The recent announcements on improvements in the New Pension Scheme (NPS see here) have created a lot of buzz around the scheme. The most impact is seemingly from the new ‘Exempt-Exempt-Exempt’ (EEE) nature of NPS. In this post we see why NPS is still not a good enough choice for most people as a retirement asset. This is mainly due to constraints on asset mix, early withdrawals and distribution. The discussion focuses on the non-government models in NPS.
Design of NPSBefore we discuss the suitability of NPS, let us look at some salient factors of NPS that are relevant to the discussion. NPS is a reasonably complex system with multiple facets.
NPS modelsNPS started off as a replacement for the previous, defined-benefit, pension system for central government employees. It was later extended to all citizens of India. However, there are 3 models of NPS and they differ quite significantly in many aspects.
- Government Model – This is applicable to the employees of the central government. Those who joined after Jan 1, 2004 are compulsorily part of the system. Many state governments and PSUs are also part of this model.
- Corporate Model – This is applicable to corporates who want to enrol their employees in the scheme. This could be in addition to, or as a replacement of, EPF
- All Citizen Model – This is open to all citizens of India, including NRIs. Any person can be part of this model – of course if they are not covered by the above two models.
NPS investment choicesA major touted benefit of NPS (over EPF and similar schemes) is that the investor can choose to invest in equity also. Overall, NPS defines the following asset classes. Asset Class E- Investment in predominantly equity market instrument. Asset Class C-Investment in fixed income instruments other than Government Securities Asset Class G- Investment in Government Securities Asset class A: Investment in Alternative Investment Schemes including instrument like CMBS, MBS, REITS, AIFs, InvIts etc. The models differ on the choice of asset classes and the maximum permissible limit in them. Please note that for all the models, the maximum permissible limit in ‘E’ – Equity is 50%. The subscriber can actively allocate the contributions towards these asset classes, or choose one of the three pre-defined allocation methods. A very big constraint here is that private sector subscriptions in ‘E’ are limited to either BSE Sensex or NSE Nifty. Yes, as of now, the only equity choices are large cap indices.
Fund Managers and ChargesAnother touted benefit of NPS is the low charges. NPS defines an entity called Pension Fund Managers – these are the equivalent of AMCs and they manage the investment on your behalf. They are specifically empanelled by the Pension Authority (PFRDA). Currently there are 3 for government sector (which would go up) and 8 (including the 3) for the private sector. The current managers are indeed maruqee names in the mutual fund industry. But the AMCs directly don’t manage the pension funds; it is done by separate legal entities. The fund charges are indeed quite low in NPS – 0.01% for fund management. It is unlikely in the near future that the expense ratios in typical mutual funds, even index funds, would come close to this level. However, please note that there is another 0.01% to be paid to the NPS trust. And there is a sort of entry load – a fee 0.25% – to be paid to the intermediary collecting your payments. If you add these charges (see here for a list) the expenses are not too different from a direct plan index fund. Index fund is a very good comparison because private sector subscriptions in ‘E’ are limited to either BSE Sensex or NSE Nifty.
Distribution ChoicesAny retirement plan can be divided into two major phases:
- Accumulation Phase – Contributions are made during active income period towards building the corpus
- Distribution Phase – Withdrawals are made from the corpus during retirement to fund expenses