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National Pension System (NPS)
September 10 , 2012

National Pension System was established by the government in 2003 to provide retirement savings system for the masses. Back in 2003 the government made it mandatory for all new recruits in the government sector (with the exception of defense services) to subscribe to NPS. Although doors were thrown open in 2009 for the rest of non-government and private sector employees, the scheme has remained a non-starter. Many people liked NPS just for the fact that contributions made to it reduces their income tax liability.

NPS I & II

There are basically two types of NPS accounts- tier I and tier II accounts. Tier I account is a non-withdrawable account. Tier II account can be opened by anyone who holds a tier II account.  It is similar to a savings account from which withdrawals are permitted. Minimum of 1 contribution a year has to be made and any number of withdrawals are permitted subject to minimum account balance of Rs 2,000. 

Anyone between age 18 and 60 years of age can invest in NPS. Once the registration form is filled and submitted to one of the distributors or Point of Presence (PoP), as they are called, a welcome kit containing Permanent Retirement Account Number is mailed to you by the registrar NSDL. You can make minimum monthly contributions of Rs 500 or minimum annual contribution of Rs 6000.     

How does NPS work?     

Since the idea is to create a retirement fund, subscribers contribute to the funds chosen by them until they reach the age of 60 years. On reaching 60 years they exit the fund by allocating a part of the corpus created to annuity.

Contribution has to be made at least once every year. Minimum contribution in a year should not be less than Rs 6000 and minimum amount in each contribution should not be less than Rs 500.  

Subscribers have the flexibility to choose asset classes for investments depending on their risk appetite. Three options are available:

E – Majority of investments in equities

This is suitable for those can afford higher risk, the young starters and early middle aged people.

C – Majority of investments in fixed income bearing instruments

This is suitable for those who can afford lesser risk, those in late 40s

G – Investments in government securities

This is for those who are close to retirement age

Active choice vs Auto choice

You can choose to invest their entire contribution in classes C or G or a maximum of 50% in class E. You can also distribute among the different asset classes subject to PFRDA specified limits. The six Pension Fund Managers (PFMs) offer schemes distributing across these assets classes. You have to choose a PFM to manage your contributions. Presently these are the six pension fund managers –

  • ICICI Prudential Pension Funds Management Co Ltd
  • IDFC Pension Fund Management Co Ltd
  • Kotak Mahindra Pension Fund Ltd
  • Reliance Capital Pension Fund Ltd
  • SBI Pension Funds Private Ltd
  • UTI Retirement Solutions Ltd

If you are unsure about how to go about actively distributing among the asset classes as you reach different age groups, you can go the Auto choice mode. Here the investments will be made in a life-cycle fund. At the lowest age of entry (18 years), the auto choice will entail investment of 50% of pension wealth in E Class, 30% in C Class and 20% in G Class. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in E and C asset class will decrease annually and the weight in G class will increase annually till it reaches 10% in E, 10% in C and 80% in G class at age 55.

What happens after retirement?

On reaching 60 years of age subscribers can exit the scheme by investing a minimum of 40% of the corpus created in an annuity and withdrawing the remaining either as lump sum or in a phased manner between ages 60 and 70 years. If you wish you can leave more than 40% in the annuity. However if you wish to exit NPS before reaching the age of 60 years, you'd be required to invest at least 80% of the corpus created in annuity and the remaining 20% can be withdrawn as lump sum. If investments are not withdrawn till the age of 70 years, the account will be and benefits will be transferred to you. However annuities will continue even after the age of 70 years.

Starting from May 2012 NPS subscribers can choose from six life insurers appointed as annuity service providers (ASPs)- Life Insurance Corporation of India, SBI Life Insurance, ICICI Prudential Life Insurance, Bajaj Allianz Life Insurance, Star Union Dai-ichi Life Insurance and Reliance Life Insurance to manage their annuity on reaching retirement age of 60 years. These then manage and grow the amount deposited with them and pay you annually.

Conclusion

Clearly there is the need to plan for and create streams of income that will provide income and security in old age, since very few fortunate people can bank on government pension. Any investment for long term should always be allocated to market-linked products. NPS was a right step in this direction. The results so far haven't been so sweet to attract many voluntary contributors; the pension system in India still needs much pruning and watering.

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