This year, we've got a new tax-saving vehicle to get the Rs 1 lakh tax deduction. After many near misses, the Pension Fund Regulatory and Development Authority (PFRDA) launched the much-awaited New Pension System (NPS) in May 2008.
Its tier I account can build you a snug retirement nest egg, even if you work for the unorganised sector or are self-employed. It invests your money partly in index funds, has the lowest-cost structure in the market-linked space and has a lock-in up to 60 years of age —— making it an effective retirement vehicle. However, it's still no match for our age-old trusted retirement vehicles, Employees Provident Fund (EPF) and Public Provident Fund (PPF).
What is NPS?
It is a pure defined contribution product, which has a lock-in till 60 years of age. You can begin with a minimum annual contribution of Rs 6,000.
There are two investment strategies available to you.
Active choice: You can allocate your funds across three fund options: equity (under which you can invest up to 50% in equity index funds), fixed income instruments other than government securities and government securities.
Auto choice: Under this your fund allocation is linked to your age. Till 35 years of age, you get 50% exposure to equity, which tapers off to 10% by age 55.
The six fund managers you can choose from are ICICI Prudential Pension Fund Management Co. Ltd, IDFC Pension Fund Management Co. Ltd, Kotak Mahindra Pension Fund Ltd, Reliance Capital Pension Fund Ltd, SBI Pension Funds Pvt Ltd and UTI Retirement Solutions Ltd.
While it is too early to judge the performance of the fund managers, a huge variation is not expected since the funds will primarily invest in debt instruments and the equity component will be restricted to index funds.
On maturity, you get 60% of the fund value as lump sum. The remaining goes into buying an annuity to ensure regular pension. NPS discourages early withdrawal. If you do so, you get only 20% as lump sum and the rest is annuitised.
How does it work?
There are designated points of presence (PoP) that can distribute NPS. Currently there are 22 points of presence. Some of the popular ones are State Bank of India, Central Bank of India, ICICI Bank, Axis Bank, Citibank, Union Bank of India and IDBI Bank.
To open an account, go to one of PoP branches, fill up a form, give your fund preference and make your deposit. This PoP will then send your details to the central record keeping agency (CRA), which will issue you a Permanent Retirement Account Number (Pran). This number is unique to your account and is portable across jobs and locations. You would also be given a telephone and Internet password for fund transfer.
Once this card is issued, the PoP sends the funds to the trustee bank. To make subsequent payments, you would just need your Pran, which can be used at any designated PoP.
Says Rani S. Nair, executive director, PFRDA: "An investor can make contributions in any of the designated branches. However, to make changes in, say, address or fund preference, the customer will have to go to the original branch. In case of a grievance, the customer can approach the CRA and subsequently the PFRDA."
What are the costs?
NPS has two sets of charges-flat and variable. You would need to pay about Rs 470 as flat charges every year, but this is expected to come down as volumes go up. The annual variable charges are custodian and fund management charges-0.0075% (of the fund value) and 0.0009%, respectively. The fund management charges are the lowest in the industry.
What's the tax treatment?
There's no upper limit on the amount that you invest but only 10% of your income is applicable for tax deduction under section 80CCD. However, the deduction would be available subject to a maximum of Rs 1 lakh under section 80C. On maturity, the 60% that you get as lump sum is taxable. The remaining 40% that goes into buying annuity is exempt, but the pension money you would get would be taxable as income in your hands.
What to do?
In its current form, NPS is at a slight disadvantage as compared to other products in the retirement stable. NPS has been given the EET (exempt, exempt, tax) tax status. This means that while your investment is exempt at the time of contribution and at the time of accumulation, it would be taxable at the time of withdrawal.
It is at this point that it loses out to EPF and PPF, which enjoy the EEE (exempt, exempt exempt) tax status. Also, in EPF and PPF, the returns manages to beat mutual fund are guaranteed. But despite the tax shortcoming, NPS pension pension plans and most unit-linked pension plans (ULPP). While ULPPs have EEE status, pension plans by mutual funds are taxed for capital gains.
Pune-based financial planner Veer Sardesai says: "NPS invests your money in an index fund which takes away the risk linked to the performance of the fund manager. However they take a beating in terms of the tax treatment on the maturity amount."
"For effective retirement planning," says Sardesai, "one should exhaust his section 80C with EPF and PPF. If there is still scope, go for NPS instead of MF or insurance pension plans. Beyond 80C, one should look at index funds."
However, if you are not an aggressive investor, then you could look at NPS since it works like a balanced fund. But, once again, do this only after you have exhausted your EPF and PPF benefits.
Also, under the proposed tax regime, direct taxes code, all pension plans will move to EET, making NPS the most cost-effective market-linked pension plan. For now, maximise your EPF and PPF for 80C before you turn to NPS.