A wish list for the national pension scheme (NPS)

Here is a wish list for the national pension scheme. I hope the PFDRA implements at least a few of them in the coming years.

The NPS is now close to 11 years old. Actual investments were begun around 2008. It caught the attention of employers and employees only after tax breaks were provided.

First a tax break for the employer contribution was announced for both parties. That helped increase the popularity of the corporate form of the NPS, instead of, or together with EPF.

Then a tax break of Rs. 50, 000 for the employee contribution was announced in addition to the 80C deduction. Read why it is a bad idea to open an account only for this

However, there are still several undesirable features in the NPS which is a deterrent. Unless these issues are addressed, I think the NPS should be avoided, tax break or no tax break.

Here is the wish list of changes I expect in the NPS.

1) Asset allocation: As of now, the NPS corpus is reported as a single figure, irrespective if the asset allocation opted for by the user (this is the case for govt employees. Is it  different for others?).

Non-govt employees can only choose one amc. Govt employees have no option (either on asset allocation or amc) in this regard. Their corpus is managed by 3 amcs! They must be given the freedom to choose as they like.

The value of equity (E), government bonds(B) and corporate bonds (C) should be listed separately along with the XIRR.

The classification should only wrt asset class and not amc. The subscriber should be free to choose one amc for equity and another for debt. This is not possible. Non-govt. subscribers must first choose an amc and then asset allocation.

The subscriber should have the freedom to switch among asset classes and amcs multiple times a year. At present, it is only once a financial year.

2)  Taxation: It is not practical to expect the NPS to become totally tax-free (EEE). However, I think the government should tax the equity and debt portions of the NPS separately and as per the existing tax laws at the time of withdrawal. This will ensure NPS is as attractive as equity or debt mutual fund.

3) Equity investment: The equity portion of NPS is a large cap index fund (either Sensex or Nifty). I think the amc should be given an option to actively manage the fund for a higher fee. The low cost of NPS is not really much of a positive. When it is so easy to beat indices with even 3% expense ratio, NPS subscribers* should be given the option to take advantage of this.

  • here I am only referring to only those who wish to use NPS as the primary instrument for retirement.

If NPS is only one component of your retirement basket and you have separate equity exposure, then it is best not to have any equity exposure in NPS at all.

Which is why I don't care much about the 50% ceiling on equity. For those dependent only on NPS, 50% equity exposure is good enough. Others don't need to worry about it anyway.

4) Annuity: No corporate employee wants to work until age 60. So it is ridiculous for a scheme to annuitize 80% of the corpus if withdrawn before age 60. Annuitizing only 40% of the corpus is reasonable, but that must be independent of age.

Corporate subscribers should be given the option to continue the NPS account without contributions or withdrawal at least up to age 60. This will provide early retirees a good backup option. Subscribers can defer withdrawal up to age 70. This is a good option as the purchase of annuities can be staggered (this will provide inflation protection to an extent as annuity rates increase with age).

Subscribers can defer withdrawal up to age 70. This is a good option as the purchase of annuities can be staggered (this will provide inflation protection to an extent as annuity rates increase with age).

As you can see from the above, the main problem with NPS is its rigidity. As a 'retirement plan', it wants to call the shots on pretty much everything. The subscriber has only limited options. That is the reason why it should be avoided in the first place, tax break or no tax break.

It is our retirement plan and we should be in charge of it. PFDRA cannot dictate terms to us (well, at least to you. People like me don't have a choice). If at least few items in the above wish list are implemented, you can consider NPS. Until then, enjoy the comforts of EPF and the full flexibility of equity mutual funds and/or stocks.

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20 thoughts on “A wish list for the national pension scheme (NPS)

  1. Sanjay Jhunjhunwala

    I wonder if the investor can be allowed to switch between debt and equity at a reasonable cost and without attracting taxation. This facility is available for ULIPs, that are not fancied because of poor history.

    Reply
  2. Sanjay Jhunjhunwala

    I wonder if the investor can be allowed to switch between debt and equity at a reasonable cost and without attracting taxation. This facility is available for ULIPs, that are not fancied because of poor history.

    Reply
  3. ANISH MOHAN

    Dear Sir
    Again a thought provoking article from you. What has struck both hemispheres of my brain is your suggestion to use NPS as a pure Debt fund and forget about the equity portion totally, if and only if, I am already a MF+Stock investor, which is true in my case. This is a fantastic suggestion and I wonder why did this not strike me earlier ? So that will give me a debt component in my ALL-equity portfolio and bring some balance. Keep writing Pattu-Sir, I never could crack IIT for my engineering, but my respect for IIT-ians like you increases the more I read your articles.

