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Explained: How NPS' active and auto allocation choices work

Active choice is better suited for savvier investors, while others can choose the passive mode – auto choice - of investing.

May 20, 2022 / 07:41 AM IST

Despite the Employees’ Provident Fund Organisation (EPFO) slashing the interest payout rate from 8.5 percent to 8.1 percent for 2021-22, its secure returns continue to be a big draw for employees, especially risk-averse individuals.

For those with greater risk appetite and financial knowledge, however, the National Pension System (NPS) is emerging as an attractive retirement-saving avenue. As of April 2022, the subscriber base of NPS grew 22.76 percent year-on-year (YoY) to around 5.24 crore, while assets under management (AUM) rose over 25 percent to nearly Rs 7.39 trillion.

The increased adoption is thanks to higher equity allocation that can lead to potentially better returns over the long term, tax benefits and greater transparency in investment and returns disclosures. “Particularly after the tax on interest on EPF contribution of over Rs 2.5 lakh a year, NPS has become a better option. Higher equity allocation is a plus. Wherever possible, high-earners should look at renegotiating their basic salary structure with their HR. Those who contribute higher amounts voluntarily to EPF should consider redirecting the additional sums into NPS,” says Sudhir Kaushik, Co-founder and CEO, Taxspanner.com, a tax consultancy firm.

Also read: Why EPF is still a winner despite lowest interest rate in over four decades

Read on to understand the investment choices that NPS offers and how to select the one best suited for you.

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What are the various investment options available under NPS?

Under NPS, you can open two accounts – Tier-I, or retirement, account, and Tier-II, or investment account. You cannot open Tier-II account without Tier-I, the flagship account that offers tax sops to subscribers. In case of Tier-II, only government employees’ investments are eligible for deductions under Section 80C. Under both accounts, you can select either active or auto choice to invest your money. You can invest across equity, corporate debt, government securities and alternative assets through funds offered by the Pension Regulatory and Development Authority-approved pension fund managers.

Also read: NPS or EPF: Which is better for retirement planning?

How does the active choice work?

As the name suggests, you have the freedom to decide your asset allocation, subject to some restrictions. That is, your equity allocation cannot exceed 75 percent, and you cannot direct more than 5 percent towards alternative assets. The purpose is to keep a check on risks, as NPS is meant to be a vehicle for building your retirement kitty. You can, however, invest up to 100 percent in both corporate debt and government securities, as these are considered to be ‘safer’ avenues.

What are the benefits of opting for auto choice?

If you do not have the time or expertise to take a call on asset allocation, you can choose the auto mode. In this passive method of investing, the allocation across asset classes will be linked to your age in pre-agreed proportion through three lifecyle funds, with the equity portion decreasing as you grow older. The objective is to insulate your corpus against market volatility, so that you do not see a drastic dip in fund value closer to retirement. Auto choice does not allow investment in alternative assets.

Within this option, you can choose between aggressive, moderate and conservative lifecycle funds. So, if a 35-year-old subscriber were to choose the aggressive plan, the maximum allocation will be 75 percent. If the subscriber picks moderate or conservative schemes, equity exposure will be capped at 50 percent and 25 percent respectively. A 55-year-old who is closer to retirement will get an equity allocation of 15 percent, 10 percent and 5 percent under aggressive, moderate and conservative funds respectively.

Also read: A step-by-step guide to opening an NPS account online  

How should I choose between active and auto modes and also lifecycle funds?

Active choice is better suited for investors with greater risk-taking capacity who understand and closely monitor financial markets and can make changes to their portfolios based on market conditions. Auto choice allocation is linked to age, and apt for those who are not financially savvy or do not have the time to track market movements. “Auto choice has its advantages. NPS is a retirement product meant to create a safety net for you during your post-working years, so it is not easy to take right calls all the time. A pre-decided allocation strategy can help reduce risks. But if you are willing to take risks despite being in the older age-bracket, you can select the active choice,” says Pankaj Mathpal, Founder, Optima Money Managers.

You will have to follow a similar strategy while choosing from aggressive, moderate and conservative lifecycle funds. “Besides risk appetite, it also depends on your age, and thus, investment horizon. If you are 30 (and retirement is over 25 years away), you can choose the aggressive option where equity allocation can go up to 75 percent. Equity is meant for wealth creation over the long term. Those who are around 40 can choose the moderate plan, while subscribers closer to retirement can opt for the conservative lifecycle fund,” he says.

 
Preeti Kulkarni is a financial journalist with over 13 years of experience. Based in Mumbai, she covers the personal finance beat for Moneycontrol. She focusses primarily on insurance, banking, taxation and financial planning
first published: May 20, 2022 07:41 am
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