The National Pension Scheme (NPS) subscribers at times frown at the idea of having to mandatorily purchase an annuity plan with 40 percent of the accumulated NPS corpus. They compare it with products like Employees’ Provident Fund (EPF) and Public provident Fund (PPF) that provide full liquidity and freedom to use the corpus as one pleases.
But is this rule of part annuitization of NPS corpus such a bad thing?
I think not. At least not for some people. Sometime back, in why NPS deserves more attention by retirement savers, I wrote why this actually might be a sort of blessings in disguise for many.
Also read | Interest rate cut U-turn: Should you continue with small savings schemes?
Before I explain why, here is a brief refresher of how NPS works at maturity.
For subscribers, it is mandatory to buy an annuity plan with at least 40 percent of the NPS corpus at the time of maturity. Though the remaining 60 percent can be withdrawn as a lump sum and is tax-free, subscribers can choose to increase the part of the corpus over and above the mandatory 40 percent that needs to be annuitized. When subscribers buy an annuity plan, they start getting a certain amount every month (like monthly pension) as a regular income after their retirement. And there are many types of annuity plans available for NPS subscribers like Annuity for life, Annuity for life with return of purchase price on death, Annuity payable for life with 100 percent annuity payable to the spouse on the death of the annuitant, Annuity for life with a provision for 100 percent of the annuity payable to the spouse on the death of the annuitant, with the return of purchase price on the death of the spouse, and so on.
Now let’s come back to why part-annuitization of NPS corpus not such a bad thing.
Not just to build a corpus; also a pension scheme
There is a sore pain point, as it curbs the freedom that retirees have. But we must remind ourselves that NPS is the only product that gives importance to putting in place a predictable income stream during retirement years. It’s not just a retirement accumulation product but also a pension product. So it does what it is intended to do with the 40 percent annuitization rule.
Keeps greedy bankers and seller away
Many retirees aren’t financially savvy to manage a large retirement corpus at the time of their retirements. At times being ill-advised by agents and their banks, these retirees tend to mishandle the large corpus that they get on retirement. They don’t have the financial knowledge or discipline to be able to generate a regular income from a large corpus during their remaining years. And this is one of the major reasons why NPS goes about making it mandatory for its subscribers to utilize a significant chunk of the NPS corpus to buy an annuity so that the retiree gets only a certain amount every month to spend. This in a way, helps secure the retirees financially.
So having a source of regular, guaranteed, life-long pension income can be a good thing for such people as it reduces the risk of running out of all the money during later decades. So in a way, it takes care of some of the longevity risks
But given the issues people have with annuitization of NPS corpus, there are few proposals in works where the PFRDA is looking for better alternatives to the current compulsory annuity rule. One of the options is to introduce a Systematic Withdrawal Plan (SWP). Another is to have sort of a variable annuity.
Yes, annuity is taxable, but so what?
Another problem that people often quote about NPS is about the taxability of the annuity pension income. It is true that it is taxed. But in general, it isn’t as taxing as it is made out to be by many.
Note that for most people, the taxable income during retirement is low. So, even if the annuity pension is taxed, chances are that the applicable tax rates will be very low or in many cases, nil. Suppose a person accumulates Rs 1 crore in NPS. He now uses Rs 40 lakh to buy annuity. Let’s say at 6%. This would result in an annual income of about Rs 2.4 lakh. And if there are no other income streams, then this is tax-free given the tax slabs.
So I think that if a retiree has a well-structured withdrawal strategy from NPS and other products suitable for retirement, then taxes can be managed reasonably well.
To summarize, I think that for many NPS subscribers, the idea of annuitization of the part corpus may not be such a bad thing after all.
But I must also say here that just NPS will not be enough for retirement
. It should always be a part of one’s overall retirement portfolio made up of other suitable retirement products as well.