National Pension Scheme

  

When you think of a retirement, you go through a mixed feeling.

Sometimes, you feel excited about not having to go to the office, taking frequent vacations, spending all the time with your grandchildren and family members, lazying around on a beach resort, catching up with friends and living the life you once dreamt of.

 However, when a thought of helplessness or uncertainties passes through your mind, you are taken aback.

Post-retirement, not only your regular income stops or reduces but you also become ineligible for all kinds of loans except reverse mortgages.

Hence, NATIONAL PENSION SCHEME (NPS) is one of the highly recommended options you can look at for creating a retirement corpus in a disciplined manner.

 

 

WHAT IS NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) is a voluntary retirement scheme promoted by the government of India to help every Indian secure their retirement financially.

It was originally launched on January 1, 2004, for government employees only however, from May 1, 2009, onwards it was made open for the general public.

NATIONAL PENSION SCHEME (NPS) is regulated by the “Pension Fund Regulatory and Development Authority” (PFRDA).

 

 

WHAT ARE THE TYPES ON NATIONAL PENSION SCHEME (NPS) ACCOUNTS?

There are 2 types of NATIONAL PENSION SCHEME (NPS) accounts.

1. Tier-1 – It is a primary account that offers tax benefits and involves certain restrictions. To ensure, that the maturity proceeds are utilized only what it is meant for, the investors cannot make withdrawals until they reach the age of 60.

 

2. Tier-2 – To encourage the additional retirement savings, the Tier-2 account is introduced which is a secondary account that can be opened by making a separate application.

However, it does not offer and does not involve any restrictions or lock-in either and the investor is free to withdraw funds that they have invested in this account as and when required.

However, it should be noted, that the Tier-1 account is mandatory to open a Tier-2 account.

 

 

IMPORTANT POINTS TO NOTE ABOUT NATIONAL PENSION SCHEME (NPS)

The following are some of the important features of the NATIONAL PENSION SCHEME (NPS) that every investor must know.

1. Investor’s profile – It is best suited to investors who lack financial discipline and want to create a retirement corpus. The funds are locked until the investors turn 60 years old. It is not advisable for short term investing.

 

2. Risk – NATIONAL PENSION SCHEME (NPS) is moderately risky as all its assets are invested across debt and equity-oriented products. Due to the presence of equity components, its returns in the long term are comparatively better than pure debt instruments and it may generate inflation-adjusted returns.

 

3. Liquidity – Investment in Tier – 1 of NATIONAL PENSION SCHEME (NPS) account is locked until the investors reach the age of 60. Hence, investors with short liquidity needs should avoid investing in this avenue.

However, funds can be withdrawn anytime from a Tier – 2 account.

 

4. Taxation – NATIONAL PENSION SCHEME (NPS) is highly tax-efficient as the amount invested up to Rs. 1,50,000/- is eligible for tax deduction under section 80 CCD(1) which comes under section 80C.

Also, the entire maturity proceeds now are tax-free.

 

5. Volatile – Returns from NATIONAL PENSION SCHEME (NPS) are market-linked which makes them volatile. However, being a combination of debt and equity components, it involves higher volatility than pure debt-oriented products and safer as compared to equities.

 

6. Time horizon – Investment in Tier – 1 of NATIONAL PENSION SCHEME (NPS) account is locked until the investors turn 60 years old. Hence, this option is only meant for creating a retirement corpus.

 

7. Regular Income – NATIONAL PENSION SCHEME (NPS) does not provide any regular income as the returns earned get accrued and paid with the principal on maturity.

 

8. Returns – Investors can expect an average returns approximately in the range of 6% to 13% per annum.

 

9. Asset class – It is a hybrid product that is a mix of debt and equity.

 

10. Cost – NATIONAL PENSION SCHEME (NPS) involves the minimum cost of investment.

 

11. Loan facility – NATIONAL PENSION SCHEME (NPS) does not offer any loan facility.

 

 

WHAT ARE THE SCHEDULE OF CHARGES INVOLVED WHILE INVESTING IN NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) is known to be a very cost-efficient product. Some of the most common charges as stated below:

• Registration charges – Rs. 200/-
• Account opening charges – Rs. 40/-
• Account maintenance charges – Rs. 60/- to Rs. 90/- annually
• Transaction charges – Rs. 3.75/- per transaction
• Pension fund manager charge – 0.01% of assets managed
• Custodian asset servicing charge – 0.0032%

 

 

WHO CAN INVEST IN NATIONAL PENSION SCHEME (NPS)?

