities, a PoP.
>> Minimum guaranteed returns:
The Union Cabinet recently passed a Bill that seeks to ask pension fund managers to offer minimum assured return options to investors. This will come into force only after Parliament passes the PFRDA Bill. Many people oppose this. Minimum guarantee, they say, will force pension fund managers to build a more conservative portfolio with little or no equity and thus deprive investors of good returns in the long run.
Even the fund managers say this will add complexity. We will be "required to back the guarantee with net worth, increasing the need for capital", says Vikas Raj, CEO, IFDC Pension Fund.
A similar provision for pension plans of insurance companies has led to closure of most such schemes.
However, going by the text of the initial finance ministry press release, it seems the guarantee will be optional. More clarity is awaited.
>> Premature Withdrawal:
A clause in the PFRDA Bill proposes to allow up to 25 per cent withdrawal in Tier-I account before maturity subject to conditions such as purpose and frequency.
At present, any withdrawal before the person turns 60 leads to closure of the account. One can withdraw only up to 20 per cent contribution made before one turns 60. The rest, 80 per cent, has to be invested in an insurance annuity scheme.
The proposal will address a major worry of investors, that is, lack of liquidity.
Vineet Arora of ICICI Securities says too many windows of withdrawal will defeat the purpose of NPS, which is building a retirement fund.
Employee Provident Fund (EPF) allows partial withdrawal for specific expenses such as medical emergencies, house construction, higher education of children, marriage, etc.
DISADVANTAGE NPS
The changes, say critics, have largely addressed marketing and distribution issues. Core issues that directly impact investors are yet to be resolved, they say.
>> Tax on maturity proceeds:
The most key concern is the lack of clarity on taxation at withdrawal. Present laws say the funds will be taxed at withdrawal.
Under the existing laws, up to 60 per cent corpus on maturity can be withdrawn while at least 40 per cent has to be used to buy annuity. At present, returns from annuity insurance plans are not tax-free.
The proposed Direct Taxes Code (DTC) seeks to exempt NPS funds from tax at withdrawal. However, it is not clear if the DTC provides for tax exemption on returns from annuity plans as well. Further, there is uncertainty over the DTC itself with Finance Minister P Chidambaram calling for a review.
Most financial planners say tax at withdrawal is a big impediment to NPS becoming the best pension scheme.
Taxability of maturity proceeds is the major concern, says Manikaran Singhal, while Sumeet Vaid, CEO, Ffreedom Financial, says making withdrawal tax-free will give the product a big boost.
>> Compulsory annuity:
Another drag is restrictions on withdrawal from Tier-I account, the primary account for pension savings. Even on maturity, one can withdraw only up to 60 per cent funds; the rest has to be used to buy annuity, the returns from which are not tax-free.
Also, the annuity has to be bought from one of the six PFRDA-approved insurers. Options in terms of the number of annuity providers are anyway few with LIC commanding a 70 per cent market share.
"Annuity and pension is a long-term business and requires a degree of stability and financial size. In the present market, 12 companies have premium income of less than Rs 3,000 crore. How do you expect them to get into the annuity business? They do not even qualify for grant of annuity by NPS," says SB Mathur, former Life Insurance Council secretary general.
Pension plans by insurance companies have similar restrictions on withdrawal. In fact, in these, the annuity can be bought only from the pension plan provider.
>> Low on equity:
NPS portfolios cannot have more than 50 per cent exposure to equity. For those who start in their 20s or early 30s, this can mean a loss of opportunity, as equity has given 12-15 per cent returns a year over long periods.
The PFRDA chairman, while rejecting any possibility of an increase in equity exposure, said 50 per cent equity exposure was good enough for pension plans.
Compared to traditional retirement schemes such as EPF and Public Provident Fund, which do not invest in stocks at all, NPS is far more flexible in terms of equity exposure.
Nonetheless, investors looking for higher equity exposure can opt for equity mutual fund schemes such as large-cap funds and equity exchange-traded funds.
>> Competition from traditional schemes:
For long, EPF has been the main retirement savings instrument. It is a major competitor for NPS as the government has made it mandatory for 'establishments with 20 or more employees' to subscribe to it.
Though the government allows tax deduction on contribution up to 10 per cent of the basic salary and DA made by an employer towards the NPS account of an employee over and above the Rs 1 lakh limit, mandatory EPF subscription could still be a deterrent for employees to subscribe to NPS. "One of the key changes could be to allow consumers to choose either NPS or EPF," says Nitin Vyakaranam, founder and chief executive officer, Artha Yantra, a provider of retail financial services.
EPF is not the only competition NPS faces. Mutual funds also pose a challenge. In general, most financial planners and advisors recommend mutual fund schemes for achieving all kinds of goals, including retirement.
Even insurers provide pension plans that are similar to NPS, except that the cost is much lower in the latter's case.
NPS: IS IT THE BEST?
The jury is still out. NPS scores over other retirement options in terms of cost and equity exposure (vis-a-vis EPF and PPF), instills discipline and allows additional tax deduction. But some clarity on tax at maturity and liquidity can make it better.
However, if invested in a disciplined manner, mutual funds (large-cap funds, exchange-traded funds and balanced funds) can generate equally decent returns in the long run and that too without taking too much risk.
"As far as structure and cost are concerned, NPS is the best retirement option. But people are reluctant to invest due to taxation and liquidity issues. Mutual funds score over NPS in both these aspects, which is why financial advisors are reluctant to recommend the product," says Singhal.
