It is true that even during the early part of the last decade, people used to think and talk about retirement planning only in their early 50s. They had a number of reasons for that:
- The state of the Indian economy during most part of the 20th century
- The economy was predictable, stable, smooth, and without shocks
- The feeling that pension is only for government employees
- The lack of awareness on the need of pension and the planning for it
- The inaction of the financial sector in not creating a market for pension products
- The joint family system and the traditional Indian mentality of taking care of elders
The developments in the past 10 years changed the scenario drastically. The youth of this generation experienced the boom and the recession in the same decade. The roller-coaster ride experienced in the personal and professional fronts are still fresh in their memories. The advent of new generation private insurance companies has led to the introduction of a breed of new pension products. In the modern era, we could see the deterioration of the joint family system and the emergence of the nuclear family. These factors have led to some change in the popular approach too. Now, most people want to start planning for their retirement life in their early 30s or even earlier.
But the pity is most of them are getting lost in the numerous choices being offered by various pension providers. And many land up with very costly products, leading to depletion of their savings. Eventually, this leads to a shortfall in their targeted corpus when they retire. This necessitates a search to identify an ideal pension plan to take care of all requirements – cheaper, secure, stable, decent growth, and, last but not the least, tax concessions, which will make it more attractive. National Pension System (NPS) seems to be an ideal choice.
National Pension System
NPS is a social security initiative of the Government of India, which aims to provide financial cover to the individuals after their retirement. The government has set up the Pension Fund Regulatory and Development Authority (PFRDA) as an autonomous body to govern the NPS. The scheme is being widely promoted by the PFRDA so that people of all classes are benefited. The contributions made in NPS are invested into three classes of funds, namely Equity (E), Fixed Return Instruments (C), and Government Bonds (G). Individuals have the option to choose the allocation of funds. However, investment in equities is restricted to 50% of the contribution. While ensuring that individuals benefit from the equity market, the allocation to government and fixed return instruments ensure a balance in an underperforming stock market. NPS has features such as transparent investment norms, regular monitoring, and performance review of pension fund managers by NPS trust. An NPS account can be operated from anywhere in the country irrespective of employment and geography. The PFRDA recently launched a portal (eNPS) to enable online transactions. New accounts can be opened with Aadhaar or PAN card, contributions can be made, and fund performance and status can be tracked online.
Charges and fund management: NPS is perhaps the world’s lowest cost pension scheme and it is one of the key selling points of the scheme. Though the fund management fee which is currently fixed at 0.01% may go up, the maximum is capped at 0.10%. On an investment of Rs 1 lakh, the fund management fee is just Rs 10 a year (max 100 in future), compared to Rs 1,500-2,500 charged by mutual funds or Unit linked Insurance plans. This low fee structure will play a major role during accumulation, considering the long term nature of the product. Further, the minimum annual contribution has been kept at a low amount of Rs. 1000 per year, with no maximum limit. The fund is currently managed by notable Fund Managers like LIC, SBI, HDFC, ICICI, UTI, Reliance, Kotak etc. which promises optimization of funds to ensure better returns to the subscribers, which may not be possible for Individuals to achieve at a personal level.
Tax concessions: Contribution up to Rs 50,000 made toward an NPS account is eligible for an exclusive tax deduction under section 80 CCD (1B). Further, employees can invest 10% of their basic pay through their employers to get additional tax rebate under section 80 CCD (2). Thus, while saving for retirement, additional tax benefits are available which are not available for other pension plans.
Withdrawals: A subscriber of NPS for at least 10 years can conduct three partial withdrawals during his subscription period with a gap of at least five years between two withdrawals. The maximum withdrawal limit is set as 25% of self-contribution. The purpose of withdrawal can be children’s higher education or marriage, construction/purchase of house, and treatment of specific critical illness for self, spouse, children, or dependent parents. During retirement, up to 40% of the corpus built can be withdrawn as lump sum and is exempted from tax. Individuals have to mandatorily invest 40% of the fund to purchase pension annuity. The balance 20% can either be invested in annuity or withdrawn as lump sum.
Read more on what is an annuity and how does it work in my next blog - National Pension System: a trap or a gold mine?