Why NPS deserves more attention from investors looking for retirement products

Dev Ashish

For a product that was launched for all citizens of India in 2009, the NPS All Citizens model has an AUM of just about Rs 14,000 crore (end-May 2020). This isn’t a large figure compared to the size of many individual mutual fund schemes.

And if you compare it with the overall NPS AUM of Rs 4.3 lakh crore (which is primarily made of government sector employees), it’s clear that NPS still isn’t a popular choice among common people.

NPS has a few features that make people avoid it. But some of those features are actually blessings in disguise. We will come these in a bit.

But there is another reason for the low popularity of NPS.

Low incentive for selling

Given the low incentive structure for its sale, it is not a viable option for commission-driven product sellers and agents. And that is the reason NPS is still trying to find its feet among common citizens even after a decade. If it had a commission structure even remotely close to that of traditional insurance plans (or even mutual funds), agents would have been killing each other to sell NPS as the best thing that money can ever buy.

And had it not been for the additional Rs 50,000 tax benefit offered under Section 80CCD (1B) exclusively for NPS subscribers, the product wouldn’t have garnered even its current size.

But let’s come back to the product itself.

If the low agent-push part is ignored, then a few features of NPS that many have problems with are:

- Money locked in for a very long time (decades for someone starting early);

- Large part of portfolio (minimum 40 per cent) to be mandatorily used for purchase annuity at maturity; and

- The annuity pension income is taxable.

And that’s not all. NPS being a kind of hybrid equity + debt product, is unfairly compared to pure ones such as EPF (debt) and Equity funds (equity).

Earlier, the NPS corpus at maturity wasn’t fully tax-free. But now 60 per cent is available as a tax-free lump-sum payout. The remaining 40 per cent also isn’t taxed but is used for annuity purchase that eventually gets taxed. So in a way, NPS is currently somewhere ahead of EET but not truly EEE.

But to be fair, for most people, the taxable income during retirement is low. So, even if the annuity pension is taxed, chances are that the applicable tax rates will be very low or in many cases, nil.

Most people don’t realize this and use blanket arguments like ‘annuity taxation is a showstopper.’

Annuity, not that taxing

As an example, let’s suppose a person accumulates Rs 1 crore in NPS. So, Rs 60 lakh is available tax-free. The remaining Rs 40 lakh is annuitized (say at 6-7 per cent). This would mean an annual income of about Rs 2.4-2.8 lakh. And if there are no other regular income streams, then this is tax-free given current taxation slabs. It’s possible that person may have some money in PPF, FDs, etc. as well. But a well-structured withdrawal strategy from NPS and other products during retirement can reduce taxation to a bare minimum, if not to zero.

Another reason people look away from NPS is that the compulsory annuitization takes away the flexibility as one is forced to put 40 per cent corpus in low-yielding annuity plans. And no doubt this is a pain point. But remember that NPS is the only product that gives importance to putting in place a predictable income stream in your retirement years. The rest of the products don’t focus on this aspect.

So, from a retirement corpus diversification perspective and the fact that annuity ensures a life-long pension for the investor, this is something that might be good for many who are not disciplined enough to generate a regular income from a large corpus.

By the way, there are a few proposals in the works where the PFRDA is looking for better alternatives to the current 40 per cent annuity rule.

As for the lack of liquidity, I think it’s a part of the deal and a good thing actually. NPS is a pure retirement product. It’s not meant for anything else and hence, discourages premature withdrawal. You should never dip into your retirement savings for other goals. And ideally, if someone is doing goal-based investing, there wouldn’t be a need to withdraw from NPS for other things.

All said and done, NPS isn’t that bad a product as it is made out to be at times. In fact, given its mandate of being a pure retirement product, it does a fairly decent job.

Not everyone needs NPS if they are already contributing sufficiently in EPF, PPF, equity via mutual funds and other products suitable for retirement.

But for many others, NPS can be used as part of overall retirement portfolio. NPS alone may not be enough for retirement.

Before choosing it, it’s important to consider investor’s risk profile, requirements and other retirement saving products already being invested in.