New Pension System (NPS) is an initiative launched by the Government of India in 2009 as a feasible option for providing retirement income to people. It is modeled as a social security system.

Why NPS

The NPS is based on a defined contribution plan, so the returns you receive are based on the contribution that you have made and returns generated by the fund manager you selected. In India, state and central government employees are eligible for receiving a pension once they retire from service. For people working in the private sector, there is no such security for their retirement years.

A proverb goes that the challenge of retirement is how to spend time without spending money. With rising inflation rates, it is difficult to manage expenses even while we are earning, so retirement will definitely mean being a lot more budgeting. Also the increasing trend of nuclear families means you need to be independent in your old age.

Also health care in today’s time is really expensive and old age does bring its share of health problems. So to avoid any surprises when your retired life begins, it is important to plan well and build a corpus when you are in your prime. For getting better returns in a long term horizon, equity markets are definitely a better and time tested option.

Investing in NPS is one of the ways to build a retirement corpus. Once you retire, you get a part of the accumulated sum as a onetime payment and the remaining amount is invested in a life annuity which will give stable monthly income to the subscriber for his remaining lifetime. If you need to withdraw before the age of 60, then you need to invest 80% of the accumulated sum to purchase a life annuity from any IRDA approved life insurance organization and the remaining 20% may be withdrawn as lump sum.

The governing body for NPS is Pension Fund Regulatory and Development Authority (PFRDA). All new employees in government services after 1st Jan, 2004 are enrolled in NPS while other citizens between the ages of 18 to 60 can voluntarily join this scheme.

There are two types of accounts available for investment under NPS, Tier I which do not allow any withdrawals till retirement and Tier II which allows partial withdrawal when required. A subscriber needs to have a Tier I account before opening a Tier II account. The subscriber has the choice of selecting from amongst 6 fund managers for managing his funds.

Currently IDFC, ICICI Prudential, Kotak Mahindra, UTI, Reliance Capital are SBI the designated pension fund managers. It is mandatory to select one of these fund managers at the time of subscription. If you are not happy with the performance of the selected fund manager based on the returns generated, then you may switch to another one.

But this option of switching can be exercise only once during a financial year. The NAV value will be released at regular intervals, so the investor can take an informed decision about switching. There is a cap of 50% on the funds invested in equities.

The minimum contribution for NPS is Rs. 6000 each year, there is no limit for maximum contribution. Suppose you invest Rs. 6000 per annum then the transaction charges including account opening charge comes to Rs. 560 i.e. approximately 9% of your contribution. From the consecutive year, Rs. 470 is charged and as the contribution amount increases, the fund management expenses decrease. No entry or exit load is charged.

Once you have selected the fund manager, you have to decide the investment strategy. There are two choices here, the first is active choice individual funds where the subscriber can decide the ration in which his investment is allocated to equities and fixed income instruments such as government securities.

The second choice is auto choice lifecycle fund where the subscriber is not sure how he wants to customize the portfolio and instead leaves it to the pension fund manager to make the choice for him. Typically for young investors, a larger proportion should be invested in equities and with increasing age this exposure should be reduced.

The process of subscribing and contributing to NPS is convenient because PFRDA has enlisted all public and private sector banks to provide NPS related services. Also the account can be operated from any location in the country, so even if you switch jobs and move from Delhi to Bangalore you can still use the same unique account number allocated to you.

Tax Incentives

From the tax perspective, any investment made in NPS by an individual in a financial year is eligible for tax deductions under Section 80C. At the time of withdrawal though the lump sum would be taxable based the subscriber’s tax slab.

Scheme Performance

Introduced by the government as a scheme to revamp the pension system, there has been a lukewarm response from investors so far. Voluntary participation from people has not really been observed though this is a very good low cost pension option. Once of the main reasons is that banks have not really pushed this as aggressively as other products because the margins on NPS for banks are not really attractive.

So a lot of people who do consider investing in NPS are lost for information when it comes to actually opening an account and subscribing. Also currently online transactions or electronic clearing service (ECS) is not supported. So you actually need to visit your bank every time you want to deposit the contribution cheque, so a lot of people who prefer the convenience of click and pay will not consider NPS.

As premature withdrawals are not allowed, some people may feel that the norms are too rigid, though the fund managers argue that since this is for building a retirement corpus, long term commitment is required. Many investors feel that investing directly in the stock market or via mutual funds is better rather than investing through NPS.

For investors looking for an investment avenue to build a corpus for their old age, the NPS is an option worth considering. If some more tax sops are extended to the withdrawal amount, then this scheme will start attracting lots of investors.

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