Despite its shortcomings, the National Pension System is a beautiful product. I know many won’t agree, but I think that NPS doesn’t get the respect it deserves. Although people are quite keen to use the extra Rs 50,000 NPS tax benefit, beyond that amount, people tend to avoid it. And the reason is that some of its features like illiquidity until a very late age (55-60 years), mandatory purchase of annuity and taxability of annuity income.
To be fair, the so-called primitive rule of mandatory annuitization to get a pension from the NPS corpus in retirement years is not a bad idea for many. If you are not convinced, then do read this.
No doubt NPS is a long-term commitment and takes decades to deliver. But it is still an excellent instrument that rightly focuses on putting in place a pension income for the retirement years.
Unlike the Old Pension Scheme, the NPS pension amount isn’t guaranteed and depends on your accumulated corpus. Even so, it’s a product that provides certainty of income post-retirement.
Before we see how to generate Rs 50,000 pension income per month, we need to understand the annuitisation rule of NPS.
Minimum 40% annuitization rule
As per the current rules, one cannot withdraw the entire NPS corpus at maturity. You have to use at least 40% of the corpus to purchase annuity, which will provide pension income after retirement.
The remaining 60% can be withdrawn tax-free but if one wants, one can even use more than 40% of the corpus (and up to full 100%) to purchase annuity.
Rs 50,000 monthly pension from NPS
If you want to get a monthly pension of Rs 50,000 from NPS, then we will have to back-calculate the corpus requirement based on the 40% annuity rule.
Annuities come in various flavors. But for simplicity and latest rates, an annuity rate of 6% can be assumed.
If you only use the mandatory 40% NPS corpus for purchasing annuity, then at annuity rate of 6%, you need a Rs 2.5 crore NPS corpus. Out of this, 40% or Rs 1 core will be used for purchasing annuity. This annuity (at 6%) will generate Rs 6 lakh yearly or Rs 50,000 monthly pension.
The above is when only 40% corpus is used for annuity purchase. You then also get Rs 1.5 crore (remaining 60%) as lumpsum tax-free withdrawal.
But if you are willing to use a higher percentage for annuity purchase and pension installation, then the required size of the NPS corpus changes:
· 40% for annuity purchase – NPS corpus required Rs 2.5 crore
· 60% for annuity purchase – NPS corpus required Rs 1.7 crore
· 80% for annuity purchase – NPS corpus required Rs 1.3 crore
· 100% for annuity purchase – NPS corpus required Rs 1.0 crore
The numbers will change for different annuity rates. We used 6% as an approximate for prevailing annuity rates for a 55-60-year-old retiree.
Also, the annuity income is taxable at a retiree’s tax slab rates. So to get a post-tax pension of Rs 50,000 monthly in hand, a slightly higher corpus is required.
Let’s now focus on how to reach a Rs 2.5 crore NPS corpus needed to get Rs 50,000 monthly income if 40% is to be used for annuity.
How to accumulate Rs 2.5 crore in NPS?
The answer varies for different starting ages:
· Starting at age 25, you need to invest Rs 7-9,000 monthly in NPS for the next 35 years (at 9-10% returns) and assuming 40% of the corpus is used for annuity purchase
· Starting at 35, Rs 19-23,000 monthly needs to be invested for the next 25 years
· Starting at 45, Rs 59-65,000 monthly need to be invested for the next 15 years
As is clear, if you start a bit early, then by investing a small amount every month in NPS you can build a huge corpus and get a solid pension.
But while a Rs 50,000 monthly pension might look good for today’s retiree, it will be grossly insufficient for those retiring in the next 20-30 years. Also, the annuity rate is around 5-6% today. But you cannot rely on it being that high in the future. So take the above discussion with a pinch of salt – knowing that doing this alone will not be enough.
You need to invest more, preferably in equity funds, in addition to your Employees’ Provident Fund and NPS to secure a proper retirement income.
Also, if you are someone considering early retirement, then NPS isn’t for you. That is because as per the rules, if you exit NPS before 60, 80% of your corpus (and not just 40%) will be used for annuity purchase! This restriction may not suit you then.
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