Retirement planning involves disciplined saving, vigilant investment to build a sufficient retirement corpus and its judicious drawdown in the postretirement phase. The National Pension System (NPS), launched by the Pension Fund Regulatory & Development Authority, takes all these concerns into account. It is a sophisticated innovation based on the world's best practices in the pension sector.
While saving for a long-term goal such as retirement, the cost matters a lot. Over 35-40 years, the charges can shave off a significant amount from the corpus. The NPS charges fund management fees of 0.0102% for the government employees and there's a ceiling of 0.25% for the private sector. This is perhaps the lowest in the world. Other charges are also low, making the cost-adjusted returns of the NPS quite attractive. It is estimated that the total cost of the NPS, including the fund management fee, will not exceed 0.5% per year, making it the cheapest financial product in India.
The NPS is a well-regulated, transparent and flexible scheme. It has laid down prudent investing norms for fund managers, and their performance and portfolios are regularly monitored by the NPS Trust under the overall supervision of the PFRDA. The scheme offers complete flexibility. The investor decides the percentage of the corpus that goes into equity, corporate bonds and government securities. There is only a 50% cap on exposure to equity.
One of the most outstanding features of the NPS is the 'lifecycle fund' . It is meant for those who are not financially aware. It is also the default option for someone who has not indicated his desired allocation. Under this option, the investor's age decides the equity exposure. The 50% allocation to equity is reduced every year by 2% after the investor turns 35, till it comes down to 10%. This is in keeping with the strategy to opt for a higher-risk , higher-return portfolio mix earlier in life. As the investor approaches retirement , he shifts to a more stable, low-risk portfolio.
This automatic rejigging of the allocation is a unique feature of the NPS. No other pension plan or mutual fund offers such a facility to investors. There are a few funds based on age, but they are one-size-fits-all solutions, not customised to the individual's age.
Another unique feature of the NPS is the tax benefit it offers under the newly added Section 80 CCD(2). Under this section, if an employer contributes 10% of the salary (basic salary plus dearness allowance) to the NPS account of the employee, this amount gets tax exemption. This is over and above the 1 lakh tax deduction under Section 80C. It's a win-win situation for both because the employer also gets tax benefit under Section 36 I (IV) A for his contribution. By putting in money in the NPS, the employer can provide an additional tax benefit to the employee by simply restructuring the salary at no extra cost.
The NPS allows one to accumulate the corpus from the age of 18 for 40-odd years. There is minimal leakage in the form of withdrawals for competing consumption expenses. This allows the investor to reap the benefits of compounding till he turns 60.
The NPS also offers the flexibility to draw up to 60% of the retirement corpus as a lump sum to meet financial life goals like children's marriages, housing, or draw down the lump sum in a staggered manner till one is 70 years old. The rest can be used to buy an annuity from any of the seven Irdaregulated annuity service providers.
—The author is the Chairman of the Pension Fund Regulatory and Development Authority.