India does not boast of any permanent Social Security Scheme unlike in developed countries. In May 2009, the GoI announced a new investment avenue for its citizens to plan for retirement in the form of New Pension Scheme (NPS) on a voluntary basis. On May 01, 2009, the launch of NPS paved the way for common people to secure their retirement and make their pension management easier. Till then, this pension scheme was available only to the central and state government employees. It is the single biggest initiative in pensions’ reforms story as it works on IT enabled infrastructure to extend social security cover to the citizens. The NPS Trust created by its regulator PFRDA (Pension Fund Regulatory and Development Authority) has been authorised to oversee and review the investment of the pension corpus.
What is unique about NPS over other Pension Schemes?
India didn’t have any forced pension scheme for its citizens unlike EPF (Employees Provident Fund) where employers deduct a certain portion from employees’ salary. The PPF (Public Provident Fund) also provide an additional opportunity to persons not employed; however, the investment tenure is for a maximum period of 15 years extendable by 5 years and the investible amount is also limited to Rs. 70,000 p.a. Also, the returns in these two pension schemes are fixed – EPF (9.5 percent) and PPF (8 per cent). Some insurance companies have Pension Schemes but they are costly and eat major of investors’ money.
NPS fills both the gaps. It is open for all citizens (aged between 18 years to 55 years) in India and it is categorized as one of the cheapest pension scheme in India – the lowest Fund Management Charges and Administrative charges in the market, with FMC capped at 0.0009 per cent and custodian charges in the range of 0.0075 per cent to 0.05 per cent. It also provides an opportunity to participate in equity which can let your corpus grow at higher rate. Currently, the NPS trust has appointed seven independent fund managers which manage the NPS corpus. You have the choice to select any of these fund managers based on their expertise, track record et al. In NPS, the individual invests a certain amount (minimum of Rs. 500 per month or Rs. 6,000 a year), no upper limit in a pension scheme till he retires.
What are the Options available?
Currently there are two options available under NPS – Tier I and Tier II. Under Tier I, the investible amount can be withdrawn only at the retirement period i.e. 60 years. On retirement, 60 per cent of the corpus can be withdrawn as lump sum and remaining 40 per cent has to be invested in an annuity from an insurance company to generate a regular income. Currently, the lump sum withdrawn amount is taxable in the hand of investors (EET – Exempt, Exempt, Tax) but with the force of DTC (Direct Tax Code), the corpus would be tax-free for investors (EEE – Exempt, Exempt, Exempt).
However, in Tier II option, one can withdraw his investible amount at any point of time. However, your contributions and savings will not enjoy any tax advantages.
In addition, NPS Lite caters to small investors i.e. low income earners and it works on a ‘group’ model. In budget 2010-11, the government also announced the “Swavalamban Scheme” for NPS Lite investors under which the government will contribute Rs. 1,000 to each NPS account. Currently, this benefit would be available for another three years.
NPS comparison with existing retirement saving plans
Currently there are seven Fund Managers who have been managing NPS corpuses. The Pension Fund Managers (PFM) manage 3 separate schemes, each investing in different asset classes. The table 1 describes the different available schemes of NPS Funds.
The investors can choose either of investment options – Active Choice (decided by individuals to invest in any class) and Auto Choice (predetermined asset allocation based on age of investors)
The table 2 shows the comparative performance of some existing NPS Funds and other retirement fund options. For period between May 01, 09 to April 06, 11, NPS Pension Funds have returned in the range of 9.29 per cent to 18.72 per cent in Class E category (it comprises exposures in Equity up to 50%), while Pension Funds by Mutual Fund – UTI Retirement Benefit Plan and Templeton India Pension Plan returned 14.43 per cent and 86.11 per cent respectively. These funds have 30 to 40 per cent exposures in equity.
On the other hand, pension schemes sponsored by the government – PPF and EPF have fixed returns i.e. 8 per cent and 9.5 per cent respectively; however, they differ from time to time. Both these schemes provide only lump sum withdrawal and chances remain high that after withdrawal, majority of the corpus might be squandered away due to lack of human behaviour.
NPS still not picking up
Despite being a low cost product, NPS has not found many takers. In India, people are not used to invest for a longer period if it is defined contribution as in EPF where the employer deducts a portion of your salary. The number of subscribers in NPS still counts in thousands.
The low cost determines the uniqueness of NPS. However, the low distribution cost (Rs. 20 per transaction along with one-time registration fee of Rs. 40) is the main deterrent which discourages brokers/distributors/agents in advising NPS. They contend that the amount hardly covers their sales costs. At some Point of Presence (PoPs) like Banks, the employees prefer to push their own pension products when asked for the NPS form. So, there is mis-selling even at the PoP level.
Moreover, the NPS is still costly product for entry level depositors. An investor depositing Rs. 500 per month, or Rs. 6,000 a year, will have to shell out Rs. 800 (considering transaction happens at RBI locations else additional Rs. 180 p.a. would be charged), or 13 per cent, as charges in the first year and Rs. 400 p.a. thereafter. The government claims that the charges would be reduced once the number of subscribers crosses 1 million. Refer the chart 1 for different expense ratio for different subscription amount in NPS.
Moreover, the current tax status i.e. EET (Exempt – Exempt – Tax) also acts as a dampener in comparison to other pension products i.e. the maturity proceeds would be taxed in the hand of investors. However, the new Direct Tax Code (DTC) to be implemented from FY 2012-13 has put it in EEE mode i.e. the maturity amount won’t be taxed at the hand of investors. The table 3 gives the current status of tax liability on on different pension products.
What should be done to make NPS acceptable among investors?
Though the government is not leaving any stone unturned in order to improve the spread of NPS, a lot still needs to be done. To start with, the PFRDA must tie with Online Brokers where there is minimum involvement of manual interference; also, the government must work into giving targets to PoPs and they should also incentivise the PoPs with bigger margins if they bring a certain number of subscribers. Also, the financial advertising and education would be important factors where the government can look into. Private employers should also encourage their employees to subscribe to the low-cost NPS.
At micro-levels, the government must also tie-up with NGOs, SHGs and other community centres in order to promote NPS Lite. In order to encourage the low-earning investors to subscribe to NPS, the government also introduced the “Swavalamban Scheme” for NPS Lite investors under which the government will contribute Rs. 1,000 to each NPS account for the next 3 years. The ongoing Aadhar-linked programme can also be a booster for NPS.
Is the NPS justified?
The future is undecided especially the retirement period. People must invest to protect its future at the minimal cost of investment expenses. Also, in the absence of any permanent social benefit plan in India and where a majority of the population depends on daily wages, the current NPS fits the wall. Moreover, the low cost of NPS describes its uniqueness, the lowest till date for an investor investing a particular limit. In a nutshell, the NPS gives the subscriber a portable account, simple choices (unlike complex investment products), nationwide access, and much needed pension coverage. So, the NPS experiment is worth the trouble taken.
