Flavour of The Month
ICICIdirect Money Manager - April 2015

Investing into NPS

The union budget 2015 has announced a slew of measures w.r.t. to National Pension System (NPS). First, it has allowed an extra tax deduction of Rs. 50,000 for contribution made towards NPS, under Section 80CCD (1B), which is over and above the deduction available under section 80C. Second, it has increased the limit of contribution to pension plans, including NPS, from Rs.1 lakh to Rs.1.50 lakh under section 80CCE(1). This comes to a total of Rs.2 lakh deduction available for NPS. Further, the budget has also given employees the option to choose between EPF (Employees’ Provident Fund) and NPS. These changes in the budget have put NPS into limelight. We have also been receiving queries from our readers asking about its details and the impact. Here we take you through the fine details of NPS and also try to evaluate NPS as a product as compared to other retirement products in the market. Read on.

A bird’s eye view

Launched in 2004, NPS is a defined-contribution based pension product by the government of India. It was first introduced for new government employees, but from 2009 it got extended to all citizens including the unorganized sector, on voluntary basis.
Any citizen, whether resident or non-resident, who is in the age bracket of 18-60 years, can subscribe to NPS. The subscriber gets allotted a unique Permanent Retirement Account Number (PRAN), which remains same throughout the life and can be accessed from anywhere.


NPS has two accounts: Tier-I and Tier II. The Tier-I account is a mandatory, non-withdrawable account, meant for retirement savings. The contributions to Tier-I account only are eligible for tax deduction.


The Tier-II account is a withdrawable account, simply like a voluntary savings facility. It can be opened only when there is an active Tier-I account in your name. You can withdraw any number of times from Tier-II account, provided you maintain the minimum balance of Rs. 2,000 at the end of financial year.


The minimum contribution for Tier-I account is Rs. 500 while for Tier-II account it is Rs. 250. There is no upper cap on the amount of contribution for both the accounts - you can invest any amount.  Here’s a quick snapshot of minimum contribution requirements for both Tier-I and Tier-II accounts:

 


Particulars

Tier-I

Tier-II

Minimum contribution at the time of account opening

Rs. 500

Rs. 1,000

Minimum amount per contribution

Rs. 500

Rs. 250

Minimum total contribution in the year

Rs. 6,000

Rs. 2,000

Minimum frequency of contributions

1 per year

1 per year

Maximum amount of contribution

No limit

No limit

In case you miss to contribute the minimum required amount (except for the year in which account was opened), the account gets frozen. It can however be re-activated by bringing in the un-contributed amount and a penalty of 100 per year.


Two things that make NPS a real pension product are: 1) Restrictions on withdrawal from Tier-I account; 2) A part of the corpus has to be annuitised.


Tier-I Withdrawal Options

Before 60 years

Between 60 to 70 years

Upon demise

Only 20% of the accumulated corpus can be withdrawn as lump sum, rest 80% has to be annuitized / purchasing an annuity from any IRDA-regulated life insurance company

Can withdraw up to 60%, rest 40% has to be annuitized

Any amount lying to the credit at the age of 70 should be compulsorily withdrawn in lump sum

In case of demise of the subscriber, the nominee can withdraw 100% of the corpus


NPS is a long-term product; your savings get accumulated till the age of 60. It discourages early withdrawals, which is crucial for building the retirement corpus.


Your contributions under NPS get invested across three asset classes: E: Equity, C: Corporate bonds or fixed-income securities other than government securities, and G: Government securities. You are free to decide your asset allocation among E, C and G (known as Active Choice). However, the exposure to equity asset class cannot exceed 50%.


Remember, your asset allocation is one of the most important factors that will determine the growth of your corpus. For instance, the asset class E has higher potential returns than the asset class G, but it also carries high risk. On the other hand, investing entirely in G may not give higher return but is a safer option. When you are young, have got a longer investment horizon, you should invest more into equity.


