National Pension System: Pros and some cons of NPS | The Financial Express

National Pension System: Pros and some cons of NPS

The investment costs of NPS are very low and comparable to index funds. NPS also provides an active versus auto diversification choice.

National Pension System: Pros and some cons of NPS
Investors should get into NPS with their eyes open.

The National Pension System (NPS) is one of the best ways to save for retirement. It collects contributions from workers aging between 18 and 70 years. The contributions also get tax deductions.

Under Section 80CCD (1), you can deduct up to Rs 1.5 lakh through contributions to your NPS account. Further, under 80CCD (1B), you can deduct another Rs 50,000. This way, you can claim deductions of up to Rs 2 lakh a year through this option.

The investment costs of NPS are very low and comparable to index funds.Your money is split into equities (E), government bonds (G), corporate bonds (C) and alternative funds (A) such as REITs. The returns are similar to index funds. NPS also provides an active versus auto diversification choice. In the active choice, you have a greater handle over equity allocation.

Up to the age of 50, a maximum of 75 per cent of your portfolio can be equity, which could help you earn better returns. But as you reach 60, the equity allocation is reduced to 50 per cent to budget for your lower risk appetite. In the auto choice, you can pick between an aggressive, moderate or conservative style of investment. The more aggressive your style is, the deeper your equity exposure will be.

Investors also have the choice of picking from a list of pension service providers, such as LIC, HDFC, UTI, and so on. The NPS website publishes their past performance. This data on returns can be the basis for your selection. Overall, a hybrid investment can give you better returns compared to a plain vanilla debt investment, such as PPF.

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As of December 2021, NPS had 10-year returns of approximately 15 per cent for equities, 10 per cent for corporate debt and 9.5 per cent for government debt. So for every Rs 100 248 invested with an aggressive split of 75-15-10 in the E-C-G funds, the returns could be approximately Rs 10, implying 10 per cent returns over 10 years.

If you invest Rs 1.5 lakh once in 12 months for 30 years in an investment returning 10 per cent, you will get a corpus of Rs 2.71 crore. At 8 per cent, it will be Rs 1.83 crore. At 6 per cent, it will be Rs 1.25 crore. In comparison, a 15-year PPF returning 7.1 per cent can only give you Rs 40.68 lakh under the current rules.

For conservative investors favouring corporate and government schemes, the returns are much lower in the current economic environment as a result of falling interest rates. The NPS sounds fair up to now. It is also easy to sign up for it online. The NPS website makes it very convenient. Making contributions to your account via netbanking is also easy. The problems rest in getting your money out.

Your NPS account matures when you reach the age of 60. At this point, you can withdraw your investment. However, under the current rules, you need to mandatorily spend at least 40 per cent of your NPS corpus for buying an annuity plan. You can redeem the rest—60 per cent of the corpus—as tax-free and use it the way you wish.

The NPS is managed by the Pension Fund Regulatory and Development Authority (PFRDA). Its vision is to promote and develop systems to serve the income needs of the elderly on a sustainable basis. This is achieved in part by ensuring that the retirement money is not misallocated or misused by other family members. With the annuity plan, the money keeps coming in.

You can prematurely withdraw your NPS corpus before your turn 60, but at least 80 per cent of your corpus needs to be used for purchasing annuity. However, if your corpus was less than Rs 2 lakh, you can withdraw the whole amount without buying annuity.

Under the current rules, the annuity requirement has created some problems. Annuity, as we have seen above, is a fixed income plan, and its returns do not beat inflation.

As long as you are invested in NPS with a high equity allocation, your corpus will keep growing at an above-average rate. The moment you need to take the money out and are forced to buy a low-returns annuity plan, your overall returns from your pension portfolio will fall.

The PFRDA understands the problem with the annuity requirement in a low-interest environment. It has, over the recent years, taken measures to ease withdrawal norms. This has helped NPS investors with small corpuses who do not wish to be stuck with meaningless pensions of a few hundred rupees a month.

There have also been suggestions that the 40 per cent annuity be done away with. In its place, a systematic pay-out method that returns the 40 per cent to the investor over a period of 15 years has been suggested.

This, for now, remains an idea. So investors should get into NPS with their eyes open. Unless it comes to fruition, the annuity requirement exists with its pros and cons. Mind you, these are the options today. For all we know, there will be fewer cons by the time you turn 60. Financial safety nets for the elderly form the need of the hour. May the markets provide solutions.

(The following is an excerpt from the new book on personal finance, The Bee, The Beetle and the Money Bug, co-authored by Adhil Shetty and AR Hemant, and published by Rupa.)

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First published on: 27-02-2023 at 11:37 IST
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