NPS: Is it the right path for attaining retirement goals?

TL;DR
The question is whether NPS is an efficient financial tool to execute oné retirement plan. It is often perceived as a cost-effective, straightforward, and tax-efficient tool for executing a retirement plan. It encourages saving by restricting withdrawals.
However, the article cautions that relying too heavily on NPS can be risky for overall retirement security. The biggest issue is the mandatory use of 40% of the corpus to buy a low-yield annuity upon retirement, which locks a significant portion of funds into a potentially underperforming investment. During the withdrawal phase of retirement, it is essential to adopt a bucket-based investing approach—splitting funds into short-term, medium-term, and long-term investments. This strategy, often favored by experts, can be constrained by the rigid withdrawal rules and mandatory annuity component of the NPS. The suitability of NPS ultimately depends on your personal financial situation and your current stage in your retirement journey.

Now that you are ready with your Retirement plan and have a number for the Retirement corpus, it is time to decide upon the financial product or products that are ideal for deploying retirement savings during the accumulation period of your retirement plan.

That is where the question comes: Is NPS the right financial product for you?

Please keep in mind

When drafting your retirement plan, it is crucial to accurately consider assumptions for both the accumulation and withdrawal phases of your retirement journey to ensure that you do not outlive your money after retirement.

Decoding NPS for beginners

If you are a beginner and considering NPS as an option for the execution of your retirement plan, let’s try to decode this from six perspectives:

1. Eligbility
2. How to start with NPS?
3. How can one become an NPS subscriber?
4. Schemes
5. Withdrawal flexibility
6. Tax implications

Eligibility:

To be eligible for the NPS, you must be an Indian citizen aged 18-70, according to the PFRDA. This includes resident individuals, non-resident individuals, and OCI holders, provided they have the necessary documentation.

How to start with NPS?

Before starting their NPS journey, it is essential to understand that NPS is not a specific financial product, but rather a platform for investing in schemes offered by pension funds. There are eleven PFRDA-registered Pension funds in India.

The NPS platform offers two types of accounts: Tier 1 and Tier 2. Tier 1 is the mandatory account, whereas Tier 2 is an optional one. Remember that you can’t have a Tier 2 account without having a Tier 1 account.

In both types of accounts, the available investment schemes are the same; however, in a general scenario, one can’t redeem their investments through their Tier 1 account until they reach the age of 60 days. In the case of Tier 2, one can redeem money from invested schemes at any time, provided that one has invested in a tax-saving pension scheme, which has a 3-year lock-in period.

How can one become an NPS subscriber?

If NPS is a suitable option for executing a retirement plan, there are two ways one can become an NPS subscriber.

1. If your employer is either a government or private entity that has opted for NPS for offering a pension to their employees. In fact, all central government entities are involved, as well as some state governments. The participation from Private employers is minimal. In this case, you automatically become an NPS subscriber; however, you can’t have a separate account individually.
2. The other option for becoming an NPS subscriber is to do it individually. This applies to all, whether you are a salaried employee, freelancer, or startup founder.

Remember, in the case of an employer-sponsored scheme, the employer doesn’t need to contribute, but if they do, you can receive an additional tax benefit.

Retirement Schemes:

Unlike Mutual funds, which have a complicated categorization of schemes, the scheme categorization under NPS is straightforward. Every scheme offered by a pension fund under NPS has two versions- Tier 1 and Tier 2.

The categorization of schemes under NPS is as follows:

1. Scheme E is similar to a diversified equity flexicap scheme offered by many mutual funds, which can invest in listed shares of companies across various capitalization buckets (Large, Mid, or Small) or sectors or industries, with a maximum allocation of 15% to any particular sector. Every Scheme E has two versions- Tier 1 and Tier 2.
2. Schemes C & G are similar to diversified debt schemes offered by a mutual fund house under the Gilt and Corporate bond categories, with an average maturity falling within the mid-term segment ( within 3 years ) and better credit quality (mostly AAA) with restrictions on the fund manager to invest not more than 10% of the AUM ( Asset under Management ) of the scheme in a particular bond. Similar to Scheme E, Schemes C and G are also offered in two versions: Tier 1 and Tier 2.
3. Scheme A is a distinct category of scheme that is generally not offered as a Mutual fund scheme. The scheme provides exposure to a diverse range of assets, including equity and debt instruments of companies not listed on the stock market, as well as real estate and infrastructure through Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), and Alternative Investment Funds (AIFs). It is one of the most affordable categories of schemes for retail investors for investing in these specific asset classes. Similar to Scheme E, C & G, Scheme A is also offered in two versions- Tier 1 and Tier 2.

