6 things you should be aware of before opening NPS Vatsalya for your child

Union Finance Minister Nirmala Sitharaman has introduced the NPS Vatsalya scheme, which is exclusively meant for young subscribers. NPS Vatsalya is a scheme where parents or guardians can start saving for their minor children and then have options to convert this account to an NPS Tier 1 later.

But before you sign on the dotted lines here are 6 points you should be aware of about NPS Vatsalya: 

1) Restrictive equity exposure: Through Vatsalya NPS you can have a maximum 75% of exposure in equites through Active and Auto choice. Default choice gives you the option of 50% in equities. The fact that equites tend to give you higher returns over the long run it doesn't give you the chance like mutual funds to be 100% in equities.

2) Becomes a regular NPS account: When the minor reaches the age of 18, the NPS Vatsalya account automatically transitions into a regular NPS account, allowing the young adult to continue managing their pension savings independently. The purpose is to ensure that the scheme ensures that a substantial retirement corpus is built by the time the child reaches adulthood. However, at the age of 18 you might be more worry about the education than retirement of your child.

"There are a lot of goals which one needs to plan for during the earning period – home purchase, education of children, holidays, vehicle purchase etc. They also need to put aside money for their own retirement.  One can look at investing small sums in this scheme and ask the child to top-up whatever gifts the child receives on the birthday or other occasions. If the parent is able to contribute regularly, without impacting the other goals, they can," says Suresh Sadagopan, founder of Ladder7 Financial Advisories.

3) Withdrawal: The good part is it allows withdrawal. However, the amount is limited to 25% of contribution after a lock-in period of 3 years and is allowed for education, specified illness, and disability. Moreover, maximum three times you can withdraw. So keep in mind that In case of emergency you can withdraw only upto 25% for education or other needs. 

"If the parents put in a good sum of money and late on want to withdraw from this scheme, it is not feasible. Hence they should invest only such sums that they are comfortable passing on to their children like a gift," says Sadagopan.

4) Exit restrictions: For a corpus of more than R. 2.5 lakh, 80% of the fund is utilised for the purchase of annuity and 20% can be withdrawn as a lump sum.

Therefore, you won't be able to withdraw a lumpsum amount when the child turns 18 and use for other purposes. The scheme is designed specifically for planning the retirement of your child.For corpus less than or equal to Rs 2.5 lakh, entire corpus can be withdrawn as a lump sum.

5) Saving for retirement of your child: NPS is a retirement account. So NPS Vatsalya is saving for the retirement of your child. But before saving for the retirement of your child you might have other milestones to cover such as child’s education and your own retirement.  Think of your child’s retirement only when you have sufficient funds already allocated for your short and long term goals. 

6) Tax Benefits: Lastly, there is currently no clear guidance on the tax benefits specific to NPS Vatsalya. Experts suggest that the scheme's benefits may be grouped with the regular tax deductions available for NPS contributions under Sections 80C and 80CCD (1B) of the Income Tax Act. However, official clarification is still awaited.

"The investments made in this scheme has an extremely long period of compounding and can balloon to a very big sum when the child turns 60. This can be also used to educate the child on saving for the really longterm and how small sums can grow to very big amounts over long periods of time," adds Sadagopan.