Retirement planning for pros: National Pension Scheme

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Retirement planning for pros: National Pension Scheme

17 May 2016
National Pension System (NPS) is a voluntary retirement plan designed to enable systematic savings during the subscriber’s working life. This aim of NPS is to provide sustainable retirement income to every citizen of India who subscribes to NPS.
 
 

Save now or repent later is the main premise of any retirement plan. If you want to continue living a comfortable life post retirement, without having to compromise on your standard of life, you need to start planning for your future right now.

What is the National Pension System (NPS) and How Does It Work?

Definition: In essence, the National Pension System (NPS) is a “defined contribution plan” in which employers contribute directly into a fund belonging to their employees. Launched in 2004 by the Government of India, the NPS is regulated by Pension Fund Regulatory and Development Authority. This plan was initially introduced for government recruits and in the year 2009, was opened up for the general public.

It is based on a unique Permanent Retirement Account Number (PRAN) which is allotted to each Subscriber upon joining NPS.

The National Pension Scheme is India’s answer to the US’ retirement scheme-401(K).

Related: 5 easy steps that make retirement at 45 a possibility

Age eligibility: This government approved pension scheme is available to people in the age group of 18 years to 60 years. Though mandatory for government employees, it is optional for others.

Accounts: This scheme comes with two account options: a compulsory Tier I account and a voluntary Tier II account. Tier I is the primary account without which the subscriber cannot open a Tier II 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.

Contributions: The minimum annual contribution for Tier I account is INR 6000 annually, that can either be paid as lump sum or in instalments of at least INR 500. For Tier II account it is INR 2000 in lump sum or instalments of at least INR 250.

Related: Is Retirement Planning part of your financial goals in 2016?

Withdrawals:

  • Tier I account comes with withdrawal restrictions. A subscriber can only withdraw only up to 20% before the age of 60, while the remaining 80% must be compulsorily annuitized (converted to pensions).
    After the age of 60, only 60% of the accumulated amount can be withdrawn while the remainder must compulsorily annuitized. Up to 100% can be annuitized.
    In case of death of the subscriber, the designated nominee can withdraw the entire accumulated amount.
  • Tier II account is an optional account that has no withdrawal restrictions but can be opened only if the Tier I account is already operational.

Key Operational Aspects of NPS:

  1. Investment Choices: NPS can be broadly segmented into 3 asset classes – equity (E), corporate bond funds (C) and government securities (G). The usual understanding is that equity is a high risk - high return proposition, while the bond fund falls in the medium risk - return category. Government securities (Gilts) constitute the safest of the three portfolios, with the lowest risk – returns trade-off. The three options are entirely contingent upon the individual’s preference, often dictated by requirements and intended deployment of the funds.

 

  1. The option of Auto Choice Schemes: At times, making a choice between the asset classes can confuse an average investor. In such a situation, s/he can opt for the auto choice scheme. Under this, at the age of 18, the automatic asset allocation would be 50% in equity funds, 30% in bond funds and the remainder in Gilts, till the age of 35. As time passes, the ratio of investments in equity and bonds will decrease while the Gilts allocation will go up to about 80% of the total corpus, by the age of 55. This is to incorporate the changing risk profile of investors as they age.

Related: Are you ready for Retirement? [Infographic]

  1. Fund Managers: The distinguishing feature of this scheme is the option to switch between different fund managers. At present in the Indian context:

For Tier I Account,

  • There are 3 government fund managers: LIC Pension, SBI Pension and UTI Retirement Solutions. Fund Management Fee is 0.0102%.
  • There are 6 non-government fund managers: ICICI Prudential, IDFC*, Kotak Mahindra, Reliance Capital, SBI, and UTI. Fund Management Fee is 0.25%

For Tier II Account,

  • There are 6 fund managers: ICICI Prudential Pension, IDFC Pension*, Kotak Mahindra Pension, Reliance Capital Pension, SBI Pension Funds, UTI Retirement Solutions. Fund Management Fee is 0.0102% (non-government) and 0.25% (government).

*IDFC Pension Fund has recently opted out of NPS; DSP BlackRock Investment Manager has received approval to manage the corpus.

Taxation Benefits under NPS:

The financial Year 2015-16 budget announced an additional INR 50,000 deduction from gross taxable income for those investing in NPS. In addition, the finance minister made withdrawals from NPS on maturity, tax free up to 40% of the total corpus. These benefits have generated a positive response among the public towards this retirement plan, resulting in an upswing in subscription rates.

Related: How will Budget 2016 affect your personal budget?

Thus, NPS is an ideal retirement plan option that provides exposure to equity and instils investment discipline while allowing additional tax benefits for the investor.

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