Personal Finance

A peep into the New Pension System

Rajalakshmi Sivam | Updated on April 22, 2011 Published on April 16, 2011

If you are looking for a low cost investment avenue to build your retirement corpus, the New Pension System (NPS) is an option you can consider.

Even as other pension products in the market charge around a 1 per cent fee for managing funds, the fee is just 0.0009 per cent per annum under NPS. The NPS is regulated by the Pension Fund Regulatory & Development Authority (PFRDA).

Under NPS it will be the top mutual fund houses and insurance managers who will manage your money. PFRDA has till date authorised six fund managers- LIC Pension Fund, SBI Pension Fund, UTI Retirement Benefit Pension Fund, IDFC Pension Fund Management, ICICI Prudential Pension Fund, Kotak Mahindra Pension Fund and Reliance Capital Pension Fund to manage pension funds.

The choice of asset allocation and the fund manager from this list is left to the investor. From the structure, the scheme looks investor friendly, but what about the returns?

The equity schemes of NPS managed returns of 8-11 per cent last year; mainly because it was a choppy year for the stock market. Debt schemes managed 11-14 per cent return.

What is NPS?

Government employees were automatic subscribers to a defined benefit scheme of pension until the year 2003, where the government was single-handedly contributing towards the pension funds for its employees. But the onerous pension obligations for the government prompted a rethink of this scheme.

The government moved to a defined contribution based pension system in 2004. Under the new scheme, the employees were required to make a contribution at par with the employer (10 per cent of basic pay plus DA) to the pension fund. In another path breaking change in 2008, the government allowed the pension kitty to be managed by private pension fund managers. Currently three fund managers- LIC Pension Fund, SBI Pension fund and UTI Retirement Benefit Pension fund are managing the government's pension fund.This new pension system was opened to the general public, non-government employees, in May 2009. Any one in the age between 18-55 years can now subscribe to NPS.

All the mandatory contribution of government employees go into the tier I account of NPS. This mandatory contribution is 85 per cent invested in debt schemes and 15 per cent in equity. For any investment that is over and above the mandated contribution, the employee can decide the asset allocation as also the type of account (tier I and tier II).

However, do note that an individual should compulsorily have an active tier I account to open a tier II account. So, if you are a non-government employee and desire to open a NPS account, you should first be opening a tier I account.

 The minimum amount of contribution under tier I account is Rs 500 a month. A tier II account can be opened with a minimum contribution of Rs 1,000 (regular contributions not mandatory).

Investment choices

A NPS subscriber is given two options - active choice and auto choice. In active choice, the investor can decide how much of his money should go into asset class ‘E'- equity (to a maximum of 50 per cent), asset class ‘G'- government securities and asset class ‘C'- other fixed income options (includes liquid mutual funds, corporate bonds, credit rated infrastructure bonds, etc.)

In the ‘auto' option, investments are made in a life cycle fund. Depending on his age, the investor's money will go into a pre-defined portfolio mix. Between 18-35 years, your portfolio will be 50 per cent in equity, 30 per cent in fixed income options and 20 per cent in government securities. As the individual ages, the equity exposure is reduced, terminating at 10 per cent at the age of 55.

Investments in the tier I account can be withdrawn by the investor when he attains 60 years. At the time of withdrawal, it is compulsory that the individual converts at least 40 per cent of the accumulated fund into an annuity (the remaining can be withdrawn as a lump-sum).

Tax benefits

Subscribers of NPS have an added tax advantage. The contribution to NPS is exempt from tax.

At the vesting age, the amount that is commuted (subject to some restriction) is tax exempt.

However, the pension amount that is received from an annuity scheme is taxable under the normal tax slab of the individual.

Mr Vineet Agarwal, Director- Tax and Regulatory Services, KPMG adds that in the recent budget the government has further incentivized NPS subscribers with employer's contribution to NPS removed from the Rs 1 lakh limit under section 80CCE. By this move, the tax-free income of an individual increases - he can use this limit to claim other benefits or increase his contribution to NPS.

Do note that the tier II account is not eligible for tax benefits under the income tax act (it is considered similar to a normal savings account).

How to subscribe?

PFRDA has appointed several POP (point of presence) service providers who are authorised to accept applications for subscription to NPS. You can find the list of providers at PFRDA's website (http://pfrda.org.in/).

On submitting the application form with initial contribution amount and the required KYC details, your account will be opened. After this you will get a welcome kit with a unique account number called - Permanent Retirement Account Number from NSDL.

The NPS accounts are maintained by NSDL. NPS subscribers can contact NSDL for any query on their accounts or for any other grievance. One can find a fund's NAV too at NSDL's website (http://www.npscra.nsdl.co.in/)

Short track record

NPS has been open to general public only in the last one year, making for a limited record to judge performance. Though all the equity schemes have to necessarily invest in index funds that replicate BSE Sensex or NSE Nifty index by the mandate, the schemes are showing divergent returns, for which no explanations have been provided in the website. 

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