Secure your retirement- NPS

Pension regulations have been long awaited for the Indian populace. With the setting up of the PFRDA (Pension Fund Regulatory and Development Authority) and the New Pension Scheme, this has now become a reality. The major aim that NPS seeks to achieve is to bring people from the unorganised sector into the pension fold. Pension space in India has been dominated by employer-sponsored plans with contribution from the employee to a certain extent. In addition to the superannuation plans offered by employers, mutual funds and insurance companies also offer voluntary pension schemes. With the NPS, the government is able to offer flexible, growth-oriented scheme that has the potential to generate by far the best returns compared with the products that are available in the market today. The NPS the most effective tool to accumulate wealth for the life post retirement.

Why do you need NPS?

The conventional retirement options like the Employee Provident Fund (EPF) and the EPS (Employee Pension Scheme) give fixed returns but do not offer sufficient flexibility to the employees during their working and post-retirement years. In these schemes, the neither the subscriber nor the employee can choose how his or her money is invested. Also, the amount collected through all schemes administered by the Employees' Provident Fund Organisation including the two mentioned above may not be adequate for individuals' future. The major change that the NPS brings in is the shift from a defined benefit to a defined contribution regime for the government employees.

Structure

The unique option that the NPS gives to subscribers is a selection of fund managers with whom they wish to entrust their funds' management. Thus, this flexibility and a competitive environment would push the PFMs (pension fund managers) to work for better returns. The scheme currently has six pension fund managers:

*ICICI Prudential Pension Funds Management Company

*IDFC Pension Fund Management Company

*Kotak Mahindra Pension Fund

*Reliance Capital Pension Fund

*SBI Pension Funds Private

*UTI Retirement Solutions

Subscription types

To apply for the voluntary pension scheme, there are two types of accounts:

Non-Withdraw-able account: The tier 1 account is the basic NPS account that is non-withdrawable till retirement or in the case of death of the subscriber. In this type of account, the total corpus at the retirement age is split, whereby a minimum of 40 per cent of the final corpus has to be compulsorily used to buy an annuity while the subscriber is free to withdraw the remaining 60 per cent as a lump sum or in installments.

Withdraw-able Account: A tier 2 account is available to only those who are existing subscribers of the tier 1 account. The unique selling point of the tier 2 account is that money contributed into this account can be freely withdrawn as and when the subscriber wishes except for a minimum balance that needs to be maintained at the end of each financial year.

Investment options

In NPS, there are two types of fund management options available and the contributions can be invested in various ways. The investment decision should be guided by two factors -risk appetite and ability to actively manage money. This makes NPS flexible for the subscribers whereby they can customise returns.

Auto choice - lifecycle fund. Under this option, contributions made by the subscriber are pooled into a lifecycle fund and then invested as per pre-defined asset allocations that change over the life cycle of the subscriber. Up to 35 years of age of the investor, 50 per cent of the assets will be invested in equity index funds and the rest will be in debt instruments. As the person gets older, investment in equities will taper off by a certain percentage every year and get diverted to debt instruments. By the time the investor turns 55, his assets in equity instruments will be contained to 10 per cent and a major chunk (around 80 per cent) will be invested in government securities.

Active choice. Under this facility, investors have the right to choose the investment pattern as well as the pension fund manager. Investors are also allowed to revise their choices once every year in May.

Asset allocation class options:

Asset Class E. Growth option under the NPS that invests in equity (index funds). The cap for equity investment is 50% of the investment corpus.

Asset Class C. Medium-risk option with investments in fixed-income instruments but not necessarily in government securities.

Asset Class G. Low-risk option whereby investments are made only in government securities.

NPS - The cheaper option

Our calculations show that an investment of Rs 1 lakh per annum over the next 30 years yields the maximum returns if invested in NPS when compared with a unit-linked pension plan or pension plan offered by a mutual fund company. This is considering that all three options give similar returns at the rate of 10 per cent per annum. For the sake of this projection, we have considered funds that would match the asset allocation pattern followed by the aggressive portfolio under NPS.

NPS has the lowest set of charges and therefore delivers the highest returns. The table (Your retirement kitty) shows how the progression of the invested amount happens over 30 years. From the initial period, wealth under the new pension scheme grows faster and owing to the low charges levied, the difference between NPS and other products is almost to the tune of Rs 50 lakh towards the end of the 30-year period. For retail investors looking to invest around Rs 1,000 or so monthly, NPS is clearly a better option because it comes with low charges and flexible fund management options. Due to higher charges levied in ulip-based pension plans during the initial years, the difference in the corpus at the end of the tenure is also substantial. In case of maximum allowable lump sum to a pensioner, the mutual fund pension plan would pay out less in comparison to insurance-based plans as they have the advantage of tax-free lump sum. The mutual fund pension plan is taxed at the rate of 20 per cent (without indexation) and 10 per cent (with indexation).

Taxation

NPS allows subscribers to grow their retirement corpus in the most cost effective way possible. However, NPS is taxed under the EET (Exempt-Exempt-Tax) regime. This means that the investment gets tax exemption and so do the returns on investment. However, all withdrawals are taxed under the applicable tax slabs and so is the annuity interest. Even under the current scenario, i.e. the EET regime, NPS competes on an even field with other instruments. With ULIP based schemes there is the advantage that the withdrawn lump sum is tax-free. Even taking into account this loss of money to tax, NPS returns are higher.

When the Direct Tax Code is introduced it would be interesting to see how it changes the game for the NPS. It could well make or break the market for NPS.

Challenges

The major challenge for the NPS remains its distribution. When the NPS was opened for the unorganised sector, it was expected to be profitable to its fund managers by cornering high volumes of subscribers. However, with not so many distributors and barely 4,000 odd subscribers, in the voluntary (non-government) sector, it has been a major disappointment.

The largest pie of investments in this space is cornered by unit-linked retirement plans offered by insurance companies. Comparing insurance based retirement solutions to NPS shows one major point where the NPS scores. The NPS is a savings and retirement security product and as such, it does not burn a hole in the pockets of the subscribers by the charges it levies. ULIP based pension schemes, on the other hand, are in between, they are inefficient routes for buying insurance and as investment. The investment corpus in ULIP based pension schemes takes a major hit especially in the early years with high charges of around 10 per cent in the first five years. There are and have been ULIP based plans with low charges but distributors have not actively promoted them because of lower commissions.

Conclusion

NPS is a safe and effective post-retirement tool. With its lowest charges, it also is the cheapest way to get an exposure to the market. For thousands and lakhs of employees in the unorganised sector, who have negligible or no postretirement social security benefits, NPS is a boon and greater awareness and marketing will not only increase NPS accounts but also make them available to this immense market, this new and yet ignored tool called the NPS.

Source: http://in.biz.yahoo.com/100524/50/bavngz.html