Any Indian citizen between 18 and 60 years can invest in NPS. NRI can also invest as long as there is no change in their citizenship status.

 

 

MINIMUM AND MAXIMUM INVESTMENT

The minimum contribution required to open a Tier-1 account is Rs. 500/- whereas for the Tier-2 account, the minimum contribution is Rs. 1,000/-.

Subsequently, the annual contribution of at least Rs. 500/- is required to be made towards the Tier-1 account and Rs. 250/- towards the Tier-2 account.

 

 

WHERE DOES NATIONAL PENSION SCHEME (NPS) INVEST YOUR MONEY?

Returns from investment made under NPS are market-linked and divided across 4 different categories:

1. Equities (E) – where the assets are primarily invested in equity markets.

Currently, NPS has a cap of 75% on equity exposure. For government employees, it is 50%. In the range prescribed, the equity portion will reduce by 2.5% each year beginning from the year in which the investor turns 50 years old.

However, for a 60 years old investor and above, the cap is fixed at 50%. This stabilizes the risk-return equation in the interest of investors, which means the corpus is somewhat safe from the equity market volatility.

 

2. Corporate Bonds (C) – where the assets are primarily invested in bonds issued by Public Sector Undertakings (PSUs), Public Financial Institutions (PFIs), Infrastructure Companies and Money Market Instruments.

 

3. Government Securities (G) – where the assets are primarily invested in Securities issued by Central Government, State Governments and Money Market Instruments.

 

4. Alternative Investment Funds (A) – where the assets are invested in other avenues like CMBS, REITS, AIFs, InVITs etc.

The schemes are managed by 7 different “Pension Fund Companies” and they are the ones who actively manage the above four categories of asset classes and run the show.

These “Pension Fund Companies” are regulated by PFRDA.

The investors are given the choice to either make a selection of asset allocation themselves (Active) or let pension fund companies place bets for them (Auto).

If they decide to choose asset allocation themselves, then they can choose how much money will be invested in each asset class. Otherwise, the allocation is decided by “Pension Fund Companies” based on the investor’s age.

Also, NPS gives its investors the choice to choose the fund manager too and replace them if they are not happy with the performance.

Both the options, “Active” and “Auto” have their pros and cons and the investor can choose to switch between the two options (Active or Auto) however, only once in a financial year.

The 7 “Pension Fund Companies” are as follows:

1. SBI Pension Funds Private Limited.
2. UTI Retirement Solutions Limited.
3. LIC Pension Fund Limited.
4. Kotak Mahindra Pension Fund Limited
5. HDFC Pension Management Company Limited
6. ICICI Prudential Pension Funds Management Limited
7. Birla Sun Life Pension Fund Manager

 

 

HISTORICAL DATA OF RETURNS IT GENERATED

 

 

ACCESSIBILITY OF FUNDS AND LOCK-IN, IF ANY

The money invested in NPS is locked until the investor turns 60. However, if the investor has invested for up to 3 years, then partial withdrawal up to 25% with no tax implication is possible, but in special conditions as specified below:

• If the funds are required for the medical treatment of an investor or his family members for any of the critical illnesses.
• If the funds are required towards their children’s higher education or wedding expenses.
• If the funds are required towards the purchase and construction of a house.

 

Also, the following conditions must be noted while making partial withdrawals.

• The maximum of 3 premature withdrawals are permitted in the entire tenure.
• Every withdrawal should have a gap of at least 5 years.

 

WHAT HAPPENS ON MATURITY?

Upon maturity, 60% of the total investment value can be withdrawn and the remaining 40% of the total investment will be converted into an annuity to provide regular income in the form of pension.

For example, if the total value of the investment upon maturity is Rs. 1,00,00,000/- then only 60% i.e. Rs. 60,00,000/- (exempt from tax) can be withdrawn and the remaining 40% i.e. Rs. 40,00,000/- has to be converted into an annuity to provide regular income in the form of a pension.

An “Annuity” is a fixed amount that investors receive until death. It has to be purchased from the insurance company. Investors are given range to annuity options to select from where they can select the one that suits their lifestyle and requirements.

