Pros and Cons of the NPS

What is the National Pension Scheme?

The National Pension Scheme is a voluntary, contribution-based retirement savings scheme introduced by the Government of India. Retirement Planning in India through NPS is open to all Indian citizens, including the self-employed and the unorganized sector. The scheme is managed by the Pension Fund Regulatory and Development Authority (PFRDA) and offers a range of investment options to suit the risk appetite of individuals.

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Pros of the National Pension Scheme

• Tax Benefits: The NPS offers attractive tax benefits to individuals. Contributions made towards the scheme are eligible for tax deductions under Section 80C of the Income Tax Act, 1961. Additionally, an exclusive deduction of up to Rs. 50,000 is available under Section 80CCD(1B), making it an excellent tax-saving instrument.

• Flexibility: NPS provides a range of various investment options and a choice of PFs (Pension Funds) for planning the investments growth in a reasonable way and monitoring the growth of the pension corpus amount. Subscribers are allowed to switch from one option of investment to another or from 1 fund manager to another. 

• Opening an account is simple: Account opening with NPS offers a PRAN (Permanent Retirement Account Number), which is a unique number that remains with the subscriber all over his/her life. This scheme is divided into two tiers:

  • Tier-1 account: It is the non-withdrawable retirement account in which the regular contribution made by the subscriber atre added and then invested as per the fund/portfolio manager selected by the subscriber. 

  • Tier-II account: It is a voluntary account that is withdrawable. This is only allowed in case of an active tier-1 account on subscriber’s name. 

• Portability: Another advantage of the NPS is its portability. Subscribers can conveniently shift their NPS account from one sector or location to another, allowing for seamless management of their retirement savings irrespective of job changes or relocations.

• Withdrawal Exemptions: The NPS provides exemptions for partial withdrawals in specific situations, such as higher education, purchasing a home, or medical emergencies. This flexibility allows individuals to meet unforeseen financial requirements while still maintaining their retirement savings.

• Option of Opening Multiple Accounts: Individuals can open multiple NPS accounts, allowing them to segregate their investments based on different financial goals or risk preferences. This feature provides greater control and customization over their retirement savings strategy.

• Double benefit of compounding power and low cost: The pension wealth accumulation grows over time till retirement with a compounding effect. The maintainence charges of account are low, the benefits of accrued pension wealth to the subscriber becomes large eventually. 

• Easy Access: The NPS provides easy access to account information and transactions through online portals and mobile applications. Participants can conveniently monitor their investments, contribute funds, and make changes to their investment preferences from the comfort of their homes or offices.

• Wide Coverage: The NPS is open to all Indian citizens, including employees from the public, private, and unorganized sectors. This wide coverage ensures that individuals from different walks of life can participate and secure their retirement savings through this government-sponsored scheme.

• Safeguarding the Investments: The NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA), ensuring that the investments made by individuals are managed and safeguarded by authorized fund managers. This regulatory oversight enhances transparency and instills confidence in the system.

• Easy Documentation: The process of opening an NPS account and managing the investments is straightforward and involves minimal documentation. This ease of documentation eliminates unnecessary paperwork and simplifies the participation process for individuals.

• Low Investments: The NPS allows individuals to start investing with a low minimum contribution, making it accessible to a wide range of individuals. This feature encourages early participation in the scheme and enables individuals to accumulate substantial savings for their retirement over time.

• Higher Returns: The NPS offers the potential for higher returns compared to traditional fixed-income investment options. By investing in a mix of asset classes such as equities, government bonds, and corporate bonds, participants have the opportunity to earn competitive returns over the long term.
  Individuals can use the NPS calculator to find the potential growth of their investments over time.

• Multiple NPS Funds: Depending on an individual's financial objectives, they can opt for a specific asset category and then select the most suitable manager for their NPS funds. 

Each asset category has a specific investment limit. NPS offers four asset classes:

• Asset Class A: Investments in assets such as Commercial Mortgage-Backed Securities (CMBS), Real Estate Investment Trusts (REITs), and Infrastructure Investment Trusts (InVITs).

• Asset Class C: Investments in corporate bonds.

• Asset Class G: Investments in government bonds issued by central and state governments, or Government Securities.

• Asset Class E: Investments in equities or stocks.

The allocation of assets within NPS can be done through either the Active Choice or

Auto Choice options.

• Active Choice: Subscribers have the freedom to decide the percentage of funds to allocate to each asset class, like E, C, and G. However, the allocation to equities should not exceed 75%.

• Auto Choice: Investments are handled by the fund manager, who determines the asset allocation percentages based on the subscriber's age.

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Cons of the National Pension Scheme

• Mandatory Annuity Purchase: On maturity, the NPS requires subscribers to utilize a certain percentage of the accumulated corpus to purchase an annuity. While this guarantees a regular income stream during retirement, it limits the flexibility to utilize the entire corpus as per individual needs.

• Market Volatility: The NPS offers an option to invest in equities, which can be subject to market fluctuations. While equities have the potential for higher returns, they also involve a higher level of risk. Subscribers should carefully assess their risk tolerance before allocating funds to equity-based investment options.

• Account Opening Restrictions: Account opening restrictions in the National Pension Scheme (NPS) dictate that an individual can hold only one NPS account throughout their lifetime. This means that through their NPS CRA login, they can maintain a single account. Although the Permanent Retirement Account Number (PRAN) can be transferred across different geographical locations and employment opportunities, each individual is entitled to only one PRAN.

• Lock-in Period: The NPS has a long lock-in period until the age of retirement. Premature withdrawals are not allowed except under specific circumstances, such as critical illness or disability. This may restrict liquidity for urgent financial needs.

• Withdrawal Limit: In addition to the predetermined lock-in period of the NPS, there are limitations on withdrawals from the pension account. The NPS imposes restrictions on all types of withdrawals until the subscriber attains the age of 60. The subscriber is eligible to make the initial withdrawal from the NPS after a period of 10 years from the opening of the account. Furthermore, they can make a total of three withdrawals until they reach the age of 60. Withdrawal amount cannot exceed the cumulative sum of the subscriber's contributions.

• Limited Investment Choices: Although the NPS provides flexibility, the investment choices are limited to the funds offered by the Pension Fund Managers (PFMs). Subscribers must evaluate the performance and track record of the available PFMs before making investment decisions.

• Limited Exposure to Equities: The restriction on equity investment has been capped at 75%, which could pose a notable concern for individuals in their twenties and thirties. This means that there is a potential missed opportunity to gain exposure to the equity markets.

• Tax on Annuity Income: While contributions to the NPS offer tax benefits, the annuity income received post-retirement is taxable as per the prevailing income tax laws. Individuals should consider this tax liability while planning their retirement income strategy.

• Challenges in Selecting the Optimal NPS Fund Manager: The process of selecting the most suitable NPS fund manager can be challenging for individuals who lack knowledge about financial terms such as equities, debt, securities, and other related concepts. As a result, they may struggle to identify the optimal NPS fund manager to handle their investments.

In a Nutshell!

The National Pension System (NPS) offers a systematic and transparent approach to retirement planning, with the potential for tax benefits and customization. It is essential for individuals to assess their financial situation, risk tolerance, and long-term goals to determine whether the NPS aligns with their retirement planning needs.

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