New Pension System – A good investment alternative but requires more clarity on performance

New Pension System (NPS) was introduced as a defined contribution pension system for government employees in 2003 and was extended to all citizens of India from July 2008.  To make it more popular, tax incentives were extended, wherein any investment made in NPS by an individual would qualify for tax deduction under section 80C.  However, these incentives failed to attract investors to NPS, which is otherwise a good investment vehicle for retirement planning. Till 7^th Feb 2011, less than 40,000 subscribers have registered for NPS which is low for a good scheme running for more than 2 years now.

Due to the structure of NPS, neither the fund managers of NPS nor the employers were interested in popularizing it.  To give more fillip to the scheme, this budget has further boosted its tax attractiveness.  Before analyzing the tax benefits extended in the budget, let’s first understand more about NPS in detail.

Also read:  What’s the budget has in store for salaried employees?

What is NPS?

New Pension System has been introduced to enable individuals to save for their retirement.  In NPS, a subscriber contributes money every year till retirement and is invested as per the investment pattern selected by the subscriber.  On retirement, part of the investment corpus (called as pension wealth) accumulated is paid as lump sum while the balance goes in purchasing a life annuity which will ensure stable monthly income to the subscriber till death.

Who can invest in NPS?

Any Indian citizen, whether resident or non-resident, can invest in this scheme provided he is between 18 to 60 years of age as on the date of submission of application.

How to Invest in NPS?

Tier I and Tier II are the two types of accounts available for investment in NPS.  A subscriber needs to have Tier I account before opening Tier II account.  The difference between the two accounts is on limitation of withdrawals.  Tier I account is non-withdrawable account.  i.e. one cannot withdraw any contribution made in this account before retirement.  Tier II offers flexibility and the subscriber is free to withdraw his savings from this account whenever required.

NPS is regulated by Pension Fund Regulatory & Development Authority (PFRDA).  PFRDA has appointed six fund managers to manage the fund and a subscriber has to choose one with whom he wishes to place his money.  These managers manage the investment made by the subscriber as per the investment mandate selected.  ICICI Prudential, IDFC, Kotak Mahindra, Reliance Capital, SBI and UTI are appointed as Pension Fund Managers (PFM).  A subscriber has to compulsorily select one of these fund managers; otherwise the application shall be rejected.   In case he is not satisfied with a performance of a fund manager, he has the option to switch to another manager.  However, this option can be utilized only once in a financial year.

PFRDA has also appointed various service providers to act as Point of Presence (POP) to accept applications and contributions to the scheme.  They are the subscribers’ point of contact and are responsible for providing range of services to the NPS subscribers.  The complete list of such service providers is available on PFRDA website.  After submitting the application and the initial contribution amount, subscriber will receive a welcome kit which will contain the subscriber’s unique Permanent Retirement Account Number (PRAN) card, telephone and internet password.  The PRAN will be the primary means of identifying and operating the account.

How much to contribute per annum?

	Tier I	Tier II
Minimum contribution at the time of account opening	Rs. 500	Rs. 1000
Minimum subsequent contribution per transaction	Rs. 500	Rs. 250
Minimum contribution in a year	Rs. 6000	Rs. 250
Minimum number of contribution in a year	1	1
Minimum account balance to be maintained at the end of the year	Not applicable	Rs. 2000

The contributions can be made through cash, local cheque or demand draft.  Further there are no restrictions on maximum amount of contribution. 

Where do the funds get invested?

After selecting the fund manager, the subscriber needs to select any one of the two approaches available to invest the money.  NPS offers the following two approaches:

1.     Active Choice – Individual funds

2.     Auto Choice – Lifecycle Fund

Active Choice – Individual Funds

Under active choice, subscriber has an option to decide how the money is to be invested in the following options:

Asset Class	Descriptions	Limits
E	Investment in equity market instruments	Up to 50%
C	Investment in fixed income instruments other than Government securities	Up to 100%
G	Investment in Government Securities	Up to 100%

A subscriber can invest up to 50% of its pension wealth in equities and the balance either in fixed income instruments or government securities or both.  Equity investment will be similar to index fund and the returns will be identical to index returns.  In case, subscriber does not want to have exposure to equity markets, he has an option to invest the entire portion in either Asset Class C or G or divide the investments amongst them.  Once the option is selected, the pension fund managers will manage your investment in the said proportion.  A subscriber has an option to change his allocation pattern for subsequent investments.

Auto Choice – Lifecycle Fund

In case an individual do not want to choose the allocation pattern or in case he is not aware which allocation pattern is right for him, he can choose Auto Choice option.  If the subscriber does not select any option, by default Auto Choice will be selected.  In this option, the investments are made in a life-cycle fund.  The proportion of funds across the above 3 asset classes will be determined by a pre-defined portfolio.  When the subscriber is young, major portion of the investment will go to equities.  As he grows old, the exposure to equities will reduce and government securities will increase.  Till the age of 36 years, 50% will be invested in equities, with 30% in asset class C and balance 20% in government securities.  With each passing year thereafter, exposure to equities and asset class C will be reduce by 2% and 1% respectively and exposure to government securities will increase by 3%.  This will continue till the age of 55 years when the maximum exposure (80%) will be in government securities and balance 20% equally divided between equities and asset class C.

