People have strong feelings about the National Pension System (NPS).
Some invest in it diligently every year for the extra (and exclusive to NPS) tax deduction of Rs 50,000. Others feel that it is too restrictive (due to the mandatory annuitization), and is best avoided.
But as an investment advisor, I have found that NPS as a retirement savings product can suit a small set of investors if not for everyone.
How NPS works
Before we discuss whether NPS is good for your retirement planning, here is a small refresher on NPS rules:
- Once you enrol, you need to make contributions until retirement (till age 60).
- And NPS is a defined contribution plan and not a defined-benefit program like PPF, etc., where you invest at a pre-determined interest rate. Your returns depend on the NPS portfolio asset allocation and what returns these underlying assets deliver.
- On maturity, you can only withdraw up to 60 per cent of the NPS corpus as a lump-sum (tax-free). The remaining 40 per cent has to be compulsorily annuitized; i.e., you buy an annuity for 40 per cent of the NPS corpus and that annuity gives pension for the rest of your life. If NPS exit happens before 60, you have to compulsorily annuitize 80 per cent of accumulated corpus. Only the remaining 20 per cent can be withdrawn as a tax-free lump-sum.
- The pension income you get in retirement is taxable! So NPS isn’t a pure EEE (Exempt-Exempt-Exempt) product like the EPF and PPF, but something in between EET and full-EEE as the pension gets taxed after maturity. If the eventual pension is taxed, what is the point in offering tax deduction now, many ask. But even this deferred taxation can be managed with a proper withdrawal strategy as, for most people, NPS won’t be the only source of retirement savings and many won’t have very large pension incomes from the NPS.
So, no doubt, the NPS maturity rules are pretty restrictive.
But to be fair, this type of illiquid saving, which cannot be withdrawn until retirement, ensures that people don’t dip into their retirement corpus for other goals. It’s a blessing in disguise that discourages subscribers from withdrawing too soon.
Also, NPS is the only retirement-focused product that tries to put in place a real source of reliable pension during retirement years. And to be fair, this is good for those who would find it hard to generate regular income from their retirement kitty.
Of course the sophisticated and DIY (do-it-yourself) investors would feel that they can do it on their own. But for most people, it is good to have some level of monthly fixed income in retirement products and, of course, have lump sums coming from EPF, PPF, Equity Funds, etc. Remember that most other products allow only full lump-sum payout at maturity. And we all know that people tend to spend money recklessly when they receive large amounts. So, NPS annuity can be a good option for them.
NPS is a hybrid product that puts restrictions on the money you can invest in high-return-potential equity. And the restriction gets tighter with advancing age. So, for those who are comfortable with volatilities of equity investing and are willing to tolerate risks to earn higher returns, NPS may not be a good option. For them, taking the equity funds route is better as it offers potentially higher returns (with higher risks) and a lot of flexibility to get in and out of funds and rebalance occasionally.
Many other arguments that can be discussed for having a higher equity retirement portfolio.
Using the product for your retirement
Different people will require different strategies. For some, it can be the core, while for others it might not even be relevant.
But here are few general thoughts.
Don’t just invest in NPS for the Rs 50,000 tax benefit. And saving just Rs 50,000 per year in NPS will not be enough for your retirement.
If you are young (in your 30s or 40s), you can and should be fairly aggressive. So invest more in pure equity funds. And assuming you are already contributing to EPF, your NPS can have a high-equity bias as well initially.
If you are older, but have a significant corpus in debt, then you too can benefit from the NPS Aggressive Choice.
And for those who are investing heavily in equity (irrespective of age) and don’t have much in provident funds, taking a conservative approach in the NPS portfolio would work better.
Generally speaking and assuming you are going ahead with NPS, it should only be a part of one’s overall retirement portfolio.
I am sure having pure debt options such as EPF, VPF and PPF, and pure equity options such as SIPs in equity funds, are more than sufficient for the core of the portfolio. NPS can be a good add-on for generating a pension income in your later years.(The writer is the founder of StableInvestor.com)