A layman’s guide to the New Pension Scheme

On May 1, 2009, the Pension Fund and Regulatory Development Authority (PFRDA) threw open the New Pension Scheme (NPS) to all Indian citizens. Till then, this pension scheme was available only to the central and state government employees.

What is NPS?
NPS is a defined contribution pension scheme open to any Indian citizen between the age of 18 and 55.

What is a defined contribution scheme?
In a defined contribution scheme, the individual invests a certain amount in a pension scheme till he retires. At retirement, he is allowed to either withdraw the money that has accumulated or buy an immediate annuity from an insurance company to generate a regular income, or do both. The option he exercises depends on the way the pension scheme is structured. Buying an immediate annuity assures a regular payment from the insurance company. This payment can be monthly, once every three months, once every six months or once every year.

What do I need to do to start investing in the NPS?
First and foremost, you need to open an account. The form to open an account can be downloaded from http://www.pfrda.org.in/writereaddata/eventimages/Subscriber%20registration%20form%20finalised3969192803.pdf.

This form then needs to be submitted at a point of presence. To find out which is the nearest point of presence for you, check out the following link
http://www.pfrda.org.in/writereaddata/linkimages/POP-%20LOCATION575033432.pdf.

Once the form is submitted and the processing is done, you will be given a permanent retirement account number (PRAM). The PRAM will be the primary means of identifying and operating this retirement account.

How much do I need to invest?
The minimum amount that needs to be invested per contribution is Rs 500. A minimum of four contributions need to be made per year. Other than this, a minimum of Rs 6,000 needs to be invested per year. This means those who plan to invest the minimum amount of Rs 500 need to make 12 contributions per year. There are no upper limits on the amount of money that can be invested as well as the number of contributions that can be made. You need to decide on the frequency of your contributions across the year, at your convenience.

The investments can be made through cash, local cheque or a demand draft at the chosen point of presence.

How will the money be invested?
The money you invest in NPS will be managed by professional fund managers. Currently, you have the choice of picking up one of the following six fund managers: ICICI Prudential Pension Management, IDFC Pension Fund Management, Kotak Mahindra Pension Fund, Reliance Capital Pension Fund, SBI Pension Funds, and UTI Retirement Solutions. It is important to remember that at the point of filling up the form, the choice of one of these six pension fund mangers needs to be indicated. The application will not be accepted if this choice is not made.

Can I switch fund managers if I am not happy with my current fund manager?
Yes, you can switch fund managers. PFRDA, the pension fund regulator, will declare the value of your investment every year in April. At that point of time, if you are not satisfied with the performance of your fund manager, you can switch to another fund manager between May 1 and May 15. 

Will the money be invested in debt or equity?
The NPS currently offers three investment funds to choose from:
Asset class E: Investments will be made in thirty stocks that constitute the Bombay Stock Exchange Sensex or the fifty stocks that constitute the National Stock Exchange Nifty. The investments in stocks will be made in the same proportion as the weightage of the stock in the particular index. Reliance Industries currently has around 17% weightage in the Sensex, so if Rs 100 is being invested in Asset Class E, that would mean Rs 17 would be invested in the stocks of Reliance Industries.
Asset class G: Investments will be made in debt securities issued by the central as well as the state governments.
Asset class C: Investments will primarily be made in debt securities issued by entities other than the state and central government, liquid funds of mutual funds, fixed deposits of banks etc

At the time of filling the form, you need to indicate what proportion of your money should be invested in which asset class. You can choose to invest a maximum of 50% in the equity option, i.e. asset class E and a maximum of 100% in the other two options. 

What if I do not have enough expertise to exercise a choice?
In case you decide not to exercise any choice regarding the asset allocation, the Lifecycle Fund of NPS kicks in. In this case, your age will decide what fraction of your investment is invested in which asset class and as you come become older, your exposure to the equity class will keep coming down (see table).

In fact, for the risk averse, it might be a good option to choose the Lifecycle option, given that exposure to equity decreases as the age of retirement nears.

But NPS gives me only a maximum of 50% exposure to equity...
Many so-called experts have gone to town criticising this aspect. But anybody who has been through the stock market crash last year will agree that betting all investment on equity isn’t a great idea, always, especially when you are saving for retirement. PFRDA has also done a great job by limiting investments only in Sensex and Nifty stocks. This is an extremely passive form of investment and has taken active fund management by fund managers totally out of the equation. What this ensures is that you will get a rate of return that is equal to the broader market. You may not get a rate of return that is better than the overall market, but at the same time you will not get a rate of return that is much worse than the overall market.

What if I default on payment?
For every year of default you will have to pay a penalty of Rs 100. This will have to paid along with the minimum amount (i.e. Rs 500) that would be needed to reactivate the account. Also during the period you do not pay, NPS will keep charging its expenses against your accumulated corpus. If you continue to default, the account will be closed as and when the value of the account falls to zero.

Can I withdraw money from the account?
The NPS offers two accounts: tier I and tier II. Currently only tier I account is available. This is a non-withdrawable account and investments in this keep accumulating till you turn 60. Withdrawal is allowed only in case of death, critical illness or if you are building or buying your first house. In case of death the nominee can get 100% of NPS wealth in a lump sum. He can however continue with the NPS in case he wishes to.

Tier II account, on the other hand, will be a voluntary savings account which will allow you to withdraw money as and when you want to. This option is currently not available.

Will I get a tax deduction for the investment?
Yes, under Section 80CCD of the Income Tax Act investments of up to Rs 1 lakh in the NPS can be claimed as tax deductions. Readers should remember that this Rs 1 lakh limit is not over and above the Rs 1 lakh limit available under Section 80C. In fact, the combined limit of investments made under Section 80C, 80CCD and section 80CCC (for investments made into pension plans of insurance companies) is Rs 1 lakh.

What happens at retirement?
NPS by default sets the retirement age at 60. Once you attain that age, you can use the money that has accumulated to generate a regular pension for yourself. In order to do this, you have to compulsorily buy immediate annuity from a life insurance company with 40% of the money that has accumulated. As explained at the beginning, buying an immediate annuity will assure a regular payment for you.

Since a minimum of 40% needs to be used to buy an immediate annuity, a maximum of 60% of the money accumulated can be withdrawn. However, unlike other tax-saving instruments like Public Provident Fund (PPF) and Employees’ Provident Fund (EPF), wherein the amount at maturity is tax-free, in case of NPS this amount is taxable.

This is one negative feature of NPS. However, the PFRDA, which is running the NPS, has approached the government to given NPS a tax treatment similar to that for PPF and EPF. Currently, the only way not to pay tax is to buy immediate annuities using the entire amount at maturity, which is not bad because you were anyway accumulating the corpus to generate a pension.

What if I want to withdraw the accumulated amount before I turn 60?
If you want to withdraw the accumulated amount before you turn 60, you need to compulsorily buy immediate annuity with 80% of the money that has accumulated. This is another negative feature of the scheme.

What are the charges?
This is where NPS wins hands down against all other modes of creating a corpus to generate income after retirement. The fund management charge of NPS is 0.0009% of the value of the investment, every year. In comparison, pension plans of insurance companies charge 0.75-1.75% as fund management charge, which is 800-2000 times higher. The other expenses charged are also very reasonable.

Am I guaranteed a certain rate of return?
No return is guaranteed as it is in case of EPF and PPF. The amount of money you make is dependant on how well the fund managers chosen by you perform. But, the extremely low charges in NPS sure give it an edge over the the pension plans of insurance companies.