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NPS Vatsalya details revealed: is it good for your children's future or avoidable?

Posted on 18 Sep 2024
Author: Sayan Sircar

Tags: News ; NPS ; Children

15 mins read
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This article discusses the NPS Vatsalya scheme that does not really offer any greate benefits over simply investing in mutual funds.

NPS Vatsalya details revealed: is it good for your children's future or avoidable?

📚 Topics covered:

What is the NPS Vatsalya Scheme?
Does your child really need a pension plan?
Is the NPS Vatsalya Scheme the only way for your child to get a pension after retirement?
NPS Vatsalya Scheme locks in your money and that is good for your child
What are the alternatives to investing in NPS Vatsalya Scheme?

What is the NPS Vatsalya Scheme?

Union Budget 2024 introduced the concept of the NPS Vatsalya Scheme. This scheme allows parents to open an NPS account for their child and contribute to it. When the child becomes an adult at 18, this NPS Vatsalya Scheme account will become the child’s own NPS account for their retirement at the age of 60. No tax deductions are available to the parent if they invest in the NPS Vatsalya Scheme.

We have covered detailed further arguments against the NPS Vatsalya Scheme here: NPS Vatsalya: A Gimmicky Product That Should Be Avoided If You Are Serious About Investing For Your Children

On 18th September 2024, the Finance Minister revealed these additional details:

KYC of the guardian and date of birth of the child needed
NPS Vatsalya Scheme account can be opened with ₹1,000 and subsequent contributions have to be at least ₹1,000/year. There is no maximum cap on contributions
up to 25% of the invested amount (not the corpus value) can be withdrawn three years after opening the account for education, illness and disability for up to three times
NRI guardians can open this account for their children

The complete details of the scheme are in this thread from the PIB: https://x.com/PIBChandigarh/status/1836320481516855749

Does your child really need a pension plan?

A pension plan gives you money every year until life. Pension is a fantastic product that made a lot of sense in the socialist world of the 1960s-2000s India but is meaningless today. Here are the reasons why we say so:

Pension plans offer fixed payouts which do not grow with inflation
40-60 years later, when these pensions start, India will be more developed and just like Western developed nations, pension yields will be much lower than today

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Is the NPS Vatsalya Scheme the only way for your child to get a pension after retirement?

No, of course not.

A pension plan, very simply, is a deal between an insurance company and you to get regular sums of money until death in exchange for a large lump-sum payment today.

How Does A Pension Plan Work

If you invest in NPS, the government makes it a rule to invest at least 40% of the corpus reached at the age of 60 into a pension plan while the rest is given to you tax-free. You can, of course, invest more than 40% also in the pension plan.

Here are two important points regarding the pension plan:

you don’t need NPS to buy a pension plan. You can go to any insurance company and buy a pension plan today
the pension you get depends on the investments you make over time to reach the corpus at the age of 60

So while the pension payment is guaranteed to you for life, the amount you get as a pension depends on how much you invested into the pension plan.

Imagine two fathers, Ram and Shyam, who invested for their kids Raju and Sanju (respectively) into NPS Vatsalya Scheme. Both accounts were started on the same date when the kids, who were both born on the same date in 2015, turned 10:

Ram starts investing ₹1,000/month
Shyam starts investing ₹5,000/month

8 years later the accounts become major NPS accounts when the kids turn 18. The same amounts keep getting invested. At the age of 25, on their birthday, Raju and Sanju start working. Their fathers stop investing and they start themselves:

Raju starts investing ₹10,000/month
Sanju starts investing ₹50,000/month

They invest the same amount every month for the next 35 years and retire at the age of 60. They take the entire NPS corpus and purchase the pension plan.

Who gets more pension every month?

Obviously, the answer is Sanju since throughout the 50 years (age 10 to age 60) there was more invested in his NPS account. In fact, everything else was the same, except that Sanju’s account had 5 times the amount invested and therefore he gets 5 times the pension than Raju.

You can easily reach the same corpus without NPS by simply investing in mutual funds.

So, if you see a headline in news media that

NPS Vatsalya Scheme lets children receive pension

please understand the nuance that you do not really need NPS Vatsalya Scheme to get a pension for your child.

Also read
Why you must complete your mutual fund nominations before 31st December 2023?

NPS Vatsalya Scheme locks in your money and that is good for your child

This is another flawed argument. Let’s say that lock-in up to 60 is a good thing that stops the withdrawal of the retirement corpus for “frivolous” things.

That is true.

However, retirement corpus, by its very nature, is a multi-crore and multi-decade journey. Since an NPS account can be kept active with just a ₹1,000/year investment, anyone with a tendency to take out retirement money for non-retirement uses, can simply stop investing in the retirement account and use the money not invested for whatever they feel like.

Unless the parents pump in a few crores into an NPS Vatsalya Scheme account and let the child continue that until 60, the lock-in will not help in securing retirement. Even then, once the child is an adult, they can take out the entire NPS corpus, put 80% into an annuity (as per NPS rules on premature withdrawal) and start having “fun” with 20% of the corpus. By the time they reach retirement age, that annuity they purchased when they were young will not even cover a basic sustainable lifestyle.

What are the alternatives to investing in NPS Vatsalya Scheme?

We are not saying that NPS Vatsalya Scheme is bad. We are saying that better alternatives with full flexibility and more options exist once you follow the process described below step-by-step:

Step 1: Identify your child’s goals

Your child’s school and other regular expenses will come from monthly income. But you need to plan for bigger expenses in advance:

Which of these are you saving for:

school admission
school trip to the US at age 14
UG-PG college degrees
house down payment after their first job
marriage

To understand how to create a child’s education plan:

Step 2: Insure yourself first

You need to ensure that an untimely death will not prevent your child from going to their future dream college. Term insurance is the right product here. Every earning member of the family must have adequate term insurance.

The whole family, i.e. child and parents should also have sufficient health insurance. This step prevents loss of income or a setback to investment goals due to illness.

Step 3: Make an investment plan to cover your child

Children’s education and other goals do not exist in isolation. They are a part of the comprehensive goal-based planning that parents need to do for their own retirement and everything else. The process is explained best with these examples:

There are more case studies here: Case Studies.

We have proven that the goal-based investing process works in most market conditions in this article: What is the best way to invest for your child’s college education?.

Step 4: Review the plan once a year

As time passes, things change:

stock markets go up and down creating or reducing portfolio value
income increases or decreases (sabbaticals, parents leaving the workforce to look at the kids, illnesses, parents re-entering the workforce)
the amount of money available increases (windfalls like inheritance or RSUs) or decreases (loss of income, death, medical emergencies)
college degree plans change as the kid grows up

Therefore the plan created in Step 3 has to be reviewed and rebalanced to check if you are still on track: Are your investments on track for your goals?.

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