NPS-Pension-Retirement

The National Pension Scheme (NPS) was introduced as a potential replacement of the Old Pension Scheme (OPS) from 2004. Hence NPS is also colloquially termed as New Pension Scheme. Apart from mandatory contributions to the NPS for government employees, even private sector employees and self-employed professionals can invest in the NPS. 

 

Advantages:

  • Tax Saving: Up to 10% of basic pay put in NPS is tax-free, but within the ceiling of Rs. 1.5 Lakh/ year under section 80C. Additional exemption of Rs. 50,000 per year, over and above the 1.5 Lakh ceiling. 

  • Low expense ratios: Compared to mutual funds, NPS has much lower expense ratios in the range of 0.15% to 0.21%

  • Choice of asset classes: Equity (E); Government Bonds (G); Corporate Bonds (C); Alternative Investment Funds (AIFs) like REITs and INVITs (A)

  • Rebalancing between asset classes: (1) Auto-choice – to automatically rebalance based on age and preset limits; (2) Active choice – to manually specify % allocation to each asset class within allowed limits

  • Compared to many endowment-type life insurance policies (ULIPs) which give about 5% returns (lower than inflation!), investing in the NPS is a much better option. 


Disadvantages:

  • Mandatory lock-in until age 60: As this is designed to be a retirement product, no withdrawal is allowed until you reach an age of 60. Conditions apply – see below.

  • Mandatory annuities for 40% of the corpus: Even at the age of 60, you can only take out 60% of the corpus to manage on your own. 40% has to be mandatorily invested in an annuity through one of the specified providers and at the rate offered at that time. 

  • While the 60% corpus withdrawal is tax-free, the monthly income from the annuity from the balance 40% is taxable at slab rate for the rest of your life, unlike EPF, VPF or PPF, which are EEE. 

  • You can pre-maturely exit and withdraw from the NPS before the age of 60, but you would then be able to withdraw only 20% of the corpus and the balance 80% has to be mandatorily deployed into an annuity.

  • Even if you don’t work until 60 and retire earlier, or have an emergency expense, you will not be able to dip into the NPS bucket easily. Even EPF has more relaxed rules for withdrawal under certain life conditions. 


Should you invest in the NPS?

  • Most people invest in the NPS to save a tax of up to Rs. 15,600 per year (at the 30% tax slab) by investing Rs. 50,000 every year over and above the 80C tax limit. 

  • If you are investing only this amount in the NPS exclusively to save tax, that would be woefully insufficient for your retirement needs. 

  • You can however use NPS for ALL your retirement needs, but you should be investing a lot more than the tax saving limit – typically up to 30-50% of your gross salary. The tax saving would then be only incidental, not your main goal. 

  • The advantage of such an option is using a very simple mechanism to lock away your savings in a retirement fund without the temptation to withdraw and spend for other life desires. 

  • It is also a very simple way to benefit from the principles of asset allocation and rebalancing by choosing auto-choice even if you don’t understand how all of this works.  


What’s the downside of investing in NPS for all my retirement needs?

  • The major downside is lack of liquidity – Most people don’t just need to save and invest for retirement, but also for other goals such as children’s higher education and wedding expenses, but you will not be able to withdraw for such goals. 

  • Also if you end up having a medical emergency and need to stop working earlier than age 60, then you need to mandatorily convert 80% of the corpus into an annuity – and this may or may not be sufficient for your needs

  • The other problem with annuities is that – if you choose an option of fixed monthly income for life, this amount will not grow with inflation, whereas your expenses over the next 20-30-40 years will grow exponentially with inflation.

  • There are a few annuity options that do allow you to increase the monthly income by 3% every year, but this could be insufficient when inflation is growing at 6-8% per year. 


Is there a better option?

  • While the NPS offers simplicity, cheaper expense ratios, and ease of management, sometimes it is far better to manage your own investments if you understand the basics of asset allocation and rebalancing. 

  • You can alternatively invest in a mix of equity and debt mutual funds, after calculating how much you need to invest to meet your life goals – retirement, children’s higher education or wedding expenses, choose an asset allocation suitable for your risk appetite, and rebalance once a year.

  • You can withdraw the amount required for each year’s expenses, adjusted for inflation every year – and leave the rest of the corpus to grow, without having to lock any part of it with annuities. This gives your corpus a higher chance of growth.

  • This would allow you complete flexibility and full liquidity to manage your investments at your fingertips and can come in handy even during unexpected emergencies in life that cannot be planned for.  


TL;DR: What to do if I don’t understand any of this?

  • You can outsource all of this to a trusted professional who can guide you through all the steps from opening an investment account, to helping you calculate how much you need to invest for your goals and choosing an optimal set of funds to help meet your goals. 

  • You will still retain the flexibility and liquidity with no lock-in constraints, but with the added hand-holding of a knowledgeable expert.

Leave a Reply

Your email address will not be published. Required fields are marked *