Decoding the National Pension System (Part II of II)

Salient features of NPS

1. Low Cost - The investment management fee is as low as 0.0009% p.a., irrespective of the type of portfolio the account holder desires. Yes, there are some small fees charged for various purposes, but even then it is claimed that the asset management fee for NPS is a fraction of what Mutual Fund companies charge. 

2. Diversified Investment - The corpus will be invested in three asset classes –– Equity (E), Government Securities (G) and Corporate Bonds and Fixed Deposits (C).

3. Dynamic Asset Allocation -  The account holder can opt for an active choice i.e. change the asset mix at any time he desires or opt for a default option called Life Stage Fund, where the asset mix changes automatically depending upon the age of the subscriber. For example at the age of 18 years, the asset allocation would be 50% in E, 30% in C and 20% in G till the investor turns 35 when the ratio of investment in E and C will then decrease annually, while the proportion of G will rise. At 55 years, G will account for 80% while the share of E and C will fall to 10% each.

Because of the link of NPS with equities, you may stagger your investments in some installments like the SIP of a mutual fund. However, take into account that there is a transaction charge of 0.25% or Rs. 20 (whichever is higher) on every contribution.

4. Low annual contribution -  Minimum annual contribution is Rs. 6,000 per FY payable in one or more installments of minimum Rs. 500.

5.Biased Transparency - Transparency could be improved. Whereas Mutual Funds have to announce their NAV's on a daily basis, NPS would announce NAV on a yearly basis.

Now that we have understood the basics of NPS let us continue to calculations and for the sake of simplicity, I am comparing NPS to only Employee Provident Fund EPF(for now).

In the beginning, Rs 5,000 is put into each every month. Taking into consideration rising income, this amount goes up eight per cent every year. The EPF investment earns 8.75 per cent a year and let us assume (no not the aggressive historic return of 20% of equity markets) the NPS achieves a very conservative return of 12.75 per cent.

तीस साल बाद..... , Rs 68 lakh(approx) have been invested in both.

While the EPF account has Rs 2. crore(approx) in it,  the NPS account on the other hand will have Rs 4. crore(approx)in it. 

With 40 per cent of this amount, (Rs. 1.60 crore) the saver will have to compulsorily buy an annuity which will yield a lifelong pension. That leaves Rs 2.4 crore(approx) for a lump sum withdrawal. The tax outgo on the returns will be indexed but even if we assume that it will be ten per cent, we are left with Rs 2.16 crore!

You see, what the magic of conservative equity returns over a long period means!!

It means that even after paying for a lifelong pension-bearing annuity, and even after paying taxes, the saver will be left with a higher lump sum amount than EPF.

Clearly, this passion of savers for the false safety of fixed income returns, and the fear of the false dangers of equity are a prime cause of old-age financial stress among retirees in India. 

So, don't fall for conventional saving options, and embrace the NPS for your retirement savings. Of course, that doesn't change the fact that it's truly unpardonable for the government to give EPF and PPF a free pass on taxes and yet tax NPS at maturity.

With that let us come to the landmark announcement by our Finance minister in this year's budget. 

In order to give a (much needed) fillip to NPS, the FM has proposed a separate deduction of Rs. 50,000 over and above the current deduction of Rs. 1,50,000 available u/s 80CCE for contributions to NPS. Consequently, now it is possible for a taxpayer in the 30% tax bracket to save up to Rs. 15,450 in tax every year over and above what he could do so far. 

There is No Doubt that Retirement Planning should be the Numero Uno Financial Goal in any investors mind especially with rising life expectancy! I hope this tax benefit for NPS provides the boost in this direction.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source Behaviour Gap, PFRDA

Decoding the National Pension System (Part I of II)

This year the finance minister in his budget speech on 28th Feb 2015, made a revolutionary announcement with regards to the National Pension System or NPS. He created a separate window of tax deduction for this financial product aimed at retirement. Now, before we understand this budgetary provision in detail, let us take a look at the product, because even for a financial adviser like me, this product was quite confusing in its first impression.

What is NPS?

