National Pension System or NPS—a defined contribution pension scheme—became operational in 2008-09. NPS is a government-approved pension scheme for Indian citizens in the 18-60 age group. While central and state government employees have to subscribe mandatorily, it’s optional for others.
Defined contribution plan
A defined contribution plan is a type of retirement plan in which fixed contributions are paid into an individual account by employers and employees. The Government of India adopted NPS based on defined contributions in respect of all new entrants to Central Government services, excepting the Armed Forces from 1 January 2004. Pension regulator PFRDA (Pension Fund Regulatory and Development Authority) has also made NPS available to all citizens of India from 1 May 2009 on a voluntary basis.
NPS: Tier-I & voluntary Tier-II account
The scheme offers two kinds of accounts-a compulsory Tier-I account and a voluntary Tier-II account. One can open a Tier-II account only if one has an active Tier-I account. While Tier-I is a basic pension account with restrictions on withdrawal, Tier-II is a voluntary savings option from which a person can withdraw money freely, subject to conditions.
The NPS was created with a unique and defining feature of individual retirement account with portability. NPS is a pension plan where you can invest during your working years and withdraw when you retire. The Scheme should ideally work as a long term investment. Liquidity is not important for the pension product. A subscriber can invest into government security (up to 100%) or corporate bonds (up to 100%) and equity up to 50% (only Nifty or Sensex).
NPS Corporate Model
In December 2011, PFRDA launched a separate model to provide NPS to all public and private sector employees in India. This model is called NPS—Corporate Sector Model. According to pension regulator, more than 235 companies have enrolled under NPS Corporate Model. Existing as well as prospective employees can be brought under NPS platform. However, many people are not aware about the ‘Corporate Model’ of NPS which is designed for workforce employed in the corporate sector.
At the end of the tenure (retirement), up to 60% of the corpus can be withdrawn from NPS and the remaining 40% will be invested in an annuity provided by insurance companies. If you want to withdraw before 60 years of age, you would be required to invest at least 80% of the pension wealth to purchase a life annuity from any IRDA–regulated life insurance company. The remaining 20% of the pension wealth may be withdrawn as lump sum. Pension will be given to the subscriber on a monthly basis based on annuity scheme chosen at the time of retirement.
An employee can claim tax deduction of up to 10% of the salary contributed towards NPS under Section 80 C. Under Section 80 CCD (2), an employee can claim tax deduction on contribution made by the employer, not exceeding 10% of his basic salary plus dearness allowance (if any). This is above the overall limit of Rs. 1 lakh offered under Section 80C. Even the employer can claim tax benefit for its contribution by showing it as business expense in the profit and loss account.
Merits of NPS Lite
On the other hand, NPS Lite was launched for people belonging to low income group so that they can plan for their retirement even with small investment amount of Rs. 100 per month. An offline service, NPS Lite is designed to ensure very low administrative and transactional costs for investors. Both NPS & NPS Lite provide Swavalamban (self reliance) benefits.
Under NPS-Lite each subscriber can contribute as little as Rs. 100 per month. There is no fixed monthly contribution. Contribution can be made, whenever the subscriber is comfortable and has the necessary disposable income.
However, minimum of Rs. 1,000 contribution per year is recommended. Those desirous of availing Swavalamban scheme of the government must invest at least Rs. 1,000 during the year so that they can get government contribution of Rs. 1,000 in the account each year. This additional benefit is available to NPS Lite subscribers opting for Swavalamban Scheme Benefit. The Scheme is valid till FY 2016-17 and may be extended thereafter.
To avail the benefit of Rs. 1,000 in each of these years–2011-12, 2012-13 & 2013-14—the subscriber has to deposit a minimum of Rs. 1,000 and a maximum of Rs. 12,000 during each of these years.
As of 30 June 2012, only 35 lakh subscribers have registered under NPS across central government, state government and NPS-Lite, while assets under management (AUM) of NPS stood just at Rs. 181.1 billion. NPS has not found many takers till date. The number of subscribers in the Scheme is still in a few lakhs.
There should be a minimum return guarantee in NPS
Despite its unique features and the potential to address the issue of old age income security in the informal sector, NPS has remained unpopular, possibly due to the faulty assumption that pension products do not need to be sold. PFRDA formed the Committee to Review Implementation of Informal Sector Pension (CRIISP) to review the implementation of NPS. According to the Committee, no intermediary took up the responsibility for marketing the scheme.
The Committee examined the role of all three agencies / intermediaries in the NPS model—point of purchase (PoP) agents, central record-keeping agency (CRA) and pension fund managers (PFMs). However, the committee did not examine the role of government as a stakeholder. As the pension wealth accumulation grows, government can use these pension funds for infrastructure development and social sector planned expenditure in the country. The success of NPS will partially reduce the government’s social security burden.
The CRIISP had also recommended that instead of guaranteed returns, PFRDA could examine incorporating two features in NPS—capital guarantee and inflation protection— that could provide for an unfunded safety net.
Once the original capital invested has been protected by investing only a portion of each instalment, the balance can be invested with caution to earn returns that will provide for old-age income security. Over an extended period, the returns earned have the potential to be higher than the guaranteed returns assured by the provident fund scheme.
To attract retail participation, PFRDA extended the role of pension fund managers to market NPS. Also, the fund management charge was increased from 0.0009% to 0.25% from 1 November 2012— i.e. Rs 250 on an investment of Rs 1 lakh against Re. 1 charged earlier. NPS still remains the cheapest way to save for your retirement. Under the revised draft of the DTC (Direct Taxes Code), NPS is proposed to be brought under the EEE (exempt-exempt-exempt) method of taxation. This means that investors get a tax exemption at all three stages of investment, appreciation and withdrawal, making it more attractive.
PFRDA has also done away with the system of bidding to be a fund manager. Now any eligible company can become a fund manager. The changes have been made to encourage promotion and marketing of the product. However, fund managers have found it difficult to sustain their businesses. Mumbai-based IDFC Pension Fund Management Co. Ltd was the first fund manager to exit NPS after three years. At present, there are six fund managers under NPS, including SBI Pension Fund, UTI Retirement Solutions and ICICI Prudential Pension Fund Management.
There is need to raise the awareness about the tax benefits of the scheme for employers, HR professionals and employees to motivate them to participate in it.
The Union Cabinet recently passed a Bill that suggests pension fund managers to offer minimum assured return options to NPS subscribers. This will come into force only after Parliament passes the PFRDA Bill.
Many employers and employees—under the NPS Corporate Model—are seeking the minimum age of investing in the Scheme up to 50 years and not 60 years as most corporate employees seek retirement by the age of 50 to 55 years. Since returns from other investment avenues for senior citizens are comparatively better than NPS, many people have also asked for fixed rate of return from NPS at the time of buying an annuity. There should be a minimum return guarantee in NPS. Once it is being fixed by the government, we can find more investment in this particular scheme.
NPS Lite: A simple but effective way to plan your retirement
Awareness about NPS needs to be created among investors