18 July, 2011

Is NPS a good choice for retirement funding ?

“I want to enjoy life in Rishikesh, after I retire”, Mayank was telling me one of the evenings when we were discussing about work, life and everything in between. He has been saving for it too. He wants to take New Pension Scheme (NPS) as he has seen lots of favourable coverage about it. He in fact knew about CRIISP Report on reforms proposed for NPS. He was saying that the committee had found the structure of the product itself flawed in that it depended on buyer pull rather than being actively sold. The report was proposing to incentivize both Points of Presence ( POP) as well as allow fund managers to earn a remunerative fee to make it worthwhile. He was wondering still why it did not appeal to people.

Mayank knew that it has the lowest Fund management charges, that existed today. I agreed that it is low at 0.0009%pa. Mayank, in fact, knew a lot more… enough to write a product review!

Funds for Investment : There are three funds to choose from. A person can choose to invest in a Equity Fund (E ) , Fixed Income fund other than Government Securities ( C ) and a Government Securities Fund (G), according to the preference of how much risk a person wants to assume for returns. The Equity fund is an index fund that tracks NSE Nifty 50 or BSE Sensex. You can actively allocate the proceeds to the different funds, if you choose to. In the Equity Fund, you could place not more than 50%, in this case. However, you are at liberty to allocate upto 100% in any of the other two funds.

You also can choose the Auto choice for allocation of your investments. In this case, the allocations are made as per the age in the three different funds and they are rebalanced every year, automatically, in a predetermined way. Upto 35 years, there will be 50% in Equity & the balance will be in C & G. From the 36th year onwards, Equity allocation keeps coming down and more money gets allocated to the other two funds. This will be useful for those who do not want to manage their funds and the proportion for themselves.

There are 6 fund managers currently. The investor needs to choose the one of his/her choice necessarily. The returns generated by the fund managers ( for year ended March 31, 2011 ) are widely different in all the three funds. In the Equity fund, the returns of the various funds varied between 8.05% - 11.89% compared to Sensex and NIFT Y returns of 10.94% & 11.14% respectively. Similarly in the C fund, the returns varied between 6.26% – 12.66% and in the G Fund it was between 6.97% – 12.52%. It was found that the best performing fund in one category was not a best performer in other categories as well. One can invest in all three funds, but with one fund manager only. This means that if one invests with one fund manager and invests across funds, there will invariably be one or more funds that are not performing to potential.

Charges : There is a one-time account opening charge of Rs.50/-. Annual Maintenance Charges are Rs.280/-. There are charges per transaction of Rs.20/- at the Point of presence (POP )& another Rs.6 by the Central Record keeping Agency (CRA). The POP also charges Rs.40/-for intial subscriber registration and contribution upload. There are custodian charges of 0.0075% p.a for Electronic segment & 0.05% p.a. for Physical segment & the unbelievably low Fund Management Charges ( FMC ) of 0.0009% pa.

Types of accounts : There is a Tier 1 account, a non-withdrawable account, into which you contribute for building the retirement corpus till age 60. At, age 60, you would have to annuitise at least 40% and the remaining can be withdrawn at one stroke or in a phased manner. If you withdraw before age 60, you will have to compulsorily buy an annuity for 80% of the accumulated amount and could withdraw only 20%. One could also open a Tier 2 account, which is akin to a Savings account. One can put in and withdraw money anytime here. A person having Tier 1 account can open a tier 2 account, without any further charges.

Mayank seemed to know his stuff. He was able to rattle out so much information. He now wanted to know from me, if it is good to subscribe. I told him I see lot of positives and some negatives here and that he should decide after hearing me out.

Positives – A comprehensive, low-cost way of building one’s retirement corpus. Since it has a tier 1 & tier 2 accounts, it neatly addresses the long-term and short-term needs of an individual. In the Tier 2 account, since there are no exit loads on withdrawal anytime, it is like a savings account, which can potentially yield better returns. The charges being low, is a positive for the investor. Portability of the account across the country is a big positive.

The negatives – Since there is little incentive for the Points of Presence ( POP)to sell the product, Banks and other entities are just not interested in promoting it. In fact, in many banks they don’t have the forms. No one is selling it and awareness is still low, leading to very poor penetration of NPS among the public. The fund managers too have little incentive - for the fund management charge is 0.0009%pa! Anything that is win-lose proposition, won’t work. If they have to commit good people, they also need to earn something. For all three funds, there is one fund manager. This restricts choice for investors as they may want to keep the money in Equity fund with one & debt fund with another, much like in Mutual funds. Taxation as it stands today is against pension products. All annuities are currently taxable as income.

So. Mayank, it’s your call now, I had said. Consider all these aspects carefully and take your call. It is certainly not a bad product. It has it’s limitations, however. The other options which you could consider is to invest in a basket of securities from PPF, FDs, Bonds, Debentures, debt funds, Equity oriented products etc. and accumulate a corpus till retirement. At retirement, an immediate annuity can be taken , if required. This offers flexibility during the investment phase and a choice to choose the annuity provider at retirement.

Article by Suresh Sadagopan ; published in Business Standard on 17/7/2011

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