NPS or the National pension system was launched on 1st January, 2004 with the objective of providing retirement income to all the citizens. NPS aims to institute pension reforms and to inculcate the habit of saving for retirement among the citizens.

What are the different options available in NPS?

There are two options available, but for those who want to save for retirement and avail tax benefits you have to open Tier I Account.

Why you need to open a NPS A/c?

1. It is transparent - NPS is transparent and cost effective system wherein the pension contributions are invested in the pension fund schemes and the employee will be able to know the value of the investment on day to day basis.

2. It is simple - All the subscriber has to do, is to open an account with his/her nodal office and get a Permanent Retirement Account Number (PRAN).

3. It is portable - Each employee is identified by a unique number and has a separate PRAN which is portable i.e., will remain same even if an employee gets transferred to any other office.

4. It is regulated - NPS is regulated by Pension Fund Regulatory and Development Authority, with transparent investment norms & regular monitoring and performance review of fund managers by NPS Trust.

What are the tax benefits of opening a NPS A/c.?

Presently, the tax treatment for contribution made in Tier I account is Exempted-Exempted-Taxed (EET) i.e., the amount contributed is entitled for deduction from gross total income upto Rs.1.50 lakh (along with other prescribed investments) as per section 80C (as per the provisions of the Income Tax Act, 1961 as amended from time to time).

The appreciation accrued on the contribution and the amount used by the subscriber to buy the annuity is not taxable. Only the amount withdrawn by the subscriber after the age of 60 is taxable.

Additional Benefit Available till 31 March 2017

To encourage people from the unorganised sector to voluntarily save for their retirement the Central Government launched a co-contributory pension scheme, 'Swavalamban Scheme' in the Union Budget of 2010-11. Under Swavalamban Scheme, the government will contribute a sum of Rs.1,000 to each eligible NPS subscriber who contributes a minimum of Rs.1,000 and maximum Rs.12,000 per annum. This scheme is presently applicable upto F.Y.2016-17.\

What are the charges applicable?

To be continued....

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Don't invest in Khatkhatem products choose Tax savings mutual funds instead.

A couple of weeks back I had written about an unhealthy concoction of investment products. After reading it one of the readers sent me a couple of queries on a popular messaging platform.

After carefully going through his queries and answers, here are my inputs....

1. I fully agree to his view that I need to make an apple to apple comparison, and the shortfall (27 years hence) is just Rs. 3 lakhs, but imagine that time in future when you will fall short of that same 3 lakhs for your child's wedding/ buying your dream car/house and you have to avail a loan for that purpose even after very well knowing that you could have achieved it easily by avoiding the 'khatkhatem' product.

2. I do not agree to his premise about the hassles of multiple products, as you can easily set up a direct debit (ECS mandate) in your bank account for the specified tenure for both the products, remember this needs to be done only once and the future debits will take place automatically.

3. I also differ from his view that most Indians would never psychologically invest in a term plan, as this article states that sales of online term plans are rising by 40%.

4. It is also important to note that, where pension income receive from insurance companies is taxable, withdrawals from PPF are totally tax free.

While it is great to see that my readers are financially literate (not taking the things I write for granted) and are aware of what is going on, this time I would like to build another perspective, and yes it must include Mutual Funds (what else).

I have talked about tax saving Mutual Funds (ELSS) earlier too but let us put them to use now by preparing a  Retirement Plan for the same friend I was talking about a couple of weeks back.

I have assumed that he is going to invest the same amount of Rs. 61,000/-(70,000 less term insurance premium) per year only on a monthly basis.

So, the investment per month is of Rs. 5,080/-

Let us now assume that in the next 27 yrs we will achieve only half the returns.

So 15% (approx)

Investment amount 

= Rs 5,080 x 12(months) x 27(yrs)

= Rs. 16.45lacs(approx)

Value after 27 years @ 15%

= Rs. 1.86 crores

It is clearly seen that even after applying probability of risk(50%) this investment is still worthwhile and generates better wealth in the long term.

So what are you waiting for.... start a SIP in Tax saving mutual funds today.......

Don't forget to download the friday financials app on android

Disclaimer : Funds are used for depicting long term performance and should not be construed as advice for investment.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source Valueresearch online