The pros and cons of New Pension Scheme

The New Pension Scheme (NPS) is a defined contribution-based pension scheme, launched by the government and effective from April 1, 2009. While the existing pension fund of the government offers assured benefits, NPS has a defined contribution structure, where an individual can decide where his contributed money will be invested.

NPS is intended to resemble the 401k plan offered for employees in the US , but not in totality. NPS follows an EET (exempt-exempt-taxable) structure, similar to its global peer, but the withdrawal amount after the age of 60 can?t remain invested nor can be withdrawn fully. Another important difference is that premature withdrawal is subject to a few life-changing situations. Let?s explore other aspects of this scheme.

Product structure

The scheme is available in two forms:

Tier-I account: Premature withdrawal not allowed;

Tier-II account: Premature withdrawal allowed.

Features

Before the launch of NPS, pension schemes were available to government employees and employees of big firms with the provident fund facility. With NPS, the common man gets an entry into the system. The other important features of the schemes are:

Low cost: Annual fees of 0.00009% (90 paisa for R10,000) for fund management;

You can choose from six different funds for investment;

Withdrawing from one fund and investing in another will not have any tax implication;

No upper limit on investment;

Minimum limit of investment is R6,000 per year

Tax benefit over and above the current limit of R1 lakh under Section 80C; and

All citizens between 18 and 55 years can invest in NPS.

Taxation

Under the newly introduced Section 80CCD (2), up to 10% of an employee’s basic salary put in the New Pension Scheme is tax deductible. If you fall in the 30% tax bracket, the NPS investment under Section 80CCD (2)

will reduce your tax liability by almost R15,000.

From the next financial year, contributions by employers to the NPS accounts of their employees can be deducted as a business expense, which was not allowed till now. As such contributions will not be a part of the R1 lakh tax deduction limit under Section 80C, your employer’s contribution on your behalf will be a tax-free benefit for you.

Fund withdrawal

Premature exits before 60 years: You will have to invest 80% of accumulated wealth to purchase a life annuity from registered life insurer. The remaining 20% is liable for withdrawal as lump sum.

Exits after 60 years: You will have to invest at least 40% of pension wealth to purchase an annuity.

No exits till 70 years: Beneficiary account will be closed and the accumulated amount will be transferred in lump sum; in case of death of the scheme holder, the nominee will receive the whole amount as lump sum.

NPS on its own vs NPS offered by the employer

If the employer is offering NPS, he will be making an equal contribution in the scheme from his side. The structure will be of Tier-1 type where premature withdrawal will not be allowed. You will be liable for additional tax benefit on the employer?s contribution. An individual can also choose a voluntary Tier-II account having the premature withdrawal facility. The government and employers will make no contribution to this account. The accumulated wealth in this account can be withdrawn anytime without stating any reason.

Benefits to investors

Additional tax saving: Both the employers and the employees will get tax exemption on their

contributions;

Low cost of fund management. The fund management cost is very low, which will enhance the returns; and

Higher return potential compared to old plans: As it?s a defined contribution plan, investors can choose from the six funds available for investment for better returns. Rebalancing of accumulated amount is free of cost; so, you can always invest in the best fund.

The drawbacks

Tier-I option doesn?t give much flexibility: It?s a rigid structure. A little flexibility with respect to premature withdrawal would have made it more lucrative;

Annuity rates after maturity not fixed: There is no floor rate; so, you cannot be sure of the returns until maturity;

Fund management costs might increase: Depending on the pension liability and the costs involved, this rate might shift northward;

Only six fund managers makes it a risky proposition: If we take into account the working population of India, this number seems to be pretty risky. As the number of subscribers increases, hopefully, government will increase this number.

How do employee and employer benefit?

The scheme will benefit both employees and employers alike. Employees get tax deduction on their contribution and, from the next financial year, employers , too, will be in a position to show their contribution as business expense, generating additional tax benefits for the firm.