PERSONAL FINANCE: NPS catches investors’ fancy

Sound returns and additional tax benefit of ~50,000 have led to doubling of subscribers. But, taxation remains a sore point

Sound returns and additional tax benefit of ~50,000 have led to doubling of subscribers. But, taxation remains a sore point. SANJAY KUMAR SINGH writes

On May 1, the National Pension System (NPS) for all citizens will complete eight years. The number of investors in the scheme for the unorganised sector doubled to 439,000 in 2016-17. The sound performance of funds, additional tax benefit of ~50,000, and the many changes that have enhanced the attractiveness of the scheme have led to increasing number of investors joining it.

Returns close to benchmark: NPS funds have given attractive returns in 2016-17 (see table). Returns of equity funds hover around the benchmark. “Though active fund management has been allowed, equity funds of NPS still appear to be in index-hugging mode,” says Manoj Nagpal, chief executive officer (CEO), Outlook Asia Capital. This is unlike equity mutual funds (diversified category) where returns varied from 10-49 per cent over the period. There is not much of a case at present for changing your pension fund manager (PFM) based on equity funds’ performances.

As for the debt funds of NPS, their returns need to be viewed differently from those of debt mutual funds. In the latter, the fund manager garners returns from coupon, trading income, and mark-to-market gains. “The PFMs hold papers till maturity in NPS. There is no trading income and the mark-to-market gain is also notional because papers are redeemed on maturity at face value,” says Nagpal. Therefore, he says, the net asset value (NAV) returns of debt funds are not significant for investors. He suggests investors select a corporate bond fund that holds papers of the highest credit quality and offers a reasonable yield to maturity. (Yield to maturity data is available in the portfolios disclosed by PFMs.) Since one has to choose the same PFM across all fund categories (E, C and G), you could then go with the gilt and equity funds of the same fund manager.

New fund managers soon: The process of giving licences to pension fund managers is underway. “Subscribers need not worry about having to change their PFM. All the seven existing players’ licences will be renewed and two new ones will be appointed,” says Sumit Shukla, CEO, HDFC Pension Management.

Costs creeping up: The cost of fund management is one basis point currently. All the players have bid between seven and 10 basis points, which is what the new fund management cost will be. “Even at the new levels, NPS will be much cheaper than other investment options. Cost should not be an important consideration for deciding whether to invest in NPS or for selecting your PFM,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Partial withdrawal allowed: You may now withdraw up to 25 per cent of your contributions from NPS under some circumstances. The Union Budget 2017 made these withdrawals tax-free. “This measure has made NPS more tax-efficient. At the same time, people should avoid using up their retirement corpus for other purposes as far as possible,” says Dhawan.

The provision that you can withdraw up to 25 per cent of your contribution (and not the corpus value, which over time will be significantly bigger) is meant to ensure the retirement corpus doesn’t get exhausted.

Port from superannuation funds: Tax-free portability between superannuation funds and NPS has been permitted. “Four to five years prior to retirement, shift from a superannuation fund to NPS, as this will bring you several benefits,” says Shukla. In superannuation funds, 66 per cent of the corpus goes into annuities, while in NPS it is limited to 40 per cent. In superannuation funds, 33 per cent of the final corpus is tax-free; in NPS, it is 40 per cent. Also, when you buy an annuity from a superannuation fund’s corpus, you have to pay service tax. No such tax is levied when you buy using the NPS corpus.

New fund options: To build a significant retirement corpus, young investors need an aggressive portfolio. Earlier, NPS allowed allocation of up to 50 per cent in equities. In November 2016, the Pension Fund Regulatory and Development Authority introduced two new lifecycle funds: Aggressive life cycle (LC 75) and conservative life cycle (LC 25). “LC75 will be beneficial to people in the 25-41 age group who wish to take more than 50 per cent exposure to equities,” says Nagpal.

Investment up to five per cent has been permitted in a fund that will invest in alternative investment funds, real estate investment trusts and infrastructure investment trusts. Investors should wait until this fund category, suited only for aggressive investors, develops a track record. The mere five per cent allocation means the impact on overall portfolio return might not be significant.

Online option: You can now open the NPS account online. Any changes you wish to make to your scheme options can also be done online. This has made transacting much easier.

Should you invest? Those who don’t invest in NPS cite two points against it. One, while instruments like Public Provident Fund (PPF) and Employees’ Provident Fund (EPF) are tax-exempt at all stages, NPS gets taxed at retirement. Some experts, however, believe taxation is not a significant disadvantage now. By allowing partial withdrawal to be tax-free, the finance minister has softened the tax blow.

Moreover, 40 per cent of the final corpus is tax-free. The annuitised portion also doesn’t get taxed immediately, though the income from it does get taxed. Only the remainder portion of the final corpus gets taxed immediately. “Over a significant period, the overall impact of taxation on your return will not be more than 20-25 basis points. If you believe NPS can earn 25 basis points more than other retirement options, invest in it,” says Nagpal.

Compulsory annuitisation remains an issue since annual returns from annuities are low, around seveneight per cent. Permitting withdrawal through the systematic withdrawal plan (SWP) mode is under consideration. Until then, invest ~50,000 annually to benefit from the additional deduction provided under Section 80CCD.