Five big changes in the NPS

For folks who are not keen to build their retirement portfolio brick by brick, National Pension System (NPS) has been a good choice. It allows investors to choose their own allocation to equities, bonds and alternates. It has delivered respectable returns of 13% to 14.6% on equities, 8% to 8.6% on corporate bonds and 7.8% to 8.8% on gilts in the last 10 years. 

However, like all government schemes, NPS has one too many rules dictating your investments and exit. To popularise it, the PFRDA (Pension Fund Regulatory and Development Authority) has now gone into an overdrive, overhauling it. If you are an investor, here are five big changes to the NPS you should know about. 

# 1 From 40% to 20% annuity 

Many folks hesitated to put big sums into their NPS Tier 1 account because of the 40% annuity rule. This rule said that when you go for a ‘normal exit’ from NPS (that is close your account at 60 or after) and finally withdraw the funds you’ve accumulated, you had to compulsorily invest 40% of your maturity proceeds in an annuity plan (from insurers that PFRDA approves). 

This was a pretty bad deal, because annuity plans in India offer measly pre-tax returns of 5-6%. They lock-in your upfront investment for life, set stiff penalties for surrender and do not offer any inflation adjustment on the pension they provide. Annuity income is also taxable at your slab rate. 

PFRDA has now slashed the annuity requirement on normal exit from NPS by half from 40% to 20%. So, on closing your NPS account, you can now take home 80% of your accumulated corpus as lumpsum with only 20% going into annuities.  

One grey area though is the tax treatment of this lumpsum. Currently, Section 10(12A) of the Income Tax Act exempts upto 60% lumpsum payment made to NPS subscribers on normal exit, from tax. If the lumpsum now rises to 80%, 20% of this will get taxed. It remains to be seen if the upcoming budget fills this gap and raises this tax exemption from 60% to 80% of the lumpsum. 

Do note that the 20% annuity applies only to the All Citizens Model (individually opened accounts) and Corporate model (where the employer offers the scheme) of NPS. It does not apply to government employees who still need to invest 40% of their final proceeds in annuities. 

Impact: The reduction in annuity requirement makes the NPS far more attractive than before. It makes the corporate bond (C ) and government bond (G) options particularly appealing, as 60% of your maturity amount from these debt investments will now be tax-free.  This contrasts with taxation at your slab rates for returns from other debt instruments such as bonds, fixed deposits and debt mutual funds.   

PFRDA has brought in another useful amendment too and that is the concept of a 15-year vesting period for NPS. Until now, if you wanted early exit from the NPS, you had to abide by its ‘premature exit’ rules. These said that if you exited before the age of 60, you could take out only 20% of your corpus as lumpsum and had to invest 80% in annuities. This was a very big deterrent to early exit from NPS and effectively forced investors to stay with the scheme until age 60. 

But now, you can close your NPS account and withdraw 80 per cent of your money as lumpsum (20% annuity) if you complete the vesting period of 15 years with the scheme or turn 60 years of age, whichever is earlier. 

Impact: This is incentive to start your NPS account as early as possible. Open the account in your early twenties starting with a token sum of Rs 1000. If you manage to do this by 25, you can look to exit the scheme from the age of 40. This will allow early retirees and those taking VRS to monetise their NPS savings without waiting for their 60^th birthday. This facility however applies only to All Citizens Model and not to Corporate or Government subscribers. 

# 2 Higher lumpsum withdrawal  

While insisting on compulsory annuities for larger balances, the NPS offers some concessions to investors who have accumulated smaller sums in their retirement accounts and want to normally exit the scheme (at 60 or after completing 15 years). 

Earlier, subscribers with balances of upto Rs 5 lakh in their account during normal exit, could withdraw the entire sum at one go without any annuity. The latest amendment increases this limit. 

Now, if your NPS balance at normal exit is Rs 8 lakh or less, you can withdraw 100% of the amount as lumpsum. You also have the option of choosing two other new withdrawal routes introduced by NPS – Systematic Unit Withdrawal (SUP, which resembles SWPs in mutual funds) and Systematic Lumpsum Withdrawal (SLP, where you can withdraw fixed sums in instalments). 

However, in a strange twist, if your final balances are between Rs 8 lakh and Rs 12 lakh at normal exit, you can only withdraw Rs 6 lakh as lumpsum and must use SUR or annuity for the remaining. If your corpus is over Rs 12 lakh, you can take out 80% as lumpsum but invest 20% in annuities. 

Impact: If your final NPS balance is a little above Rs 8 lakh and your normal exit is coming up, you can use partial withdrawals to reduce your balances to Rs 8 lakh, so that you can withdraw the whole sum at one go without the hassle of buying annuities.  

Apart from normal exit and premature exit, NPS allows you to withdraw limited amounts from your account without closing it. Such partial withdrawals from the NPS, which were earlier subject to a 5-year lock-in, are now allowed anytime after joining. You can make such withdrawals 4 times during the account’s life. But the amount that can be taken out is capped at 25% in total.

# 3 For post-retirement too 

NPS has so far functioned mainly as a vehicle where young folks accumulate a corpus for retirement. Now the NPS can be used by seniors as an investment vehicle after their retirement too. This is because the maximum age to enter and exit the NPS has been stretched to 85 years, instead of 75 earlier. 

