BT Insight: Secure a stress-free retirement with NPS

In India, where nationwide social security cover is not that robust, individuals must do their retirement planning while they are earning. By the time people realise it, they are already in the evening of their careers. To ensure a decent regular income during heydays of life you need a big retirement corpus which is difficult to be accumulated in the last few years. To avoid such disappointment closer to the old age, you must understand the importance of small but regular investments for the long-term. For instance, if you deposit Rs 10,000 per month and get an annual return of 8 per cent on your investment, you can easily accumulate a corpus of 1.4 crore in 30 years. However, if wish to accumulate same corpus in 10 years you would need to invest Rs 78,000 per month which is almost 8 times higher. Therefore, it is prudent to start your retirement investment early even with small amount each month to build a substantial corpus for a stress free retirement life.

Earlier we didn't have many high-yielding superannuation investment options, however, with the launch of National Pension System (NPS), the government has offered an attractive investment avenue that has fetched better returns than defined benefit pension plans such as PPF. For example, investment in both corporate bond and government securities have delivered over 9 per cent returns over the last ten years as on 31 March, 2020 while equities have given a return of around 6% during the same period. However, return on equities came down due to unprecedented correction but once the market recovers over 3-5 years these are bound to go much higher.

Although NPS works like a mutual fund, it is much more regulated where fund managers cannot take undue risks that may jeopardise your capital. So, if you are a layman investor, NPS may serve as a great opportunity to commit long-term regular contribution to accumulate substantial corpus by the retirement age.

Regulated by Pension Fund Regulatory and Development Authority (PFRDA), NPS was launched in 2004 for government employees and was opened for salaried and self employed in 2009. Now any person in the age between 18 and 65 years can invest in NPS. We tell you all about it:

Types Of NPS

NPS provides two types of account - Tier-I, which is the pension account that most people open, and another is Tier-II, an optional investment account. "The long-term pension goal is achieved by investing in Tier-I account, while the Tier-II account is optional where subscriber can invest for their short-term goals," says Amit Sinha - Executive Vice President, NSDL e-Governance. Unlike Tier-I account, which has restrictions on withdrawal, subscriber can withdraw from Tier-II account at any point of time, however, it doesn't enjoy tax benefits under Section 80-C of the Income Tax Act and withdrawals attract tax as per your slab rate.

Tier-I account, on the other hand, enjoys Exempt-Exempt-Exempt (EEE) status. For a self-employed individual, NPS contributions of up to 20 per cent of his gross income is allowed as a deduction under Section 80CCD (1) which is subject to a ceiling of Rs 1.5 lakh under Section 80C. For a salaried individual, contribution of up to 10 per cent of his basic salary and dearness allowance can be claimed as deduction under Section 80CCD (1) subject to the overall top limit of Rs 1.5 lakh under Section 80C. Besides, both self-employed and salaried individuals can additionally claim up to Rs 50,000 under Section 80CCD (1B). This is over and above the Rs 1.5 lakh deduction available under Section 80C of Income Tax.

How To Select A Pension Fund Manager

In NPS, pension fund managers pool in money to invest in various schemes as per PFRDA guidelines and individual selection of asset mix. You have option to select one among seven fund managers authorised by PFRDA - SBI Pension Fund, LIC Pension Fund, UTI Retirement Solutions Pension Fund, ICICI Prudential Pension Fund, Kotak Mahindra Pension Fund, HDFC Pension Fund and Birla Pension Fund. While all fund managers strictly adhere to PFRDA guidelines for investments, you must still run a comparison on the basis of past returns and portfolio holdings. Assets under management could also be a criteria that shows which fund manager has larger number of NPS subscribers. For example, SBI PF had highest AUM (Rs 4,294.90 crore) under Scheme G (Tier-I) as on March 31, 2020. It delivered 9.67 per cent returns over the last five years compared to  10.66 per cent, 9.14 per cent, 9.56 per cent, 9.76 per cent and 9.62 per cent, respectively by LIC PF, UTI RSL, ICICI PF, Kotak PF and HDFC PF. You can change your pension fund manager once in a financial year.

"Under NPS, pension funds are responsible for receiving contributions and managing pension corpus through various schemes in accordance with the guidelines issued by PFRDA. The portfolio details of the NPS schemes are available in the website of the concerned Pension Funds. However, a subscriber doesn't have choice to choose his own investments within the asset classes available," explains Sinha.

Two Approaches To Invest In NPS

There are two approaches to invest in NPS - in active choice, you have the option to actively decide in what proportion your investments should be allocated in equities (E), corporate bonds (C) and government securities (G-Sec). A risk-averse subscriber can choose to invest only in C or G asset classes, while an aggressive investor can allocate maximum 75 per cent of funds to asset class 'E' till the age of 50. Equity allocation has to reduce by 2.5 percentage points every year after 50 years of age.

