Wednesday, August 3, 2011

Informative -- National Pension Scheme (NPS) or New Pension System


We have been hearing about National pension scheme or New pension system, this article will address as to what is NPS.

Lets understand pension first, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. In some countries they are also called as retirement plans or superannuation.

How does it work?

In case of government employees or public servants a part of their salary is contributed towards pension scheme provided from their organizations.  This individual contribution is administered by Employees Provident fund organization of India (EPFO). EPFO is a statutory body of government of India under Ministry of Labour and Employment which administers a compulsory contribution of Provident fund, pension and also an insurance scheme for Indian work force.

Superannuation or retirement pension is payable upon fulfillment of the below conditions:
1)      Completes 10 years of service
2)      Attaining age of 58 years.
Contribution made by the employee every month is invested in government securities ,fixed income securities and other debt instruments.

What is the National Pension Scheme (NPS)?
The NPS is a new voluntary contributory scheme introduced by Government of India through Pension fund Regulatory and development Authority (PFRDA) to promote savings for retirement or income on retirement. This is a purely a voluntary contribution scheme available to all the citizens of India other than those who are already covered under the pension scheme.  Under the NPS individuals who open retirement account will be provided by PRAN (permanent retirement account number) through PFRDA.

To an INDIAN citizen the following two types of accounts will be available:
1)      Tier 1 account: Citizen shall contribute savings for retirement into his non-withdrawal account.
2)      Tier 2 account: Citizen shall contribute savings for retirement. In this case he/she is allowed to withdraw whenever they wish.
Minimum contribution is Rs 500 per month or Rs 6000 annually. Minimum number of contributions is 4. One can invest in both Tier 1 account and Tier 2 account.

Every individual has a choice of investment type he/she wants to subscribe.

Active choice:  In this option the individual is allowed to invest in any of the mentioned below choice of investment option.
Ø  Asset Class E:  Invest in Equity markets up to a maximum of 50%.
Ø  Asset Class C: Investment in fixed income securities other than government securities like bonds.
Ø  Asset Class G: Investment in government securities.
An individual is allowed to invest the entire fund in C or G asset classes, or up to a maximum of 50% in Asset Class E and remaining in other 2 classes. 

Lifecycle choice:  In this option the investment will be made considering 3 major factors, Age, risk taking ability and planned retirement age. Refer the below mentioned table as to how the investor contribution will be invested.


Investment of the individual wealth or contribution
Age of individual
Asset class E
Asset class C
Asset class G
between 25 to 30 years
50%
30%
20%
Between 30 to 35 years
50%
29%
21%
36 years
48%
29%
23%
37 years
46%
28%
26%
38 years
44%
27%
29%
39 years
42%
26%
32%
40 years
40%
25%
35%
41 years
38%
24%
38%
42 years
36%
23%
41%
43 years
34%
22%
44%
44 years
32%
21%
47%
45 years
30%
20%
50%
46 years
28%
19%
53%
47 years
26%
18%
56%
48 years
24%
17%
59%
49 years
22%
16%
62%
50 years
20%
15%
65%

All this is managed by pension fund managers, ICICI pension fund management, IDFC pension fund management, KOTAK Mahindra, Reliance Capital, SBI pension funds, UTI retirement solutions and annuity service provider.
Once the investment is done NAV or Net Asset value of the contribution will be released at regular intervals, so that investor will be able to take an informed decision. On this basis an individual can switch from current portfolio. Currently only one switch is allowed in a year (NAV will be discussed in detail in my following blog).
The government through PFRDA charges .009% fee for managing your wealth. The charges are as follows:
Opening account charges Rs 50, Annual PRA (permanent retirement account) maintaining charges Rs 350, Initial subscriber registration charges for selecting either of the investment type mentioned above Rs 60, Custodian charges are at .075% pa deducted through NAV and finally the investment management fee of .009% pa deducted from NAV.

Tax advantage

This forms part of Sec80C of income tax act , where an individual is eligible for tax exempted upto Rs 1 lakh. 
Although upon withdrawal of the pension amount the interest component is taxable.


Think point: Does this sound like a Mutual Fund, Watch out for more on this space I will blog on Mutual funds in my next Post.



3 comments:

  1. Is this a better option than Mutual fund? Since its introduced by Govt, is this more reliable?

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  2. Anonymous
    We have to keep in mind that NPS does not guarantee any fixed returns unlike other government instruments PPF, kisan vikas patra, etc... it all depends upon how your fund manager performs(ICICI, SBI,KOTAK etc..). One thing is clear that the charges are very low or rather least as compared to any financial instrument in the world. We can say that it is more reliable as it is closely monitored by PFRDA.

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  3. UPDATES

    Depending upon the age of withdrawal from pension account, the following benefits are available:

    At any point in time before 60 years of age: The sub-scriber is required to invest at least 80% of the pen-sion wealth to purchase a life annuity from any regu-lated life insurance company. The remaining 20% may be withdrawn as a lump sum.

    On attaining the age of 60 years and up to 70 years of age: The subscriber is required to invest a minimum of 40% of the accumulated savings to purchase a life annuity from any regulated life insurance company. The remaining pension wealth can be withdrawn ei-ther in a lump sum upon attaining the age of 60 or in a phased manner between the ages of 60 and 70 at the discretion of the subscriber.

    Death due to any cause: A beneficiary will receive 100% of the pension wealth in a lump sum.

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