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Highlights of the New Pension System / Scheme (NPS) for non-government employees

The New Pension System (NPS) (also called the New Pension Scheme) is being introduced in India from 1st April, 2009.

What are its features? What are its advantages and disadvantages? How does it compare with provident fund (PF) and public provident fund (PPF)? Is the NPS right for you?

Let’s find out.

Saving for your retirement should be one of the most important goals during your working life. (For more on defining goals and achieving them, please read “Goal Based Investing”)

If you are lucky, you get a pension from your employer. Otherwise, you have to plan and save for your retirement on your own.

Government employees have long enjoyed the benefit of getting a pension post-retirement. Some good private sector companies also offer a pension to their employees after they retire.

But what about the employees of private companies that do not offer a pension? What about the employees of the very large unorganized sector? And what about businessmen and people who are self-employed?

Till now, they did not have many choices for getting a pension. These people have been depending on schemes like Public Provident Fund (PPF) or pension schemes of life insurance companies to save for their retirement.

Now, there is a new ray of hope – in the form of the New Pension System (NPS). Absolutely anyone can participate in it!

(Note: A new pension scheme was launched for government employees joining service after 1st January, 2004. This article is not about that. This article is about the NPS being launched for non-government employees)

Let’s have a look at the features of the New Pension System (NPS).

Structure of the scheme and entities involved

The NPS would be administered by the Pension Fund Regulatory Development Authority (PFRDA).

A Central Recordkeeping Agency (CRA) would maintain all the records (like account balances) related to the NPS. National Security Depository Limited (NSDL) has been selected as the nationwide CRA for the New Pension System.

There would be six Pension Fund Managers (PFMs). The PFM would be responsible for investing your funds and generating returns from them.

There are also entities called Points of Presence (PoPs). The PoP would be responsible for the sales and marketing of the NPS. (These are similar to the distributors for mutual funds).

List of Pension Fund Managers (PFMs)

  1. ICICI Prudential Life Insurance Company Limited
  2. IDFC Asset Management Asset Management Company Limited
  3. Kotak Mahindra Asset Management Company Limited
  4. Reliance Capital Asset Management Company Limited
  5. SBI Pension Funds Limited
  6. UTI Retirement Solutions Limited

List of Points of Presence (PoP) entities

  1. Allahabad Bank
  2. Axis Bank Ltd.
  3. Bajaj Allianz General Insurance Co Ltd.
  4. Central Bank of India (CBI)
  5. Citibank N.A.
  6. Computer Age Management Services Private Ltd.
  7. ICICI Bank Ltd.
  8. IDBI Bank Ltd.
  9. IL&FS Securities Services Ltd.
  10. Kotak Mahindra Bank Ltd.
  11. Life Insurance Corporation of India (LIC)
  12. Oriental Bank of Commerce (OBC)
  13. Reliance Capital Ltd.
  14. State Bank of Bikaner & Jaipur (SBBJ)
  15. State Bank of Hyderabad
  16. State Bank of India (SBI)
  17. State Bank of Indore
  18. State Bank of Mysore
  19. State Bank of Patiala
  20. State Bank of Travancore
  21. The South Indian Bank Ltd.
  22. Union Bank of India (UBI)
  23. UTI Asset Management Company Ltd.

Permanent Retirement Account Number (PRAN)

Each investor in the NPS would be allotted a Permanent Retirement Account Number (PRAN). This would be a unique identification number that would be used to identify an investor irrespective of his PFM.

The PRAN would be issued to investors by the RCA (i.e., by NSDL).

Investment Options available to you as an investor

You would get multiple options for investing your funds in the NPS. These options span the entire risk spectrum – from risky to risk-free.

Three investment options would be available to you.

A growth option would be an equity biased option, wherein the investments would be primarily done in equities. This option has the potential to give the highest returns, but also carries a higher risk.

(Please read “Stocks – The winning bet for the long term” and “Equity Investment is Risk Free – Here’s the Proof” for more on merits of equity investment for long term)

The investment would be passive – there wouldn’t be any active buying and selling of stocks based on the fund manager’s analysis. Instead, funds would be invested only in the 50 stocks comprising the NSE’s NIFTY stock index.

This option is most suitable for young people who are just starting out in their careers. This could also be suitable for middle-aged people who do not have many dependents.

In a more moderate option, the funds would be invested in corporate debt and other fixed income instruments. This option has the potential to give moderate returns, but also carries a moderate risk.

This option is most suitable for risk-averse young people and for mid-career people. This could also be suitable for some of the more adventurous (read: risk taking) people nearing retirement.

The most cautious option would be government security biased. Here, your money would be invested in government securities. These securities are risk free, and thus, this option would give you returns that are totally risk free.

The returns are risk free, but are also expected to be the lowest among all the options.

This option is most suitable for people approaching their retirement and risk-averse mid-career people.

(These investment options have been finalized by a panel headed by HDFC chairman Deepak Parekh).

You would get an option to allocate your funds between these three options in any proportion that you prefer. Thus, you can create a balance between the risky and risk-free options based on your own risk profile.

(Please come back to read the article “Understanding your risk profile”)

If you do not want to allocate your funds, there is an auto choice feature. Here, investments would be allocated between the three options depending on your age. Thus, when you are young, more investment would be made in the equity biased fund, and as you age, more and more funds would be invested in the low risk government securities biased fund.