Impact: This is useful in many ways. Even folks who woke up late can start retirement savings through NPS at say age 50. They can then hold their accounts for the next 35 years to allow their returns to compound. If you were an early starter and market conditions are not very favourable when you turn 60, you need not exit NPS. You can simply hang on until the markets offer a better exit opportunity. Retirees who aren’t very active market trackers can also use the NPS as their post-retirement investment vehicle and continue their investments until 85. 

Emerging options like SWL and SUR may also help you avoid a big tax outgo on closing your NPS account after retirement. 

# 4 Expanded definitions of E, C and G 

For a long time, the NPS offered only three asset choices to its subscribers – E, C and G. Later, A (Alternative Assets) was tagged on. Under this asset class, which was capped at a 5% allocation for each subscriber, fund managers were allowed to invest in exotic and riskier vehicles such as Alternative Investment Funds (AIFs), AT-1 bonds, venture capital funds, private equity funds, REITs and InvITs. Very few subscribers opted for this. 

Recently however (on December 10), PFRDA has done away with this A option. NPS investment guidelines have been modified to sweep the alternative instruments that featured in A, into the mainstream asset classes of E and C. This is where E, C and G can now invest. 

• G: Central and State government bonds, bonds from PSUs, mutual funds investing in gilts (with a 5% cap). 
• C: 90% of the investment must be in AA rated bonds or higher, with 10% allocation allowed to AA- and A-rated bonds. Residual maturity for bonds should be 3 years or more. Allowed instruments as follows.: Listed corporate bonds, term deposits with banks, debt mutual funds with Macaulay Duration of over a year (with a 5% cap). Bonds issued by REITs and InvITs. Bonds issued by infrastructure Debt Funds. Municipal bonds. Bond ETFs from the government (capped at 5%). Units of InvITs, Tier 1 bonds from banks or PSU NBFCs, debt AIFs (capped at 5% of the assets under C). 
• E:  Stocks which are part of the Nifty250 or BSE 250 index, with 90% invested in the top 200 stocks. The following are also allowed: Equity mutual funds, Sensex or Nifty ETFs, ETFs investing in PSUs, derivatives for hedging alone. IPO/OFS of companies which would fit into the top 250 listed companies. Category 1 and 2 equity AIFs, Units of REITs, Gold/Silver ETFs (total capped at 5% of E). 10% of assets can also be parked in short term debt instruments temporarily. 

Impact: It is not clear what the logic is for including gold and silver ETFs, mutual funds and REITs into the equity portion of NPS. Or InvITs and debt mutual funds etc into the debt portion. While the earlier A option allowed individual investors to avoid risky vehicles like AIFs and AT-1 bonds by simply skipping it, this choice has now been taken out of their hands. It is fund managers who will now be deciding whether or not to dabble in riskier instruments within the E, C or G categories. 

In current market conditions, having gold, silver, InvITs, REITs etc as part of the equity or debt categories may make for diversification of risk. But this can also be return-dilutive in the long run. Investors need to check on the monthly portfolio disclosures provided by their fund managers to know if they are dabbling in these alternative instruments. 

# 5 Multiple scheme menu

Since its inception, NPS has offered investors a simple proposition. Open one account with us and choose your own mix of equities, corporate bonds and gilts to build your own portfolio. To help out investors who couldn’t decide on allocations, there was the “Auto” choice which made standard allocations and adjusted them based on the investor’s lifestage. 

But in September this year, PFRDA came up with a “Multi-Scheme Framework” which will allow NPS pension fund managers to offer many schemes, a la mutual funds. NPS investors can subscribe to these schemes along with their main NPS account. The entry and withdrawal rules of the mainstream NPS will however apply to these schemes as well. The following will be the features of these new schemes:

• Schemes can take their equity exposure to 100% and invest in all the instruments allowed under the new investment guidelines. 
• They can provide both retirement accumulation and withdrawal solutions 
• Each scheme will have two risk variants – Moderate and High Risk
• Can be offered under Tier 1 and Tier 2 
• Can be targeted to customers of a specific age, segment (digital economy workers) or employment status (professionals/entrepreneurs). 
• No labelling or categorization rules
• Investors can switch from such schemes to the Common NPS account, but not vice versa 
• Fund managers can charge a maximum of 0.3% as fees. Custodian, record keeping, NPS trust charges are extra
•  Entry and exit norms will be the same as that for Common NPS account 

Impact: The multi-scheme framework may undermine one of the best features of the NPS – its clean structure and simple choices. Right now, there’s no compelling reason for you to invest in these schemes if you’re an NPS subscriber. For one, these schemes are new and have no track record. Two, with the low fee and restrictions such as sticking to the top 250 stocks, it needs to be seen if these schemes outperform passive mutual funds. Three, unlike mutual funds, exiting these schemes on poor performance won’t be easy. The NPS’ premature exit rules will require you to lock 80% of redemption proceeds into an annuity if you exit within 15 years or before age 60. 

Overall, this seems to be an avoidable ‘innovation’ in the NPS for investors.