NPS (National Pension System or New Pension System) was originally launched in 2004 for government employees but later on in 2009, it was opened for all citizens of the country. It’s a market linked defined contribution scheme which invests your contributions in various assets (based on your choices) and provides regular income once you turn 60. Well, that could just be the definition of it. I won’t be writing minute details regarding the scheme as the same can be found here at the official source. Instead, I wanted to write about some key points about NPS which I believe would be useful for anyone concerned. Let’s dive in…
• Defined contribution. A what?
It means that contributions you make into the scheme are known in advance. A subscriber can decide how much money he wants to deposit in the account and at what intervals. Thus, the depositions or contributions are defined. However, you won’t be able to know in advance how much pension you will get. Because this is a market linked scheme, the pension will depend on the contributions made as well as the returns generated thereon throughout the investing period.
• Where actually does the money get invested?
There are four asset classes for allocation of your investment money as below.
E- Equity assets. Can invest in equity and equity related mutual funds.
C- fixed income assets. Can invest in fixed income assets like corporate fixed deposits, corporate bonds etc.
G- Govt Securities. Can invest in Govt securities like Govtbonds, treasuries etc.
A- Alternate Investment Fund. Can invest in assets other than mentioned above like real estate trusts etc.
There are also two choices, Auto choice and Active choice. In Auto choice, money is allocated across different assets classes as per pre-defined portfolios. There are three such pre-defined portfolios based on further selection of Agressive, Moderate or Conservative investment style. In active choise, you can allocate percentage for each of the asset classes mentioned above, and change that allocation as per your need once a year.
There are points to consider though. In Auto choice, you will get up to 75 percent allocation in equity which, in Active choice, is limited to 50 percent. On the other side, you can invest maximum up to 5 percent in assets class A (Alternate Investment Fund) which is not available in Auto choice.
If a subscriber doesn’t choose anything, default choice will be Auto choice and a Moderate investment style.
• What taxes will I have to pay?
Currently, the scheme is EET in terms of taxation.
E- The money you invest is exempted from tax. (total of up to 1.5 lakh under 80CCD(1) inside broad category of 80C and extra 50K under 80CCD(1b) which is exclusive for NPS subscribers.)
E- Capital gains and returns on investment you earn throughout the lifetime of account are also not taxable.
T- Maturity proceedings are, however, taxable. On completion of 60 years, 40 percent of the accumulated corpus(AC) can be withdrawn without paying taxes. Another 20 percent can be withdrawn but is taxable.
Purchase of annuity from one of the registered ASP is not taxable but the monthly pension you will receive, is taxable.
Also, partial withdrawals(before 60 years of age) up to 25 percent of the contributions made by the subscriber are allowed for specific purposes and will be exempted from tax as per a budget 2017 provision.
• How will I get my money back?
As the scheme is market based, the AC (Accumulated Corpus) will depend on the performance of the asset classes that your money has been invested into.
All will be straight forward until it comes down to getting your money back. Partial withdrawals are allowed as mentioned above. However, in case of closure of account (premature closure or attaining the age of 60 years), things get a little complicated. In case of premature exit, you will get “maximum 20 percent + pension”. That is, maximum 20 percent of the AC can be withdrawn and purchase an annuity with the rest. Similarly you will get “maximum 60 percent + pension” in case of superannuation. As for pension, there are number of options available to choose from as to how an annuity will operate regarding pension and return of purchase price to nominees.
• What are the Pros?
These are some of the good features of the scheme.
○ Low cost
If you compare this with other market based products regarding cost, NPS has the lowest among them, around 0.1 percent, While you will find even least costly MFs in the range of 1.25- 1.50. Even a small difference of 1 percent can make a big deal over longer term.
○ Feel of security
It may not be perfectly safe like PPF because of it’s market linked nature. But consider this. Every central and state govt employee who has joined after 2004 is enrolled in this scheme. Govt owned bodies like PFRDA and NPST are regulating this scheme. Three of the PFMs (Pension Fund Managers) SBI pension fund, LIC pension fund and UTI retirement solutions have stakes of some of the largest Govt organisations in them. At such a large scale, the scheme I think, has been designed to provide decent returns with a feel of security. And as the Govt has already shown a positive attitude towards pushing the scheme by ironing out some of the rough edges, you can expect more fine tuning of the scheme in the future.
○ Tax Saving
It is one of the attractive points about NPS. Additional exemption of 50K can save you a lot of tax over the years.
• What are the Cons?
There are certain adverse features too. Some of them are…
○ Risk of underperforming
The scheme is market linked. Nobody knows how markets will fare in the future. Though equity exposure is kept under a limit to minimise risk. But because of that, you lose out on the potential of equity to grow your funds exponentially. Also, its not defined how much pension will you get once you reach 60 years of age. Current pension plans offer monthly pension in the range of 5-6 percent per annum, I am pretty sure they are not going to go much higher in upcoming years. Instead, there is a possibility that these rates will go down further. In that case, the pension amount will be much lower even with larger corpus.
○ Your funds get locked for a very long time
If you start investing in NPS at 20 years of age, then you will have to wait for 40 years to be substantially benefitted from the scheme. Untill than your money will be locked in the account. Although partial withdrawals are allowed, they are for specific purposes and are available just 3 times during the lifetime of an account. Also, on maturity, at least 40 percent of your corpus will still have to be invested in an annuity for pension. Premature closure also won’t be much helpful as it mandates that 80 percent of the corpus be invested in an annuity.
○ Caveat in taxation
In mutual funds and equities, the long term capital gain is liable for tax at 10 percent (as per budget 2018 provision). In NPS taxation on benefits is little unclear. Capital gain is not taxed while your account is at investing stage. At maturity though, the extra 20 percent of the corpus you withdraw is expected to be taxed at marginal rate. It means that that the amount will be taxed as per income slab after adding it to your income. To understand, suppose your total corpus at maturity is 1 crore rupees. You are allowed to withdraw total of Rs. 60L, but out of that, Rs. 20L will be taxed as per stated above. This entire Rs. 20L will not be capital gain. Some of it can be your investment too. This investment also gets taxed which is not the case with mutual funds as only capital gain is taxed there. (ELSS funds are good contestants if you are thinking about investment exemptions).
All in all, its a good retirement planning option with extra tax benefits. Especially for those of us who don’t want to (or may be don’t know how to) actively manage their investments. Also, for the risk takers, you can invest in equity mutual funds in addition to investing in NPS to compensate for the limit placed on equity exposure in NPS. Extra 50K exemption is great for people coming under higher tax slabs. There are certain rough edges and ambiguities, but I think they will get polished soon which can make the scheme more popular and acceptable among masses.
That’s it for the post. What are your thoughts about the scheme, it’s offerings, the good, and the bad? Let me know in the comments below.
Will be back soon…