Under the auto choice, the allocation is done based on the age of the subscriber, that is, life-cycle (LC) matrix. Depending on the risk appetite of a subscribe, three options are available within the auto choice - aggressive (LC-75), moderate (LC-50), conservative (LC-25). In the aggressive mode, equity allocation is fixed at 75 per cent till the age of 35 years, following which it is reduced gradually. Similarly, in moderate and conservative modes, equity portion is fixed at 50 per cent and 25 per cent, respectively till the age of 35 years. A subscriber can change the asset allocation or Active/Auto choice twice in a financial year.

Contribution Amount

Minimum contribution amount per year stands at Rs 1,000 and minimum number of contributions per year is one. But you need to invest at least Rs 500 per contribution.

Partial And Pre-Mature Withdrawals

One can make partial withdrawal after three years of opening the account. However, withdrawal amount cannot exceed 25 per cent of the contributions made by the subscriber, and has to be for specific purposes such as purchase or construction of house, children's education or their marriage or medical expenses. Withdrawal can happen maximum of three times during the entire tenure of subscription.

Premature exit can happen only after 10 years and one can only withdraw 20 per cent of the corpus; the rest 80 per cent has to be compulsorily annuitised. If total accumulated corpus is less than or equal to Rs 1 lakh, the Subscriber can avail the option of complete Withdrawal.

"We are trying to inculcate a sense that you are going to build the corpus for future. We discourage withdrawals because otherwise corpus will be so low that you will receive nearly nothing in pension," says PFRDA Chairman Supratim Bandyopadhyay.

Annuity Plans For Pension

At the age of 60, subscribers can withdraw 60 per cent of the total corpus, while with 40 per cent, they have to compulsorily purchase an annuity plan. These plans offer typically a fixed or growing regular income during the selected annuity period. The rate of return offered in an annuity plan is on the lower side, but it is a trade off that you do for guaranteed regular payment. This happens because the corpus is invested in conservative products which are the safest.

In case the total accumulated pension corpus is less than or equal to Rs 2 lakh, subscriber can opt for 100 per cent lumpsum withdrawal. There are over 10 Annuity Service Providers (ASPs) associated with PFRDA. Sinha shares the types of annuity schemes available with these ASPs:

1. Annuity for life- On death of the annuitant, payment of Annuity ceases.

2. Annuity for life with return of purchase price on death- On death of the annuitant, payment of Annuity ceases and the purchase price is returned to the nominee.

3. Annuity payable for life with 100% Annuity payable to spouse on death of annuitant- On death of the annuitant, Annuity is paid to the spouse during life time. If the spouse predeceases the annuitant, payment of Annuity will cease after the death of the annuitant.

4. Annuity payable for life with 100% Annuity payable to spouse on death of annuitant with return on purchase of Annuity- On death of the annuitant, Annuity is paid to the spouse during life time and purchase price is returned to the nominee after the death of the spouse.

Risks In NPS

With role of equity element into NPS, while NPS does assure better returns than other superannuation plans, it has an element of risk due to its linkage with stock market performance. If your equity allocation is higher, your returns could be volatile. However, it's a long-term product and equities especially when well diversified are known to offer higher return than other asset classes in the long run. To manage risks, consider allocating higher proportion to equities at the younger age under 'active choice' and reduce equity exposure as you grow old. If you opt for 'auto choice', it will automatically adjust your asset allocation as per your  life cycle under which equity exposure will reduce with your age.

How To Open NPS Account?

To enrol in NPS, you need to submit the registration form to banks, Post Office or other point of presence - service providers (POP-SPs) whose list is available online. An employer can also open NPS for employees if it has registered itself with PFRDA. "Over the last few years, more than 7,600 corporates have registered with us to provide NPS to their employees. The basic difference between individual and corporate NPS accounts is that in latter, corporates also contribute to employee's NPS account, but it is not mandatory. Some corporates may only assist in opening the account," says Bandyopadhyay.

You can also open NPS account online. Visit eNPS website of NSDL CRA (https://enps.nsdl.com) and open account through PAN and KYC verification through the bank. "We do not foresee any challenge if an NPS account is opened during the ongoing lockdown," says Sinha.

Asset allocation is the crucial part of financial planning. Since basic premise of the NPS is based on it, it makes for one of the best investment options for laymen investors who cannot put in time and efforts to rebalance their investments across asset classes at various life stages. Pension fund managers do it for them as per PFRDA guidelines and EEE status makes it cost effective.

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