It should be noted that the annuity received is treated as “Income from other sources” and added to the recipient’s total income and taxed as per the applicable tax slab.

 

 

WHAT ARE THE BENEFITS OF INVESTING IN NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) offers the following benefits to its investors.

1. Flexibility to earn better returns – NATIONAL PENSION SCHEME (NPS) gives enough flexibility to its investors to create a portfolio of their choice. They can choose investments from the mix of equity and debt instruments as per their risk appetite. Also, they can review the performance of their portfolio every year and make changes in the composition of their portfolio for better returns.

 

2. Tax-efficient – Tax-free maturity proceeds from NATIONAL PENSION SCHEME (NPS) does not only help you create decent retirement corpus but also help you save tax under section 80C.

 

3. Low cost – Low investment cost with high growth potential and tax-free returns makes NATIONAL PENSION SCHEME (NPS) a favourite alternative among most of the long term investors.

 

4. Ensures fulfillment of goal – NATIONAL PENSION SCHEME (NPS) can only be liquidated upon maturity once the investor turns 60 years old. Until then, the depositor does not have access to these funds. This ensures that the objective of the investment remains protected and the funds are used only for the purpose it was meant for.

 

5. Expert Advice – Another attractive feature of NATIONAL PENSION SCHEME (NPS) is that you need not worry about choosing high-quality stocks and bonds to invest in. Successful investing requires a lot of research and knowledge. You need to dig deep into the financials of a company before you invest in it. Here, the fund manager does the job for you who is well qualified, knows the market in and out and has competency in taking sensitive investment decisions.

 

6. Risk Mitigation – Since NATIONAL PENSION SCHEME (NPS) allows you to invest in the mix of equity and debt products, you can spread out your investment across various high-quality stocks and bonds and minimize the risk of concentration.

 

 

WHAT ARE THE LIMITATIONS OF INVESTING IN NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) has the following limitations.

1. Low liquidity – Lock-in until retirement makes funds highly inaccessible in case of financial emergencies.

 

2. No regular income – Despite having a long lock-in, it fails to generate regular income. The income earned is accrued and paid with principal only on maturity.

 

3. No guaranteed returns – NATIONAL PENSION SCHEME (NPS) invests in various equity and debt oriented market-linked products. Hence, its returns are not guaranteed and unpredictable in the long run.

 

4. No control over the choice of stocks – Though NATIONAL PENSION SCHEME (NPS) allows you to select the combination and composition of equity and debt, the stocks and bonds picking are completely controlled by the fund manager. Due to this, the investors have absolutely no control over selecting his favourite companies.

 

5. Too many options – With the number of investment options that exist in NPS, investors are left confused with where to invest and how to create the best combination of equity and debt instruments. Due to this, investors sometimes end up selecting the wrong combination of products that contradicts with their investment goal and risk appetite. Hence, one should always take advice and use the expertise of financial advisors.

 

 

WHO SHOULD CONSIDER INVESTING IN NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) is most suited to the following investors:

1. Moderate risk-takers – Investors who can take some level of risk of market volatility to earn inflation-adjusted returns to create decent retirement corpus must consider investing in NATIONAL PENSION SCHEME (NPS).

 

2. High income individuals – Investors who fall under a higher tax slab of 20% or above and looking forward to earning tax-free returns can consider investing in NPS. Also, the amount invested up to Rs. 1,50,000/- per annum is tax-deductible under section 80CCD(1) which is a subset of section 80C.

 

3. Investors who want to plan for retirement – Individuals investing to create a retirement corpus only should consider investing in NATIONAL PENSION SCHEME (NPS).

 

4. Investors who lack financial discipline – This is most suited for those who lack financial discipline. Money invested in this scheme can only be used for the objective it was meant for. Every investor must invest in this scheme for their retirement.

 

 

WHO SHOULD AVOID INVESTING IN NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) may not be the best investment for the following investors:

1. Investors with short term liquidity needs – Investment under NPS is locked until the investor turns 60 years old. Hence, anyone looking forward to liquidating their investment before maturity may not be able to do so except in special conditions.

 

2. High risk takers – Young investors especially below 35 years of age, who can take higher risk to earn much better returns in equity mutual funds or direct equities. However, they can still invest in NPS if they lack financial discipline.

