Have you been investing in NPS? If not, I am not sure there are some reasons for staying away from NPS.
Some of the common (and most of them valid too) reasons for not investing in NPS are:
#1 Your money is locked in until the age of 60
Yes, you can’t access your money until the age of 60 or you can access only a small portion of it before 60. That is a problem.
But all retirement products have some kind of lock-in. Don’t they? PPF has. With EPF, well, there are workarounds. Lock-in ensures that you can steadily save for retirement (not that you can’t save with discipline without lock-in periods).
I understand lock-in is an issue. However, I wouldn’t worry much if your NPS is only a small portion of your portfolio.
#2 Pre-Mature exit is difficult
That is one of the biggest problems. If you must exit for any reason before the age of 60 or superannuation, you need to purchase an annuity for 80% of the accumulated corpus. Not only that a significant portion goes towards annuity, but the annuity rates are also low at a young age.
So, if you foresee an early retirement for any reason and need funds for retirement, this could be a problem. So, if you fall into the category, do not consider NPS.
However, you do not need to exit NPS when you retire (early retirement). You can continue to make investments in NPS account till the age of 70.
#3 Restrictions on Partial Withdrawals
With NPS, you are allowed to withdraw up to 25% of own contribution after 10 years for children education/marriage, construction/purchase the of first house and for treatment of critical illnesses.
Yes, this is a limitation, especially that you can only take out only your contribution (and not returns or employer contribution). 25% of the overall corpus would have been a better choice.
But, we do expect such limitations in any product specifically meant for retirement. Don’t we?
#4 Maximum Equity investment is capped at 50%
Under active management, maximum equity allocation is capped at 50%. Under auto-allocation, there is Aggressive Life Cycle Fund (LC 75), where equity allocation is 75% till the age of 35 and gradually moves down to 15% by the age of 55.
This is a common grouse among NPS detractors that even for young investors, the equity allocation is capped at 50%.
Personally, I don’t see this as much of a problem. NPS is not your only investment for retirement. There are other investments too. If you want greater allocation towards equity, you can achieve that outside of NPS.
#5 Mandatory Purchase of Annuity
At the time of exit from NPS at the age of 60 or superannuation, you need to use 40% of the accumulated corpus to purchase an annuity plan. If you exit before superannuation or the age of 60, then you need to purchase an annuity plan for 80% o the accumulated corpus.
The problem with annuity products are:
- Annuity rates are low.
- Annuity income is taxable in the year of receipt
- Annuity payouts are not inflation adjusted. This means your annuity income may be not able to keep up with inflation.
These are very valid points. Moreover, annuity rates improve with age. So, in case of an early retirement, you may get a very low annuity rate. Even the age of 60 may not be the best time to avoid an annuity plan. As an investor, I wouldn’t want to have this restriction of mandatory purchase of an annuity plan.
However, you can’t take out pension from a pension plan. Can you?
Moreover, annuity plans can serve a purpose in your retirement planning. With an annuity plan, you are guaranteed an income stream (however small it may be) for your life. An annuity plan can take away some portion of your longevity risk (you outliving your retirement corpus). Annuities can be extremely handy when your physical and mental faculties start to desert you at an older age.
Staggering annuity purchases during retirement may not be a bad idea.
It would have been better if there was a way to delay purchase of an annuity plan.
Do note there is an option to defer purchase of annuity by up to 3 years from the date of exit from NPS. So, if you exit NPS at 60, you can defer purchase of annuity plan till the age of 63.
By the way, there is an option to continue your NPS even beyond the age of 60. This is also an option that you can consider. While I am not asking you to consider investments in NPS beyond 60, this could be effective ploy to defer the purchase an annuity plan and hence get better rates.
Frankly, this is not as simple as it may sound. There will be many more aspects to consider. For instance, if you delay the exit, your corpus will grow over a period of time, potentially increasing your tax liability.
#6 Maturity amount is taxable
We know that at least 40% of the accumulated corpus should be used to purchase an annuity plan. And the annuity income is taxable.
Of the 60% amount that can be withdrawn lumpsum, only 40% is exempt from tax. You have to pay tax on the remaining 20% amount withdrawn as lumpsum.
Contrast this with EPF or PPF where maturity proceeds are exempt from tax.
However, I believe if you have kept NPS investments under control and withdraw from your NPS corpus smartly, you can reduce your tax outgo.
I have discussed this aspect with illustration in much greater detail in another post.
My view on whether you should invest in NPS
Investment in NPS up to Rs 50,000 per financial year is a smart choice for those falling in the 30% tax bracket. The cap of Rs 50,000 per financial year is due to exclusive tax benefit under Section 80CCD(1B).
In absence of this exclusive tax benefit under Section 80CCD(1B), I see little reason to invest in NPS.
I have considered the numbers and shown how
However, in my opinion, following conditions should also hold true in your case before you decide to invest in NPS.
- You are NOT planning an early retirement and can afford to forget about the money till the age of 60.
- NPS is NOT crowding out your other investments.
- NPS should not be a major investment for retirement.
- If you foresee other sources of taxable income during your retirement, then you need to work out the numbers for you.
The key lies in NPS corpus not becoming too big. That’s why you should not go overboard with your NPS investments.
If you have been investing aggressively outside of NPS for retirement, most of the reasons cited above to stay away from NPS automatically go away.
However, in my opinion, there are a few more problems. If these aspects about NPS continue to deteriorate, I may have to rethink my decision.
#7 The Regulator may destroy the product
This, to me, is a very big problem. In order to make NPS a one-size-fits-all solution, compete against mutual funds and life insurance companies and deepen the penetration of NPS among masses, PFRDA, the pensions regulator, may compromise some of the greatest strengths of NPS.
One of the greatest strengths of NPS was its low cost structure. Earlier, NPS was allowed to invest only in index funds.
Now, they are allowed to invest in actively managed products. Some of the fund managers (not all) are in turn, investing investor money in other actively managed mutual funds. This is clearly double incidence of costs. You pay to the pension fund manager and also bear the cost of actively managed fund.
So, if you consider NPS a low cost product, you need to recheck the portfolio of your NPS fund manager.
Costs, in general, are on the rise too. Upfront sign-up cost was increased recently. Persistency charge of Rs 50 per annum was added recently. Service charge (for subsequent investments through eNPS) has been increased from 0.05 to 0.1% of the contribution amount. Fund management costs are likely to go up once the fresh licenses are issued.
The amount may not look big but these amounts can always be increased later. Read this fine article in Mint about NPS costs.
Here is the latest cost structure for PoP charges as per PRFRDA circular dated October 27, 2017.
Intermediaries can tweak investment patterns to get more commissions. For instance, PoP charges are 0.25% of the commission amount subject to a minimum of Rs 20. For an investment of Rs 1,000, Rs 20 means 2% upfront cost. I have not considered GST yet.
Clearly, SIP of small amounts in NPS is not a good idea. Monika Halan, the consulting editor, Mint, brings out these aspects brilliantly in her article in Mint.
Recently, maximum Account opening age was enhanced to 65 years. I do not see any need for such changes. I cannot fathom any reason why anyone above 60 should invest in NPS.
I do understand that PFRDA is trying a solve a bigger problem of increasing penetration and may see these minor aspects as collateral damage. Fair enough. However, from an investor point of view, it matters little.
I just hope PFRDA does not cause much damage to the product and I don’t have to rethink my position on NPS.