    Reply
    1. freefincal

      Thanks Anish. The debt allocation reference was to those who get contributions from employers. I think individual subscribers should not use NPS. There is nothing special about being an IITian

      Reply
  4. ANISH MOHAN

    Dear Sir
    Again a thought provoking article from you. What has struck both hemispheres of my brain is your suggestion to use NPS as a pure Debt fund and forget about the equity portion totally, if and only if, I am already a MF+Stock investor, which is true in my case. This is a fantastic suggestion and I wonder why did this not strike me earlier ? So that will give me a debt component in my ALL-equity portfolio and bring some balance. Keep writing Pattu-Sir, I never could crack IIT for my engineering, but my respect for IIT-ians like you increases the more I read your articles.

    Reply
    1. freefincal

      Thanks Anish. The debt allocation reference was to those who get contributions from employers. I think individual subscribers should not use NPS. There is nothing special about being an IITian

      Reply
  5. Ashwini

    I would like to know why a pension is taxed? After all it is hard earned money for anybody and therefore going something now to provide for their old age

    Reply
    1. freefincal

      There is no free lunch. If you want good returns, you must pay revenue to the govt. Otherwise settle for low tax free returns. We have enough fiscal deficit to worry about.

      Reply
  6. Ashwini

    I would like to know why a pension is taxed? After all it is hard earned money for anybody and therefore going something now to provide for their old age

    Reply
    1. freefincal

      There is no free lunch. If you want good returns, you must pay revenue to the govt. Otherwise settle for low tax free returns. We have enough fiscal deficit to worry about.

      Reply
  7. Manu

    The only benefit that I can see to invest in NPS is the upfront Tax deduction that people in high taxation bracket can enjoy. This is uniquely available to NPS as of now. So if we want to avail this deduction, this is the only option.

    Reply
  8. Manu

    The only benefit that I can see to invest in NPS is the upfront Tax deduction that people in high taxation bracket can enjoy. This is uniquely available to NPS as of now. So if we want to avail this deduction, this is the only option.

    Reply
  9. Jaideep Shirali

    For those who wish to switch between debt and equity, some points should be kept in mind. Firstly, it seems that going by current trends, interest rates will head lower in the coming years, so switching to debt may not be useful, as debt returns will lag inflation even more in the future. Secondly, there is an Auto Choice - Lifecycle Fund option which brings down your equity component as you grow older. And lastly, at a maximum of 50% equity, it is far better to earn more in the long run, because equity returns beat inflation in the long run. But the NPS is overall a good product, not just because of its upfront tax incentive. A recent option is retirement/ pension funds offered by mutual funds such as the Reliance Retirement Fund, which gives the investor the option to switch from equity to debt like in ULIPs subject to conditions, along with income tax benefits.

    Reply
  10. Jaideep Shirali

    For those who wish to switch between debt and equity, some points should be kept in mind. Firstly, it seems that going by current trends, interest rates will head lower in the coming years, so switching to debt may not be useful, as debt returns will lag inflation even more in the future. Secondly, there is an Auto Choice - Lifecycle Fund option which brings down your equity component as you grow older. And lastly, at a maximum of 50% equity, it is far better to earn more in the long run, because equity returns beat inflation in the long run. But the NPS is overall a good product, not just because of its upfront tax incentive. A recent option is retirement/ pension funds offered by mutual funds such as the Reliance Retirement Fund, which gives the investor the option to switch from equity to debt like in ULIPs subject to conditions, along with income tax benefits.

    Reply
  11. Pradeep

    If I can take the Liberty to add my wish list too 🙂

    1) Addition of Liquid fund
    2) instead of EET can this be TEE? ( Similar to Roth IRA in US)
    3) Instead of Purchasing Annuity allow max of 2-3% portfolio withdrawal year on year?

    Pradeep.

    Reply
  12. Pradeep

    If I can take the Liberty to add my wish list too 🙂

    1) Addition of Liquid fund
    2) instead of EET can this be TEE? ( Similar to Roth IRA in US)
    3) Instead of Purchasing Annuity allow max of 2-3% portfolio withdrawal year on year?

    Pradeep.

    Reply
  13. K.Narayan

    Why annuity at all? for the benefit of LIC ? on retirement, full money should be given to the employee. Of course it is his hard earned money.

    Reply
  14. K.Narayan

    Why annuity at all? for the benefit of LIC ? on retirement, full money should be given to the employee. Of course it is his hard earned money.

    Reply

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