On the other hand, if you are unable to decide on the asset allocation on your own, there is an Auto Choice (Lifecycle Fund) available. Here, the discretion of asset allocation pattern rests with the pension fund manager based on your age. Up to 35 years, 50% is allocated towards E (equity), 30% in C (corporate bonds), and 20% in G (government securities). From the age of 36 years onwards, allocation to asset classes E and C decreases annually (by 2% and 1% respectively) and the weight in G asset class increases annually (by 3%), till it reaches 10% in E, 10% in C and 80% in G asset class at age 55. This ensures stability to your portfolio as you near the retirement age.


You can either opt for an Active Choice or an Auto Choice.  NPS also allows you to choose the pension fund manager (PFM) of your choice. Currently, there are seven PFMs:  HDFC Pension Management, ICICI Prudential Pension, Kotak Mahindra Pension, LIC Pension Fund, Reliance Capital Pension, SBI Pension Funds and UTI Retirement Solutions. You can also change the investment option from Active to Auto and vice a versa and PFM, once in a financial year.


When it comes to cost, NPS is perhaps the world’s lowest cost pension scheme. It has an investment management charge of 0.0009% p.a. on net assets under management, much lower than mutual funds and unit-linked insurance plans which charge anywhere between 1.50%-2.50% p.a. To add to its benefits, you can also invest in NPS online and maintain e-records - All transactions can be tracked online through Central Record-Keeping Agency (CRA) system.


Apart from the above listed benefits, NPS also has the potential to help you earn double-digit returns as against pure debt instruments such as Employees’ Provident Fund (EPF) and Public Provident Fund (PPF). For instance, Scheme E of NPS has given the returns up to 35% since inception. While Schemes C and G have returned up to 14% since inception. (see the table below).


Scheme-wise returns generated by NPS

Returns as on Feb. 27, 2015; returns for more than 1 year are annualized; NA: Not applicable; Source: NSDL


Such high returns are generally not possible in case of EPF and PPF as these do not invest into Equity.


Tax aspects


NPS in its current form is under the Exempt-Exempt-Tax (EET) regime, which means the contributions and earning are exempt but withdrawals from the scheme are taxable (both lump sum and annuities).


Contributions up to Rs.2 lakh are exempted from tax, as per the current tax laws: 1) Rs. 1.50 lakh under section 80CCE(1) (earlier it was Rs. 1 lakh only). 2) Rs.50,000 additional deduction has been allowed under section 80CCD (1B).


With this, a contribution of Rs.2 lakh would result into a tax saving of Rs.20,600, Rs.41,200 and Rs.61,800 for individuals in 10.3%, 20.6% and 30.9% tax brackets, respectively.


On the other hand, if you are investing only Rs.50,000 for getting the additional tax benefit under section 80CCD (1B), it will help you save Rs. 5,150, Rs.10,300 and Rs.15,450 for the tax brackets 10.3%, 20.6% and 30.9%, respectively.


Tax savings if you are investing Rs. 2 lakh a year to get full benefit


Tax bracket

10.3%

20.6%

30.9%

Tax savings

Rs. 5,150

Rs. 10,300

Rs. 15,450


Tax savings if you are investing Rs. 50,000 for getting only the additional benefit


Tax bracket

10.3%

20.6%

30.9%

Tax savings

Rs. 20,600

Rs. 41,200

Rs. 61,800


“Simple, standardized product, low expense ratio and additional tax deduction make NPS an attractive investment vehicle for retirement planning,” says Rahul Bhagat, Vice President - Group North, ICICI Prudential Life Insurance Co Ltd.

“NPS should be chosen as an investment vehicle with a clear objective of building a pension corpus. The investor should not confuse investing in NPS as any other investment vehicle for e.g. fixed deposits, mutual funds etc., which can be used to invest for a short-term and having liquidity in mind,” he adds.


The budget has also given employees the option to choose between EPF and NPS. Which one should you choose? Here we list the key differences:


EPF

NPS

Available only for salaried individuals

Available for all

Portfolio largely dominated by government securities

NPS offers the flexibility to allocate funds between equities, corporate bonds and government securities

Interest rate is pre-determined. Generally in single digit (has ranged between 8.25% and 9.5% in the last four years)

Potential to earn double-digit returns due to its exposure to equity (though capped at 50%).

