6 May 2014

National Pension Scheme

Should I invest in the National Pension Scheme?
I have been asked this question many times. The Central and State government employees are automatically enrolled in this scheme. The others are free to join. Let us discuss whether one should join or not?

You have to be an Indian citizen between the age of 18 and 60 to be enrolled in the National Pension Scheme. You can open an account in a bank.

Types of Accounts and Contributions
There are two kinds of accounts, Tier 1 and Tier 2. Tier 1 accounts have restrictions on withdrawal and Tier 2 is an account where one can withdraw money freely. Tier 2 can only be opened if a Tier 1 has been opened. Minimum annual contribution is Rs.6000 which can be made in installments of Rs.500. The minimum annual contribution has to be made, else the account will go into default.

There are charges to open the account, account maintenance and fees for transactions. These charges are minimal compared to any other investment.
- Account Opening (one time) : Rs.50
- Maintenance : Rs.100 per annum
- 0.25% of contribution is charged per investment
- Rs.6 is charged per transaction

Asset Allocation
There are 3 kinds of funds in NPS :
Class E - Index Based Funds (Equity)
Class C - Bonds issued by state government and private firms
Class G - Bonds issued by central government.
At any given point of time, exposure in equity cannot exceed 50%. An individual can decide asset allocation but if you choose the default asset allocation, equity exposure is 50% up to the age of 35 years. Thereafter, exposure to equity reduces by 2% every year till it comes down to 10% at the age of 55. You can also choose a fund manager from eight different fund managers - SBI, HDFC, ICICI, DSP being a few names. If you do not want to choose, SBI pension fund will be your default fund manager.

Employer Match - Only if you are a government employee
Employer match is only available for central and state government employees. The rest of us, do not get a match.

Withdrawal terms are not very flexible. Before 60 years of age, one can withdraw 20% of the corpus in the Tier 1 account and the rest has to be put in an annuity.

Taxes During Investment
Investment is tax deductible under Section 80C. Additional 10% of basic salary plus DA (dearness allowance) is tax deductible over and above the 1 lakh under 80C as long as the contribution comes from the employer. This does NOT mean that the employer has to contribute but that the employee has to contribute via the employer.

Taxes On Maturity
On maturity; 40% of the amount is to be put away in an annuity, 40% is tax free and 20% is taxable.
Annuity received yearly is taxable in the individual's hands as per the income tax slab he or she falls under.

Pros and Cons
- Low charges/fees which add up in the long term in any investment
- Exposure to equity. An individual requires exposure to equity in his portfolio.If he/she gets cold feet while investing in equity then NPS is a good way to start.
- A good way to build a retirement corpus
- Government employees can get their contribution matched from the employer

- This product is in its early stages and has the potential of becoming a great product as it matures.
 - If you are not a government employee, you do not get a match on the contribution
- Taxation exists on 20% of the retirement corpus and on the annuity proceeds as per the individual's taxation slab.

Overall, this is a good product. If it is possible in your situation, then contribute till age 45 (instead of the default age 35 in the scheme) to equity which have the potential to give good returns. I sincerely hope that the retirement corpus becomes tax free and the annuity requirement is waived.


1 comment:

  1. Expect NPS and Atal Pension Yojana, which is better Pension Plans in india right now available? since i am tax payer i can't get it with atal pension yojana.