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Can NPS Vatsalya be used to create wealth across generations?

Posted on 09 Oct 2024
Author: Sayan Sircar

Tags: NPS ; Children

9 mins read
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This article explores using the NPS Vatsalya scheme for grandparents to transfer wealth to their grandchildren by gifting them a large corpus to be used to create a pension income stream.

Can NPS Vatsalya be used to create wealth across generations?

This article is a part of our detailed article series on the concept of building and transferring generational wealth. Ensure you have read the other parts here:

How can grandparents invest for their grandchildren?

This article provides multiple options for grandparents to transfer family wealth to their grandchildren.

Building Generational Wealth through an Alternative Retirement Portfolio Planning Technique

This article discusses an alternative retirement portfolio construction method for generational wealth transfer.

📚 Topics covered:

Can NPS Vatsalya be used for generational wealth transfer?
Who should invest in NPS Vatsalya for their grandchildren?
Who should not invest in NPS Vatsalya for their grandchildren?
What are the points to remember before investing in NPS Vatsalya for grandchildren?
How can the grandchild benefit from the NPS Vatsalya corpus?
How much pension will be generated due to one lump sum investment in NPS Vatsalya?

Can NPS Vatsalya be used for generational wealth transfer?

In this article, we will discuss a special case of generational wealth transfer via the NPS Vatsalya scheme. We explore how grandparents can make a large lump-sum investment in the NPS Vatsalya scheme to ensure their grandchildren get a substantial pension amount whenever they want to. We have discussed before why grandparents can invest for their grandchildren: How can grandparents invest for their grandchildren?.

Here is the plan:

choose a considerable sum of money as the initial contribution say ₹50 lakhs
gift the amount to the parent of the child (this transaction is tax-free)
the parent opens the NPS Vatsalya in the name of the child and deposits the gifted ₹50 lakhs

Going forward, the grandparents or the parents can invest additionally into NPS Vatsalya.

We are against opening an NPS Vatsalya for children due to better control of the corpus usage and easier management via mutual funds/shares, FD, and real estate. We have discussed these point and features of the NPS Vatsalya scheme here: NPS Vatsalya details revealed: is it good for your children’s future or avoidable?

However, generational wealth transfer via the NPS Vatsalya can be an option in certain cases as we explain below.

Who should invest in NPS Vatsalya for their grandchildren?

There are three conditions to be fulfilled in case of grandparents choosing the NPS Vatsalya for generational wealth transfer:

the grandparents have excess corpus that they will not use in their projected lifetimes
their children, i.e., the parents of their grandchildren are well settled and do not need this corpus either
the grandchild is small and does not need the corpus immediately

Here are four scenarios where a lump sum investment can be done:

grandparents have recently received a lump sum from sale of real estate or share sale
the parents are settled in abroad and do not need their parents’ money
the grandchild is small and their immediate requirement for college and marriage will be funded by the parents
the grandparents want to ensure that their wealth directly goes to the grandchild bypassing one generation

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Who should not invest in NPS Vatsalya for their grandchildren?

These are three cases where grandparents should not invest in NPS Vatsalya for their grandchildren:

their own children i.e. the parents of the grandkids might need the money more. For example, if there is a large home loan then it will be more beneficial to pay off a part of that loan to free up the EMI which can be further invested.
there are well defined uses of the money for uses like healthcare costs or other requirements for the grandparents
the grandparents would like to give some amount to the grandchildren but not too much. Given that NPS is a pension scheme with poor returns once the pension starts, it does not make sense to put small sums into it.

Also read
Which SGB series should you buy based on the highest discount?

What are the points to remember before investing in NPS Vatsalya for grandchildren?

The amount that goes into NPS Vatsalya scheme account is a one-way journey. You can withdraw up to 1/4th of the invested amount (not the accumulated amount) three times before the child turns eighteen. These withdrawals can happen three years after the account opening.

Once the child is an adult, the account becomes a standard Tier 1 NPS account where:

withdrawal before the age of sixty is allowed if a minimum 80% of the amount is invested in a pension plan
any amount withdrawn after the age of 60 (can be deferred up to 75) must be invested into a pension plan for at least 40% and the rest is paid out tax-free

If there is no need of a pension anytime in the grandchild’s life, then the NPS corpus will be mostly wasted.

How can the grandchild benefit from the NPS Vatsalya corpus?

Pension plans are currently sold only after age 30. So, NPS can be exited once the grandkid becomes 30+

These are three cases where the NPS corpus can be useful to the grandchild:

buy a bigger house in their 30s/40s: liquidate the NPS corpus, use the 20% of the corpus for down payment and pay EMI from the pension income
retire at 60 and invest some of the corpus into a dividend paying stock portfolio while the pension offers an income floor
if the grandchild wants to go into a field where it might take a long time to get established, like in the arts, writing or painting, or simply wants to work in a less stressful job, then the 80% mandatory pension can give a boost to their lifestyle for life

It should be kept in mind that pension income is always taxable at slab rates and are either

fixed and does not increase with inflation
increases at a modest 3% rate but the initial payout is lower

How much pension will be generated due to one lump sum investment in NPS Vatsalya?

We will make two assumptions which will make the mathematics easy to understand:

a single lump sum investment is made
the investment grows at an average 12% rate and inflation is 7%

We will now switch completely to real returns so as to avoid discussing fantastically large numbers. For example, ₹50 lakhs after 50 years at 12% is ₹145 crores but is just ₹4.9 crores after adjusting for 7% inflation.

At 12% return and 7% inflation, the real rate of return is:

1.12 / 1.07 - 1 = 4.67% a year

At this rate, the investment becomes

Years	Corpus
10	1.58x
20	2.49x
30	3.94x
40	6.21x
50	9.81x
60	15.49x

Under these assumptions, the pension at 5% rate for a ₹50 lakhs investment will be

Years	Amount	Pension/month
10	₹79 lakhs	₹32,893
20	₹125 lakhs	₹51,933
30	₹197 lakhs	₹81,995
40	₹311 lakhs	₹1,29,458
50	₹491 lakhs	₹2,04,395
60	₹775 lakhs	₹3,22,711

Reading this table, a ₹50 lakhs investment for 30 years grows to ₹1.97 crore which gives a pension (pre-tax) of ₹81,995. All of this is adjusted for inflation for easy comparison.

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