Scrap the NPS annuity: Makes more sense to go for systematic withdrawal plan

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Published: December 12, 2018 3:46:15 AM

The government has also made another big change, to ensure the NPS is on a par with other pension plans such as the EPFO.

Under the earlier scheme, pensions skyrocketed, from Rs 32,690 crore in FY09 to Rs 168,460 crore in FY19, or an increase of 5.2 times versus 3.9 times for all salaries

Though government employees under the National Pension System (NPS) have been asking for the ‘defined contribution’ scheme—both they and the government contribute 10% each of the basic pay and invest this in a pension plan—to be scrapped and, instead, allow bureaucrats to move to the old ‘defined benefit’ scheme, the government has done well to sidestep this demand. Under the earlier scheme, that applies to those employed before 2004, employees get a salary equal to half that drawn by a person of equivalent rank today; so, an employee who drew a pension of Rs 5,000 on retirement several decades ago could get several times that amount today since people of equivalent rank have seen a big jump in their salaries, and hence pensions. This scheme was, however, scrapped in favour of the ‘defined contribution’ one where employees get a pension based on what returns their contributions fetch under various investment plans available under the NPS; typically, NPS schemes offer around 9-10% returns per annum, though the returns can be even higher in some plans offered by fund managers under the NPS.

Under the earlier scheme, pensions skyrocketed, from Rs 32,690 crore in FY09 to Rs 168,460 crore in FY19, or an increase of 5.2 times versus 3.9 times for all salaries; as a result, the pension-to-salary bill for the government rose from 61% a decade ago to 81% in FY19. The government has done well to sidestep this demand and, instead, promise to raise its contribution to 14% of the employees’ salary from the present 10%.

The government has also made another big change, to ensure the NPS is on a par with other pension plans such as the EPFO. Till now, while 40% of the money you saved—and the return on it—had to compulsorily be invested in an annuity product, the balance could be encashed on retirement; while two-thirds of this was tax-free, taxes had to be paid on the remaining third (or on 20% of the final retirement corpus). Under what the Cabinet has now cleared, after the 40% annuity amount, all of the balance will be tax-free.

The government would do well to replace the 40% annuity clause since this puts NPS at a disadvantage. Right now, as compared to a 10% average return on NPS, annuities fetch just 6-7%. Take a person with a Rs 250 corpus on retirement—of this, Rs 100 will have to be invested in buying an annuity that will give a return of Rs 7 per year. But if a person keeps the same Rs 100 in the NPS fund and withdraws Rs 7 per year under a Systematic Withdrawal Plan, the corpus will rise to Rs 128.6 at the end of 15 years—assuming a 9% NPS return—while, under the annuity plan, the survivors of the person would just get Rs 50 or thereabouts. If this is done, the government’s plan of ensuring a retiree gets a pension is met, but instead of tying the pensioner to a low-return plan, she continues to get the higher return most NPS products offer if she so wishes.

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