Premium

This is an archive article published on May 4, 2009

A new dawn

May 1,2009 is likely to go down as an historic day in the saga of pension reforms in India.

May 1,2009 is likely to go down as an historic day in the saga of pension reforms in India. On Friday last week the Pension Fund Regulatory and Development Authority PFRDA threw open the New Pension System NPS to the unorganised sector. So far the scheme was open to central and state government employees only. Now private-sector workers,professionals,businessmen,entrepreneurs,and even low-wage workers will be able to join this low-cost,formal retirement planning system.

NPS is a defined-contribution scheme as opposed to the governments defined-benefit scheme for its workers that existed before pension reforms happened and NPS was launched,which means that after retirement you will be paid what you have accumulated in your corpus and there will be no open-ended obligation to keep paying you till your death,as was the case earlier. Besides low cost,features like portability from one job to another and flexibility to choose from a variety of portfolios and fund managers make this new scheme attractive as a vehicle for retirement planning.

The scheme

The structure of NPS is akin to that of a mutual fund: each organisation entrusted with managing your money will consist of a trust and fund mangers. You may choose one of 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.

NPS offers two types of accounts: tier I and tier II. For now the regulator has launched just the tier I account. It is a non-withdrawal account that will accumulate your savings for retirement. You will be allowed to withdraw money only in two situations: when you have to build or buy your first house,or in case of a critical illness. The tier II account will be a voluntary saving account that will allow withdrawals at any time. However,the regulator has not launched this option yet.

The process of saving for retirement saving is split into two phases: accumulation and disbursement.

Accumulation phase

This is the initial phase wherein you accumulate for your twilight years. Anybody between 18 and 55 years can open an account and start investing. The subscriber should be an Indian national and should not have an existing NPS account. You can open an NPS account with a minimum investment as small as Rs 500. The regulator mandates a minimum annual investment of Rs 6,000 and at least four transactions in a year. There is no restriction on the maximum amount and the frequency of transaction.

The NPS,by default,regards 60 as the retirement age. Therefore,your money remains invested till 60. Thereafter,the disbursement phase kicks off.

Disbursement phase

Story continues below this ad

Retirement at 60. In case you retire at 60,there are two ways to enjoy your accumulated corpus. First,you may withdraw 60 per cent of the money as lump sum and the rest 40 per cent has to be annuitised. Annuities will have to be bought from life insurance companies.

However,if you do not wish to retire at 60 or want to stay invested in this scheme,a second option is available. You are allowed to make staggered withdrawals over the next ten years. The minimum withdrawal in this case must not be less than 10 per cent of the accumulated corpus per year. At 70,the account will get closed automatically and the remaining corpus will be paid to you.

Retirement before 60. You can also enjoy your accumulated wealth in case of an early retirement. However,in this case,you will not be allowed to withdraw more than 20 per cent of the accumulated wealth as lump sum. The rest 80 per cent will have to be annuitised. Again,to buy annuities you will have to go to life insurance companies.

In case of the account holders death,the nominee can either withdraw the accumulated wealth as a lump sum or continue with the scheme. In the latter case,the nominee will have to open a new account with NPS.

Three fund options

Story continues below this ad

The money deposited by you can be invested in multiple funds. The scheme offers three asset classes: E investment in equities through index funds either 30-share BSE Sensex or NSEs Nifty 50; C investment in fixed income instruments; and G investment in government securities. Further,two asset allocation options are available:

Active choice. This option gives you the choice to manage the investment portfolio on your own. You can choose your own mix of asset classes with a maximum limit of 50 per cent in equities.

Auto choice. For subscribers who cannot make their own investment decisions,the scheme offers a default option as well. Here,till the age of 35,50 per cent of your investments will be made in equities,30 per cent in C category,and 20 per cent in G. After 35,investments in equities and fixed income instruments C will be gradually reduced to 10 per cent over the next 20 years while investment in government securities G category will be increased to 80 per cent. Therefore,by the time you near your retirement age,your wealth will be in the safest of funds.

Low charges

Compared with pension products by mutual fund houses or life insurance companies,the NPS has very low charges. The scheme charges 0.0009 per cent per annum of fund value as fund management charge FMC,whereas other pension products by life insurance companies and mutual funds charge between 1 and 2.5 per cent of fund value as FMC.

Story continues below this ad

Besides,there is a one-time account opening charge of Rs 50,PoP registration charge of Rs 40,and annual maintenance charge of Rs 350. You will also be charged Rs 10 every time you make a deposit See: Charges you will have to pay.

Owing to competitive charges,an investment made in NPS will give you better returns. A quarterly investment of Rs 15,000 each in a mutual fund balanced and in NPS for the next 20 years will at 10 per cent rate of return fetch you Rs 28,29,980 in case of the mutual fund and Rs 37,46,291 in case of NPS a difference of more than Rs 9 lakh.

High on flexibility

Investors have the flexibility to choose between fund managers. The regulator will publish the net asset value NAV of all the funds every year in April. In case you are not satisfied with your fund manager,you may then switch to another. The regulator will allow switching between May 1 and 15 every year.

How to open an account

You may go to any of the 22 points of presence PoP appointed by the regulator to open an account. On processing the application,the subscriber will be given a Permanent Retirement Account Number PRAN,telephone password TPIN,and an internet password IPIN. You will be required to make the first contribution at the time of applying for registration.

A few negatives

Story continues below this ad

While the NPS has a lot of positives,it has certain limitations as well. First is the ceiling of 50 per cent on equity investment. A young person can reap very good returns from equities during his initial years. Later,he can transfer the accumulated wealth to safer options like government bonds. Giving the option of 100 per cent equity exposure in the initial years would have been a good idea, says Vishal Dhawan,a Mumbai-based financial planner.

Second,if you wish to retire before 60,the scheme doesnt give you the freedom to withdraw the accumulated wealth as a lump sum. If you retire before 60,you get only 20 per cent as lump sum and the rest will have to be annuitised. People might want more flexibility in this regard, says Dhawan.

The third issue relates to tax treatment. While the scheme enjoys favourable tax treatment during accumulation and investment phase,your corpus gets taxed at withdrawal whereas in case of instruments like PPF you are not taxed at withdrawal stage. PFRDA is demanding parity in this regard. If it happens,it would provide a boost to NPS.

What should you do?

Keeping the cost structure,flexibility and portability in mind,NPS looks attractive as an instrument for retirement planning tool. However,the system is expected to have some teething problems and will evolve gradually over a period of time. Initially I would recommend people to put 25 per cent of the money they want to save for retirement in this plan. Since the system will evolve over a period of time,you can review your investments as you go along, says Dhawan.

Story continues below this ad

In a similarly cautious vein,Kartik Varma of iTrust,a Gurgaon-based financial advisory firm says: Read the fine print carefully before investing. The tax treatment of withdrawals is unclear,so be aware of what you might be getting into.

Notwithstanding the above-mentioned limitations,the launch of NPS for unorganised sector workers is a welcome step.

Points of presence

The pension regulator has appointed 22 points of presence PoP for distributing NPS. However,initially,only a select few branches will offer this scheme:

amp;149; Allahabad Bank

amp;149; Axis Bank

amp;149; Central Bank of India

amp;149; Citibank

amp;149; Computer Age Mgt Services

amp;149; ICICI Bank

amp;149; IDBI Bank

amp;149; ILamp;FS Securities Services

amp;149; Kotak Mahindra Bank

amp;149; LIC of India

amp;149; Oriental Bank of Commerce

amp;149; Reliance Capital