 

 

A PIECE OF ADVICE

THINGS YOU SHOULD DO WHILE INVESTING IN NATIONAL PENSION SCHEME (NPS)

NATIONAL PENSION SCHEME (NPS) investors must follow the below suggestions while investing to maximize the value of their investment.

1. Understand the product and the risk involved – Investors should be aware of all pros and cons of investment they are getting into. The amount required on maturity, short term liquidity needs, risk appetite etc. should be carefully assessed before signing up for this scheme.

Also, investors should be aware that NPS offers flexibility to its investors in selecting the assets class as per their risk appetite and investment goals. Hence, they should wisely select their preferences as the choices they make at the time of investment will largely influence the returns they will receive upon retirement.

 

2. Assess your risk appetite – One should always assess their risk appetite before going overboard on equities. Equities are considered to be a high risk – high return investment products. And someone with moderate income, sole bread earner of the family, low on savings, high on liabilities tend to have a very low risk appetite as even a minor loss may derail their entire financial life. Such individuals should very carefully invest in this option.

 

3. Know your investment goal – One should bear in mind all pros and cons of investing in NATIONAL PENSION SCHEME (NPS). Investment in NPS is locked until the investor reaches the age of 60 and specifically meant for creating a retirement corpus only.

 

4. Track your investments annually – It is very important to revisit your investment portfolio at least once a year to review its performance. In case, the portfolio you have created isn’t doing well, a decision needs to be taken after a thorough analysis of whether to stay invested or make changes in the combination of assets.

 

5. Returns – Investors opting for debt portfolio should be aware that though debt funds in a way are considered as fixed returns instruments, they do not guarantee returns. Thus, returns it generates completely depends on the performance of the company they have lent money to as the company performance is subject to various macro-economic factors.

 

6. Update nomination details – Updating nominee details while investing is very important. In case of an investor’s death, their family members will not have to run from pillar to post when they need that money the most to claim your investment proceeds.

 

 

THINGS YOU SHOULD AVOID DOING WHILE INVESTING IN NATIONAL PENSION SCHEME (NPS)

NATIONAL PENSION SCHEME (NPS) investors must avoid taking the following actions while investing to protect their investment from losing its value.

1. Avoid investing heavily in debt instruments during increasing interest rate scenario – Bond prices are inversely related to market interest rates. It means that the bond prices start to fall when market rates increases and vice-versa.  This happens because bonds issued at a coupon rate of 6% p.a. loses its value if market rates go up to 7% p.a. as new bonds are now available at a 1% higher coupon rate. Hence, debt instruments perform poorly in such scenarios.

 

2. Do not invest if you foresee the need of funds before maturity – NATIONAL PENSION SCHEME (NPS) can only be liquidated after the individual turns 60. Hence, anyone looking for liquidating their investment before maturity may not be able to do so. Hence, revisit your short term fund requirements before signing up for this scheme.

 

3. Avoid going heavy on a particular asset class – NATIONAL PENSION SCHEME (NPS) gives enough flexibility to its investors to create a portfolio of their choice. They can choose investments from the mix of equity and debt instruments. Also, they can review the performance of their portfolio every year and make changes in the composition of their portfolio for better returns. Hence, it is the responsibility of every investor to choose the combination wisely and adopt a balanced approach rather than going heavy on a particular asset class.

 

4. Do not get influenced by anyone but financial experts – A confused investor always has a tendency of reaching out to their friends and relatives for suggestions while making critical investment decisions. That happens irrespective of the knowledge and the level of understanding the friend has about the domain. It is as good as asking a truck driver, how to fly an airplane. Such advices in most cases are based on their individual experiences and hardly on calculations or facts and figures. Hence, instead of blindly following the financial advice of a random friend, investors must act wisely and take assistance of a well qualified financial planner who has sound knowledge about the domain.

 

 

WHAT ARE THE RISKS INVOLVED IN NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) investors should be mindful of following risks involved in this investment:

1. Interest rate risk – In the case of debt investments, investors must know that when you buy a bond, you are committed to receiving a fixed rate of return (ROR) for a set period.

However, interest rates are subject to change due to various market forces. Should the market rate rise from the date of the purchase, its price will fall as new instruments will be available at a better rate so the demand for the prevailing instrument will fall.

