Most people invest only Rs 50,000 per year in National Pension Scheme (NPS) for extra tax benefits. Some employers have an NPS-oriented policy and in such cases, their employees invest more in NPS.
And since a new financial year has just begun, let’s discuss a bit about NPS and the investment choices it offers.
Usefulness of NPS
NPS generally doesn’t get the respect it deserves. A few of its features make people avoid it. The compulsory annuitisation takes away flexibility as one is forced to put 40 percent corpus in low-yield annuity plans.
But then, for many, the same feature might actually be a blessing in disguise. NPS is the only product that gives importance to creating a predictable income stream for retirement years.
So from a retirement corpus diversification perspective and the fact that annuity ensures a lifelong pension for the investor, this (having an assured stream of income for life) might be good for many who are not disciplined enough to generate regular income from a large corpus. Read on.
Also read | Why NPS annuity is not such a bad idea
When investing in NPS, you have quite a few decisions to make. Such as:
· Choosing Active versus Auto mode
· Choosing allocation to schemes E (Equity), G (Government debt) C (corporate debt) and A (alternative investments), if going for the Active mode
· Choosing Pension Fund Manager (PFM)
Let’s focus on the first one, which is a major decision – choosing between the Active and the Auto mode of NPS portfolio management.
Also read | A step-by-step guide to opening an NPS account online
When you invest in NPS, it allows you to manage your investment in 2 ways:
· Active choice
· Auto choice
The Active option is for those who wish to manage NPS portfolio asset allocation actively. The Auto option, on the other hand, is for those who don’t want to get involved in portfolio decision-making. They need some advice or want to outsource investment management to pension fund managers.
Let’s have a look at these two options in detail now.
Also read | Explained: How NPS' active and auto allocation choices work
NPS Active choice
In Active choice, the NPS subscriber has the freedom to decide the allocation or ratio in which his NPS corpus is to be divided between various assets via schemes E, G and C. There are still some limits that have to be adhered to. You can have:
· Maximum 75 percent in scheme E, up to the age of 50. After 50, the upper limit of scheme E allocation starts reducing by 2.5 percent every year. So it goes to 72.5 percent at age 51, 70 percent at 52, 67.5 percent at 53 to finally 50 percent by the age of 60.
· You can have a maximum of 100 percent in scheme G and C if you want at all times. The upper cap of scheme E is explained in the first point.
NPS Auto choice
Under Auto choice, the subscribers need not take any asset allocation decisions. The investment allocation to various schemes is simply based on a pre-decided formula that the chosen life-cycle funds are based on. There are 3 Life Cycle Funds (LC) to choose from:
· Aggressive Life Cycle Fund (LC75) – Best for aggressive investors who want high equity exposure. The schedule for the upper cap on equity is as follows: equity component is 75 percent up to age 35. Post that, it tapers down gradually to 55 percent at 40, 35 percent at 45, 20 percent at 50 to finally 15 percent by the age of 55.
· Moderate Life Cycle Fund (LC50) – Best for investors who want medium equity exposure. The schedule for the upper cap on equity is as follows: equity component is 50 percent up to age 35. Post that, it tapers down gradually to 40 percent at 40, 30 percent at 45, 20 percent at 50 to finally 10 percent by the age of 55.
· Conservative Life Cycle Fund (LC25) – Best for conservative investors who want small equity exposure. The schedule for the upper cap on equity is as follows: equity component is 25 percent up to age 35. Post that, it tapers down gradually to 20 percent at 40, 15 percent at 45, 10 percent at 50 to finally 5 percent by the age of 55.
Under all the above-discussed lifecycle fund options in the Auto choice, the rebalancing happens once a year automatically on the date of birth of the subscriber.
Choosing between Active and Auto
The active choice is best for those who understand the nuances of equity and debt allocation and how it works over a timeline of several years. So if you have the necessary time and skill to actively switch/rebalance your NPS corpus regularly and in line with your risk tolerance and goal needs, then make the Active choice. But if you are unable to do any or all of these and want to outsource asset allocation decision-making, then go for Auto.
In any case, the asset allocation should be chosen (whether via Active or Auto route) in a manner that NPS fits into the overall retirement portfolio properly.