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Walk away from the NPS

Author: Venkata Ravi Ram/Monday, February 12, 2018/Categories: Grow, Expert View

Walk away from the NPS

If you are a government employee thanks for stopping by, but please don’t read further here as surely you won’t like what follows.

According to United Nations Population Division, world's life expectancy is expected to reach 75 years by 2050 from present level of 65 years. The better health and sanitation conditions in India have increased the life span. As a result number of post-retirement years has increased. Thus, rising cost of living, inflation and life expectancy make retirement planning essential part of today's life. To provide social security to more citizens, the Government of India had started the National Pension System (NPS) in 2009. NPS was an important milestone in the development of a sustainable and efficient defined contribution pension system in India. In simpler terms, the broad objective of NPS is to have a “retirement plan for all”. Praiseworthy initiative indeed. It comes with enticing tax benefits.. From product point of view, it is a good product. It is transparent. The fund managers are chosen using stringent criteria. Information on holdings and performance are easily accessible. It’s very cheap. Compared with regular mutual funds, NPS comes with lowest possible cost to the consumer. But, you won’t find your regular banker/advisor pushing for this product.Mainly, because there is literally not much ‘incentive’ for distributors to ‘sell’ NPS; they have many more lucrative mutual funds and insurance products  offering  much better commissions. It’s portable, like a mobile number, you can change your pension manager if you are not satisfied with their performance. Portability acts as a disincentive for the fund managers to force them to do their best. Despite all these positive vibes around the scheme, it has failed so far to gain traction as a preferred retirement planning tool among the salaried class in private sector.    

The main reasons are three. First, NPS comes under what is known as EET, i.e., Exempt on Contribution-Exempt on Earnings-Taxed at Withdrawal. Now, NPS has direct competition with two very good alternatives, PPF (Public Provident Fund) that is backed by the government and ELSS (Equity Linked Saving Schemes) which are equity mutual funds. PPF is EEE which means the withdrawal is also tax-free; ELSS also used to be EEE, but now with latest budget, ELSS would become taxable at 10% of long term capital gain.

Taxability is a significant aspect when you consider that the withdrawals from NPS are limited to 60% of which only 40% is tax-free and the other 20% is taxable. We will come to the balance 40% of the corpus in a later stage. If you are in the 30% tax bracket, which most readers of this magazine would be by the time they hit retirement, instead of  receiving 60%, you will get only around 54% with a loss of 6% at the withdrawal stage. This makes the withdrawal corpus on par with PPF which doesn’t carry an iota of  risk due to equity exposure and comes with a government guarantee.         

Secondly, it is frequently recommended to invest maximum money in equity or equity-linked products in the initial stages of life. However, in NPS, while giving the “aggressive” investor an option of choosing equity, it limits the exposure to a maximum of 75% at the age of 35. And inexplicably, it comes down by 4% every passing year till it becomes 15% at an age of 50. Historically, long term returns have been 12-16% for equity and for NPS, the weighted returns considering the debt portion- would be 10%. This mandatory upper limit on equity component cripples the NPS corpus’ ability to grow at a much faster pace in the vital accumulation period.

Thirdly, and  the unkindest cut of all to the NPS subscriber  is that remaining 40% of the balance corpus amount. With this 40%, the subscriber is not given any choice, but is forced to buy an annuity with a limited set of annuity providers. There is no choice of the service provider or the option of paying a penalty and walking away with the balance. Unlike most traditional life insurance policies, annuities cannot be surrendered, meaning the subscriber would literally be giving up on that principal amount for his/her lifetime. The historical returns from annuities have been 1%-7%, with the latest avatar of LIC Jeevan Sanchay VI offering 6.2-6.6%. And, that is also fully taxable. Effectively, you would be better off simply leaving your money in a savings bank account rather than purchasing an annuity.   Money in the bank will actually be accessible and available to you when you need it.

With these three imperfections hanging over its head, the NPS is best avoided. One can reconsider it, as and when the conditions of withdrawal limits, taxation rules of the withdrawals are changed and if and only if, the subscriber gets an option to walk away from that low-yieldingandfully-taxable annuity investment.  

Venkata Ravi Ram writes commentaries on contemporary financial, business, taxation and political issues.

 

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