Is NPS the right option for your retirement planning?
This article talks about if investors should go with NPS for retirement planning or look at other options which give them more control.
This article talks about if investors should go with NPS for retirement planning or look at other options which give them more control.
National Pension Scheme (NPS) is a defined contribution retirement plan launched in May 2009 with the following features:
NPS contributions are tax-deductible under 80C. There is an additional deduction under section 80CCD for 50,000 i.e. tax payable reduces by 30% (slab rate) times ₹50,000 or ₹ 15,000 per year.
If you are new to NPS, enter with this understanding that, unlike the “defined benefit” pension that our previous generations had, it is a “defined contribution” plan. You invest some money every year, that grows over time and once you reach 60 you can start using that corpus for retirement. The final corpus value and the amount you get to spend in retirement are unknown and depend on 4 things:
NPS replaces the earlier defined benefit old-style pension scheme in Government jobs since the pension bill has ballooned to high figures that are difficult to foot. Instead, under NPS, the participant bears market risk (in both equity and debt markets). The pension they get depends on how much they invest before retirement and how those investments perform.
Unlike the old pension scheme, there is NO guarantee of the pension amount you will receive once you retire.
Related:
Latest NAVs - National Pension System (NPS)
The investment options in NPS are governed by the Pension Fund Regulatory and Development Authority (PFRDA) rules. NPS funds are essentially mutual funds with the following four asset classes described below:
This class invests in stocks like other equity mutual funds, and risks/returns are in line with other equity mutual funds. Large fluctuations in equity funds are considered normal, say 40% or worse falls in a year or 60%+ rise in other years. Unless they have entered the stock market since the post-Mar 2020 bull run, investors are well aware of the nature of this fluctuation.
This class invests primarily in RBI, i.e. Government bonds. These bonds have a sovereign guarantee, i.e. no risk of default. However, based on the time to maturity of each bond in the portfolio, they have interest or duration risk. We extensively cover the concept of duration risk here: Should you match debt portfolio duration with goal duration?, but the summary is that the Scheme G NAV will fluctuate considerably due to interest rate changes in the economy.
This fact may surprise investors new to the concept of duration risk or who have only seen high returns from this category due to falling interest rates in line with global economic trends.
This class invests in corporate bonds, i.e. debt issued by companies, not the Central/State Governments. Apart from duration risk, this category has credit risk also since there is always the risk that the company that has issued the bond can fail to pay back interest and principal.
This class invests in alternative investments in products like Alternative Investment Funds (AIF), Mortgage-Backed Securities (MBS), REITs, InvIts, and other similar investments. Due to their nature, these products are high-risk investments and have existed since 2016 only in NPS. Therefore, we are excluding their discussion in this article. Still, the sequence of return risk applies to this category as well. Since the allowed allocation to this category is capped at 5% of the corpus, it does not make a material difference to the returns of the NPS portfolio.
We have covered asset allocation for NPS in more detail here: Asset allocation for NPS: equity or debt / active or auto?
NPS puts your money behind locked bars
NPS may be a good option for those investors who
If your employer offers to pay 10% of your basic pay into NPS, match it via your contribution since it is a part of your CTC.
Once you have your NPS investments up and running you can track your NPS portfolio value very easily:
Related:
How to use Arthgyaan API to get NPS NAV to calculate your NPS corpus value?
If at least one or two of the above conditions are false makes NPS an unsuitable investment for investors who
The fundamental critiques of NPS are
If you need to break out of NPS before 60, the rule says that at least 80% of the corpus has to be converted into an annuity.
Many proponents of NPS have the following opinion:
Related:
Calculator: UPS vs. NPS - which is better?
We believe young investors should not invest in NPS at all due to blocking the amount until age 60 and the compulsory annuity purchase requirement for 40% of the corpus.
If you still must invest in NPS, restrict the amount to get the ₹50,000 deduction under Section 80CCD and to get any employer match under the corporate NPS scheme since that is a part of CTC. Up to 10% of salary can go to NPS (limit of ₹7.5L) under corporate NPS as the company’s contribution, just like EPF.
Related:
Which is better: save tax by investing 50,000 in NPS or 35,000 in equity mutual fund?
NPS assumes that at 60, you will suddenly become able to manage a large corpus of money on your own once you get the 60% lump sum. So why not start today?
We will consider options that give us both flexibility, liquidity and a wide variety of choices that NPS doesn’t for creating a retirement portfolio.
We will choose:
Can these options replace the auto-pilot inner working of NPS?
They can, and it does not take a lot of time: around one hour of work a year to manage the retirement portfolio. A step-by-step option is given here: A low-stress step-by-step guide to creating a retirement portfolio
On 22-Sep-2023, PFRDA announced a new default scheme under Tier II for government employee subscribers. The complete details are here: What is the NPS Tier II default scheme? Should government sector subscribers opt for it?.
This article discusses how to plan early retirement in the face of lifestyle inflation and lack of health insurance for an investor in their 40s.
Published: 8 December 2024
7 MIN READ
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This post titled Is NPS the right option for your retirement planning? first appeared on 20 Jul 2022 at https://arthgyaan.com