Withdrawal flexibility

Unlike most Mutual fund schemes (other than ELSS), which offer withdrawal flexibility at any point in time, withdrawing money from Pension schemes under Tier 1 doesn’t offer a similar kind of flexibility, although it is pretty similar to the case of Tier 2 accounts. The standard withdrawal facility is only available after the age of 60. There are different ways one can access the withdrawal facility available for tier 1 schemes :

1. Suppose the accumulated corpus exceeds Rs 5 lakhs at the age of 60. In that case, one can withdraw 60% of the money as a lump sum amount, and the remaining amount must be mandatorily invested in the annuity scheme offered by an insurance company registered as an Annuity Service Provider with NPS trust. The job of the ASP would be to provide a monthly withdrawal (a percentage of the amount invested) to the NPS subscriber or its nominee, based on the contract between them and the ASP.
2. There is also an option for premature withdrawal (before the age of 60, and the corpus is more than Rs 5 Lakhs), only if we have completed 10 years of the NPS account, under which one can withdraw up to a maximum of 20%. The rest has to be invested with an ASP from which one would start getting monthly pensions after the age of 60.

Other than the two options available for withdrawals, where an NPS investor can withdraw to cover the cost of certain life events or in case of unforeseen emergency.

1. One can make a partial withdrawal of 25% of the funds after completing 3 years in their NPS account to meet the cost of significant life events, such as child education, Child Marriage, & Medical Emergency. One can make these partial withdrawals only three times during the lifetime of the NPS account.
2. Another option is available where the NPS investor and their nominee can make a complete withdrawal in the event of death, permanent disability of the NPS investor or subscriber, or an extreme medical emergency.

Tax Implications:

Suppose you plan to opt for NPS as a retirement planning tool and follow the standard withdrawal process. There are ways to enjoy tax rebates and exemptions at both the accumulation and withdrawal phases of your retirement plan.

• During the accumulation period of your retirement plan, if you opt for the old tax regime, you can get an exemption on income taxes to a maximum of ₹ 2 lakhs and an additional exemption on 14% of the money contributed by the employer. It will help individuals gain more freedom in investing for retirement without putting undue stress on their lifestyle.
• During the withdrawal phase, you can optimize for higher post-tax money in hand. As per the current law, the 60% money that you can get after a lump sum withdrawal is entirely tax-free, whereas the money that you earn as a pension from the annuity is taxable as per the tax slab, and you can always assume to be in a lower tax bracket after retirement than during the period of employment.

Making the final judgment on the NPS is enough for a retirement plan.

Though NPS at the top looks like an ideal option to execute one’s retirement plan because it is cheap, simple, and tax-efficient, and also provides a suitable incentive to you not messing with your retirement goal with others, because of withdrawal restrictions. But the question here is whether it’s enough to ensure that you will have enough money to outlive yourself?

• The first significant problem is the non-linearity of retirement goals. If you have not built that as an assumption in your retirement plan, none of the financial instruments that are available to you will be sufficient.
• If you don’t start early, your retirement plan is bound to fail, irrespective of the financial instrument you use.
• Heavily relying on a single financial option, such as NPS, can be risky. We know that it is mandatory to invest 40% of your NPS corpus in an annuity plan, which generally offers low yields, thereby locking in a significant portion of your retirement corpus in case of health emergencies that are common in old age.
• Most experts recommend a bucket-based investing approach for the retirement corpus, allocating it into short-term, medium-term, and long-term investments to ensure that the retirement corpus outlives you. This investing approach can be hindered if we heavily rely on the withdrawal options offered by NPS.

You must understand that we are not here to make judgments; however, the choices you make are entirely dependent on your personal financial situation and the stage of your retirement planning journey.