NPS as a retirement tool has become attractive with low cost, flexibility & long term higher growth due to equity component. While NPS is highly recommended, one also has to see the age of entry & likely corpus accumulation to have a meaningful pension.
It is observed that employee provident fund and public provident fund contributions are very unlikely to be adequate to manage the post retirement corpus need. The National Pension System (NPS), a retirement plan, is a very good vehicle to save for the retirement corpus gap. The idea is simple. Contribute every year till your age of 60. You can then withdraw from the corpus but a minimum 40% of the corpus must be used for buying an annuity i.e. regular pension. What makes it interesting is that NPS allows an equity component of up to 50% of your contribution. For the rest, one can select government and/or corporate bonds. The equity component is extremely useful to leverage the compounding principle & build a significant corpus in the long term. The structure of NPS allows one to select from currently listed 7 fund managers. One can also select an active choice or auto choice for allocation between the three funds. The cost structure is very light with low account opening, contribution and maintenance charges. The NSDL website at this link has more details on the charges.
Many big companies have already facilitated the employer’s contribution to NPS. While the total financial benefits being given to the employee remain same from an employer perspective, the employee gets additional tax benefit on contributions up to 10% of the basic salary + dearness allowance. Additionally, the budget 2015 introduced a new section to contribute and get tax exemption on Rs. 50,000. This benefit comes under section 80CCD of the Income Tax Act and it is in addition to the extant benefits available under section 80C of the Income Tax Act. Given the tax breaks on contributions it makes lot of sense to focus on NPS for building one’s retirement corpus. The maturity taxation of NPS is an issue with the lump sum withdrawal getting taxed based on your nature of employment. The subsequent pension will also be taxed based on your income slab. It is very likely that government will bring all retirement instruments at par. Further, the growth in the equity component of the corpus may offset for the tax impact.
While NPS is strongly recommended, it may not be a good idea if one is already in 50s. For the power of compounding to work and for one to get a decently sized pension, the corpus may not grow adequately. Since NPS does not have any limit on the amount of contributions, one can still create a sizable corpus even at this age.
Since the NPS equity fund is passively managed, can one create a better outcome with diversified equity mutual funds? Now, The NPS equity fund managers are allowed to actively manage the incremental funds. It may be possible to build a bigger corpus in the long term with diversified equity mutual funds but given that the savings here are needed for critical goal of building retirement corpus, NPS is recommended being conservative, low cost and disciplined.
Since, the NPS includes equity fund, it is recommended to setup on-going ECS instructions for monthly contributions. Even conservative investors should consider maximum equity component in NPS given that the nature of saving is very long term.
Opening NPS account is no longer as painful as earlier. You can open it online with eNPS option on NSDL website at this link. There are few banks allowing the online NPS too. Intermediaries (PoP) can also be approached to open the NPS account. You can find more details on the PFRDA website.
Author is a SEBI Registered Investment Advisor and has founded www.gettingyourich.com. The Great Diwali Discount!
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First Published on Jan 15, 2016 10:49 am