The will then trade at a discount to offset the lower return that an investor will make on the . Similarly, if the market rate decreases, the value of the existing instrument will go up and it will start trading at a premium. Hence, this factor should be considered while investing in such instruments.

 

2. Liquidity Risk – NATIONAL PENSION SCHEME (NPS) involves a lock-in and can only be liquidated at the time of maturity. Hence, anyone looking forward to liquidating their investment to satisfy their short term financial needs before maturity would not be able to do so.

 

3. Market Risk – Returns on equity funds are market-driven and are largely influenced by various macro and micro-economic factors where we have almost no control. This makes this option highly volatile and risky.

 

4. Credit risk – One of the risks involved in debt instruments is credit risk. It means that they do not guarantee payment of fixed interest on maturity. And instruments like unsecured debentures do not even guarantee repayment of your principal. This depends purely on the performance of the company in which the money is invested. However, when a company does well and makes profits then the debenture holders are entitled to get their dues before equity shareholders.

 

5. Inflation risk – Investors going overboard with debt portfolio must understand that returns on “Bonds” and “Debentures” are not in line with inflation. So, a rise in inflation can lead to negative returns from such instruments as your purchasing power reduces. For instance, If you hold a bond paying you a 2% interest and the inflation reaches 3%, your return will be in negative (-1%), when adjusted for inflation. You’ll still get your principal back when your bond matures, but it will be worthless in today’s dollars. Inflation risk increases the longer you hold a bond.

 

 

TAXATION (BENEFITS, TAX EFFICIENCY AND TDS)

NATIONAL PENSION SCHEME (NPS) is considered as one of the most tax-efficient investments due to below reasons:

1. TIER-1 – The contributions made up to Rs. 1,50,000/- per annum is eligible for tax deduction under section 80CCD(1) which is a part of section 80C. The maximum deduction a salaried individual can claim under this section is 10% of the Basic salary + Dearness allowance. Self-employed individuals can claim up to 20% of their gross income. This however has to be within the bounds of section 80C limit of Rs. 1,50,000/-.

Also, NPS offers additional tax benefit up to Rs. 50,000/- under section 80CCD(1B), if invested through their employer. This is over and above the limit of Rs. 1,50,000/- under. So, the total tax benefit that can be claimed under this scheme is Rs. 2,00,000/-.

The entire maturity proceeds are tax-free.

 

2. TIER-2 – Contributions made under Tier-2 does not offer any tax benefit at all. However, the maturity proceeds are tax-free.

 

 

DOES ANY OTHER PRODUCT OFFER BETTER PROSPECTS THAN NATIONAL PENSION SCHEME (NPS)?

NATIONAL PENSION SCHEME (NPS) can be beaten by the following products on various grounds.

1. From the returns point of view – NATIONAL PENSION SCHEME (NPS) can be a mix of debt and equities due to which its returns are volatile and to some extent restricted.

Investors looking for maximum returns can consider investing either in or direct equities like or .

If someone is looking forward to predictable returns can consider investing in the , f or .

 

2. From a safety point of view – Though NATIONAL PENSION SCHEME (NPS) is considered moderately risky, it is not 100% safe due to the participation of equities and bonds in the portfolio which are market-linked.

Hence, in order to get a higher level of safety, one can consider investing in , or or .

 

3. From a liquidity point of view – Due to the inclusion of lock-in, withdrawal in the short term is not possible. Hence, fixed deposits and liquid funds will be the more appropriate option From a liquidity point of view.

 

 

HOW TO INVEST IN NATIONAL PENSION SCHEME (NPS)?

1. Offline Mode – NPS account can be opened with designated private and public sector banks known as Point of Presence (POP). Most banks are enrolled as POPs. Several financial institutions also act as POPs.

Then, a duly filled and signed application form needs to be submitted along with the cheque and self-attested KYC documents to the applicable POP.

Once the application is processed and the account is created, a unique ID number known as Permanent Retirement Account Number (PRAN) will be created which will identify you as an investor.

 

2. Online Mode – It is now possible to open an NPS account online in no time. Log on to enps.nsdl.com. Get your account linked to your PAN, Aadhaar and/or mobile number. You can validate the registration using the OTP sent to your mobile. This will generate a PRAN (Permanent Retirement Account Number) which you can use for NPS login.