Switching Options available to you as an investor

As an investor, you would be able to periodically reallocate your funds between the three options (say, once every year).

Also, you would be able to switch between the fund managers (PFMs) periodically. That is, you would be able to move the management of your funds from one PFM to another.

This process is expected to be hassle free, as all the records are centrally kept by the CRA. And the Permanent Retirement Account Number (PRAN) would be your identification number across all PFMs.

Costs involved in the scheme

The biggest benefit of NPS compared to any other investment plan or scheme is the minimal cost involved. The very low fee is the biggest advantage of the NPS.

Fund management charge

Compared to the high management fee of most other investment options, the management fee for NPS is peanuts – it is less than 0.01% per annum! Compare this with about 1.75% to 2.25% per year charged by equity mutual funds!

Record keeping fee

The annual record keeping fee for NPS would be just Rs. 280. This is comparable to the annual charges levied by depository participants (DPs).

Transaction fee

Each transaction would cost Rs. 6. Thus, if you make a monthly deposit of say Rs. 2,000, you would be paying Rs. 6 as the transaction fee and the remaining Rs. 1,994 would be invested on your behalf.

Compare this with the 2.25% entry load charged by most mutual funds! In this case, you would pay Rs. 45 as the entry load, and only Rs. 1955 would be invested on your behalf.

Overall Impact of Low Charges

The lower charges (especially the recurring management fees) would end up saving you money on an ongoing basis. This would end up making a HUGE difference in the long run due to the effect of compounding.

(To know more about the power of compounding, please read “Start saving early and gain from Compounding – Early bird gets the worm”)

Market linked returns

As explained above, the return on the money invested in NPS is not guaranteed (unlike in PPF, for example).

The return that you get depends on the allocation of your funds between the three options, and the performance of each of the options.

Defined contribution scheme

An important distinction between the New Pension System (NPS) and the regular pension schemes (offered by the government and some companies) is that here, the amount that you get at retirement (and therefore, the pension that you derive from that) is linked to the market returns.

You choose the allocation of your funds among the three types of schemes, and your corpus would grow as per the returns generated. The return can be high or low depending on the performance.

Thus, the amount you pay into the NPS periodically is fixed, but the pension that you get after you retire is not fixed – it totally depends on the returns on your investment. (This is unlike regular pension, where you know years in advance how much your pension would be).

Thus, this scheme is a defined contribution scheme, not defined benefit.

(Please read “What are defined contribution and defined benefit schemes?” to know more about defined contribution and defined benefit schemes).

Truly for retirement – no early withdrawals

It should be noted that the NPS is not a regular investment scheme – it is meant to save for your retirement. You are expected to build a decent retirement corpus through this scheme.

Therefore, just like provident fund (PF), withdrawing any sum from your NPS account would be highly restricted. You would be allowed to withdraw only at the age of 60 years.

Early withdrawals would be highly discouraged, and would be allowed only for expenses like marriage of your children or buying a house.

(In any case, withdrawals are not advised as this is the corpus meant for your retirement).

What can you withdraw at the time of maturity?

You would not be able to withdraw the full accumulated amount as a lump sum.

You would be allowed to take out 60% of the corpus as a lump sum, and would need to invest the remaining 40% in an annuity.

Annuity is an instrument that would provide a fixed monthly amount to you in return of the fixed lump-sum investment by you (40% of your accumulated corpus in this case). Thus, it would act as your pension after your retirement.

Coexist with other schemes (EPF / EPS)

New Pension System (NPS) would not replace any existing scheme like the Employee Provident Fund scheme or the Employee Pension Scheme.

The NPS would coexist with the existing schemes like EPF, EPS, PPF, etc.

Also, as of now, your money can not be transferred from existing schemes like EPF / PPF to the NPS.

The New Pension System (NPS) and Income tax

Now let’s talk about one of the most important deciding factors – income tax.

Are there any income tax benefits available for investment made in NPS? Are the returns taxed? Or are they tax-free?

The NPS would follow the EET (Exempt – Exempt – Taxed) regime of taxation.

(To know more about different taxation regimes, please read “Taxation Regimes – EEE EET ETE TEE – What do these mean?”)

This means that the investment made in NPS would be deductible from your income, saving you income tax. (Although it has not been notified yet that the investments made in NPS would get the income tax benefit under section 80C).

(To know more about section 80C benefits, please read “Saving Income Tax – Understanding Section 80C Deductions”)

Also, the interest or profit earned for the investments in NPS would not be taxed in the year in which it is earned. (This is unlike the National Savings Certificate (NSC), where the interest earned is added to your income and taxed in each year).

The problem is that the amount would be taxed at the time of withdrawal.

Yes, that’s true. It is disappointing, but it is true. This is different from many other long-term investment schemes (like PPF, PF, etc), where the amount is not taxed even at the time of withdrawal. This can drastically reduce your overall return from the NPS.

A note on taxation

The PFRDA, who is administering the NPS, is demanding tax equity between NPS and other pension schemes. So, we can expect some change here in the near future.

Hopefully, the amount would be made tax-free at the time of withdrawal. Or (hopefully not) the amount would be made taxable at the time of withdrawal for other schemes as well.

In any case, some equality is being expected between the NPS and other pension schemes.

Information in Hindi

Features of NPS

Overview of NPS and CRA Architecture

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