Three changes that can make the NPS an attractive retirement solution

Published: November 7, 2021 at 10:08 am

We discuss three changes that can make the NPS an attractive retirement solution. Let us face a simple fact: The only reason many investors use the NPS is because of the “extra Rs. 50,000” tax saving or reduction in taxable income to be exact.

The biggest drawback of the NPS is its rigid exit rule. Anyone exiting the scheme before attaining the age of 60 will have to buy a pension plan for 80% of the corpus.  Very few corporate employees would continue working until they turn 60. Also, see: How to prepare for the “new normal” in retirement planning

Desired change no 1: The NPS exit clause should be modified to remove the 60 years limit. Exit at any age should be allowed with the same 40% annuity clause (ideally the annuity clause should also be removed but that is unlikely to happen).

Many corporate employers are offering NPS as a choice and some even allow employees to split their contributions between EPF and NPS. However, an option to change the employer contribution from EPF to NPS is rarely offered. Also, when an employee shifts from an NPS friendly employer to an EPF-centric employer it clutters up the portfolio.

Desired change no 2: NPS should be offered as a choice by all employers. This way existing NPS accounts can be used for retirement contributions even if the employer only offers EPF.  The NPS employer contribution is tax-free (to both parties) and has a much higher deductible limit than the employee contribution. To understand the limit rule see: Do Not Invest Rs. 50,000 in NPS for additional tax saving benefits!

The exit clause of the NPS implies we sever all links with the NPS on exit. There are no options to defer either the annuity or lump sum payout up to the age of 70 but these come with restrictions. For full details see: How to withdraw from NPS by optimising tax and market fluctuations after 60.

Desired change no 3: NPS should allow subscribers to continue investing the remaining corpus (that is after annuity purchase) for life. A new mutual fund can be created to segregate AUM in the accumulation phase and withdrawal phase. Then the NPS can effectively be used as a part of a retirement bucket strategy to generate inflation-protected income after retirement. Here is an example: Retirement plan review: Am I on track to retire by 50?

The pension fund regulatory authority has modified the original form of the NPS several times learning from experience. Let us hope they look beyond a “pension oriented” mindset and make the NPS a flexible retirement solution for young earners.  Until the first two changes mentioned above are modified, our recommendation will continue to be: “avoid NPS unless you have a stable job with an employer contributing to it”.

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