Premature withdrawal available for certain occasions

NPS has withdrawal restrictions

No regular income in the form of annuity

Ensures assured annuity income in old age

Tax deduction available up to Rs. 1.5 lakh under section 80C

A total of Rs. 2 lakh deduction available

Has Exempt-Exempt-Exempt tax regime (proceeds are taxable only when the amount is withdrawn before completing 5 years of continuous service)

Exempt-Exempt-Tax regime applicable 

Rahul Bhagat of ICICI Prudential Life Insurance says, “We welcome the proposed move (option to choose between EPF and NPS), as it allows employees to choose what is most appropriate for their own requirements. Once the EPF Act is amended as announced in the budget, the employees may choose between EPF and NPS.”


“The key differences in the two schemes affecting returns are asset allocation, risk profile and taxation. While NPS allows the employee to choose asset allocation based either on their own risk appetite or life stage, EPF has a standardized asset allocation throughout working life. The tax treatment of the two schemes is also very different. However, this may not be a concern for most employees who expect lower income and therefore lower tax rates in post-retirement years. The rules regarding withdrawal are also significantly different. NPS aims at ensuring a sustainable pension throughout life of the subscriber while allowing for some amount of lump sum withdrawal. EPF provides a lump sum at maturity and does not offer lifelong income. The choice should therefore consider employee’s cash-flow requirements as well as their risk appetite,” he adds.


Sachin Jain, Research Analyst, ICICI Securities says, “We believe, from retirement planning perspective, NPS is a better investment option than EPF. Flexibility to decide allocation and fund manager coupled with withdrawal restrictions ensures higher potential returns and guaranteed income in old age. Investors should incrementally prefer NPS over EPF, and may even consider shifting their accumulated corpus in EPF to NPS.”


NPS vs PPF


PPF

NPS

Open to all, except NRIs

Open to all, including NRIs

Can be opened in the name of minor

Available only from 18 years to 60 years

Minimum contribution Rs. 500 annually

Minimum contribution of Rs. 6,000 annually

Maximum contribution Rs. 1.50 lakh annually

No limit

Original duration is 15 years. Thereafter the same can be extended for one or more blocks of 5 years each

Can invest up to 60 years of age

Tax deduction available up to Rs. 1.50 lakh

Tax deduction available up to Rs. 2 lakh

Has EEE tax regime

Has EET tax regime

Provides safe but low returns (generally single-digit)

Has the potential to earn double-digit return. The average weighted return on the NPS corpus is over 12.50% ( investment comprises of mix of debt and equity)

A pure debt instrument

NPS gives choice of asset allocation to the investor. NPS has 3 fund options i.e. Equity, corporate bond and government securities

There is a lock-in period of 15 years and money can be withdrawn in whole after maturity period

Withdrawal option are available at the age of 60 or in some cases like critical illness, building or buying a house etc.


If you are genuinely looking to build a pension corpus, keeping the tax angle aside, NPS looks better than PPF, as it is structured in such a way that it provides you lump sum as well as regular income for your post-retirement needs.
Say for example, if you invest Rs. 15,000 per month into NPS for the next 30 years, you will be able to create a total pension wealth of Rs. 5.24 crore (at 12% p.a. return), from which you can withdraw Rs. 3.14 crore on maturity (60%) and get a pension of Rs. 1.22 lakh per month (See the table below):


Source: NPS Trust - Pension Calculator


Check out the calculator at: http://www.npstrust.org.in/PENSIONCALC/Index.html
On the other hand, if you are investing Rs. 15,000 per month into PPF, you will be able to accumulate only Rs. 2.33 crore (at 8.50% p.a. interest).  Apart from EPF and PPF, NPS also scores over mutual funds and unit-linked insurance plans on cost front. Though, no doubt, equity mutual funds score over NPS from return perspective.


Summing Up


Ideally, a good retirement plan should have a mix of various assets. Different options suit at various life stages based on our risk appetite and financial situation. When you are young and have limited responsibilities, you should invest more into equity and equity-related investments for growth into your portfolio. As you grow older, you should taper down the equity exposure and move towards relatively safer options such as debt.


Basically, NPS should form a small portion of one’s retirement portfolio given its low-cost and flexibility benefits. One may invest around 25%-30% of retirement portfolio into it.


You can invest online into NPS on www.icicidirect.com.