Withdrawal features:

As stated above, no withdrawals before retirement are permitted in Tier I account, whereas Tier II account provides flexibility of withdrawals.

The withdrawal options can be summarized as below:

Criteria	Benefits
At any point in time before 60 years of age	20% can be withdrawn in lump sum. Balance 80% has to be utilized to purchase a life annuity from a life insurance company.
On attaining the age of 60 years and up to 70 years of age	On reaching 60 years, maximum of 60% can be withdrawn in lump sum. Subscriber has an option to either withdrawn this in lump sum or in phased manner with minimum 10% every year.  Any amount lying to the credit at the age of 70 shall be compulsorily withdrawn in lump sum. Balance shall be utilized to purchase a life annuity from a life insurance company.
Death due to any cause	In such event, option will be available to nominee to receive either 100% in lump sum.  If nominee wishes to continue with NPS, he / she need to subscribe to NPS individually.

Tax Benefits for investing in NPS:

Though there is no limit for investment in NPS, contribution made by individual to NPS gets counted for Section 80C deduction limit of Rs. 1,00,000.  With effect from April 2011, the budget has made it more lucrative by allowing contribution made by employers up to 10% of the basic salary as tax free.  This is over and above Rs. 1,00,000 limits available under section 80C. 

At present, the lump sum receipt at the time of retirement and the annuity thereafter is taxable at the hands of the subscriber.  However, though details are still awaited, the Direct Taxes Code has proposed to exempt annuity income from tax.

Why should I invest in NPS?

NPS is a good instrument of investment for retirement planning.  Besides the tax benefits, it is also simple, portable (the account continues even if the subscriber changes city, job or pension fund manager) and regulated.  However, the most interesting aspect of NPS is its low cost.  In fact, NPS is highlighted as the lowest cost investment avenue.  While the charges in NPS are really low, it is necessary to look in to their details to benefit from them.

Following are the charges under NPS:

Intermediary	Charge Head	Service charges	Method of Deduction
Central Recordkeeping Agency	PRA* Opening Charges	Rs. 50	Through cancellation of units.
	Annual PRA Maintenance cost per account	Rs. 280
	Charge per transaction	Rs. 6
POP	Initial subscriber registration and contribution upload	Rs. 40	To be collect upfront
	Any subsequent transactions	Rs. 20
Custodian	Asset servicing charges	0.0075% p.a. for electronic segment and 0.05% p.a. for physical segment	Through NAV deduction
PFM charges	Investment Management Fees	0.0009% p.a.	Through NAV deduction.

*Permanent Retirement Account

Generally a mutual fund charges 0.5% to 1.0% p.a. as charges for managing funds.  Index fund charges around 1.0% whereas charges for debt fund are in the range of 0.5%.  As compare to that, NPS charges just 0.0084% p.a. which is ridiculously low.  However, one needs to take into account the other transaction charges also which one normally does not pay in mutual fund investments.  Back of the envelope calculation suggest that NPS is cheaper when the annual contribution is more than Rs. 50,000 assuming 50% investment in Asset Class E and balance in other asset class.  Otherwise he will be better off investing in mutual funds.

Performance of NPS funds:

The performance of NPS funds is not readily available on PFRDA website.  Based on the NAVs of the funds, 1 year performance was measured and is given in the table below in percentage terms. The historical data for Kotak, ICICI and IDFC pension funds were not available. 

Fund Manager	Tier I Asset Class			Tier II Asset Class
	E	C	G	E	C	G
SBI	5.7	13.0	12.8	5.1	16.0	13.1
UTI	7.4	9.1	13.2	9.2	6.7	16.1
Reliance	8.5	7.7	8.6	8.5	6.6	5.3

Comparable one year returns:

Nifty BeES	Debt Income Funds (1)	Gilt Funds(2)
9.3	13.0	12.8

Notes:

1. Denotes average returns of 5 star rated debt income funds

2. Denotes average returns of 5 star rated Gilt medium and long term funds

Source: Valueresearchonline, respective pension fund’s websites

As can be seen from the table, the performance of the funds varies significantly amongst them.  The variation is even more in fixed income securities and government bonds. Further, the performance of Asset Class E which tracks the Index is also lower than Nifty BeES index fund.  However, the performance of other class of assets is better than their comparables.  Hence it is imperative that before investing, one needs to check the performance history of pension fund managers.

Being so good, should I immediately open a NPS account?

NPS is a good retirement planning alternative available.  It provides cost as well as tax advantages for long term investment.  But the performance of the fund managers is not readily available and the compilation above shows that it varies significantly amongst various managers.  Moreover, the size of funds managed by them is not known.

This should form part of one’s investment portfolio, but we need to wait for some more time to check the consistency of performance amongst fund managers. PFRDA should take steps to provide more disclosures and make NPS more transparent.

Have any of you already invested in NPS?  If yes, how has the investment fare till date?  Feel free to provide your comments and suggestions on this article.  Thanks.