What makes the NPS so crucial to retirement planning in an ageing India

India still does not have a "one retirement account" concept, with the intended money distributed across various schemes. Pension fund managers are underlining NPS as the preferred way ahead

 

In 2050, one in five Indians would be eligible pensioners, having crossed the benchmark age of 60, and in dire need of old-age financial security, aka pensions. Currently, about one in ten Indians have passed 60, and the need to provide old-age security at the national level is thus going to double in the course of three decades, or even earlier. 

But how is retirement money managed in India? The short answer is that there is no single-window management for that. Let us dive into the long answer. 

Pension management is broadly dispersed across a few categories, for different classes of users. The underprivileged elderly have the benefit of Indira Gandhi National Old Age Pension Scheme, government employees have the safety net of National Pension System, formal sector employees benefit from Employees’ Provident Fund, salaried from yesteryears might recall—and some of those currently employed, too—the superannuation fund. For unorganised sector workers, there is Atal Pension Yojana. And even if the purpose is not really pensions, a large proportion of people are subscribers to the Public Provident Fund. 

Let us first look briefly at these instruments. 
 

The table above shows the distribution of Indians in these key schemes. The 1952-born EPFO is the biggest among them all, and being mandatory for all formal employees earning less than Rs 15,000 a month, benefits most lower income households. Including the Employee Pension Scheme and other instruments in its ambit, its corpus is more than Rs 16 trillion, or eight per cent of India’s gross domestic product. EPFO has 47 million contributing members (FY19).

The Atal Pension Yojana (APY) for informal workers is a success in terms of the number of workers brought under its ambit. Though the assets under management (AUM) are about Rs 13,000 crore, pale in front of EPF and NPS, it services pensions of 22 million workers. 

The National Pension System was introduced in 2004 for government employees, and later expanded to all Indians on voluntary basis in 2009. After more than a decade of this expansion, it has been able to garner only 14 million subscribers to date (excluding APY). But as experts say, NPS is the most efficient and rewarding among the lot, and the natural way ahead for universal pension management in the country. 

“The NPS is the closest to the global best practice of one retirement account with the freedom to choose the fund manager, and flexible in terms of asset allocation levers to the customer. It is the most evolved among all instruments available,” said Sumit Shukla, CEO at HDFC Pension Management. 

NPS membership is mandatory for government employees, who are the majority of subscribers, totalling 7 million. If we just look at private subscribers under the two models--Corporate and All-Citizen model--the subscriber base is merely 2.3 million. The pick-up among the general populace has not happened yet, and the reason, experts said, is that the prescribed fees (fund management charges) for NPS are probably the lowest in the world. 

“As a result, the incentives for distribution channels to market the NPS to the general populace are severely restricted, because of the low levels of fees. Raising these would be beneficial for the success of NPS in coming years,” said Sandip Shrikhande, CEO at Kotak Mahindra Pension Fund.

Currently, the NPS charges as less as one basis point for the active fund management to invest contributions into equity and debt. Due to this, NPS loses out to insurance and mutual funds, where distribution channels, including banks themselves, can afford marketing and outreach to a far better level. 

Supratim Bandyopadhyay, chairman of Pension Fund Regulatory and Development Authority (PFRDA) told Business Standard in a telephonic interaction that the NPS is actively working towards hiking the fund management charge. 

On this, HDFC’s Shukla said, “This will be a win-win situation for all: the customers in terms of “best in class”investment practices, the fund managers in terms of viability of their business, and the PFRDA in terms of marketing the NPS scheme to achieve the goal of pensioned society.”

A good example of a lucrative scheme but poor penetration is the Sukanya Samriddhi scheme under the small savings ambit. Though one of the best financial security schemes for the girl child giving the best returns among all instruments, its popularity has yet not taken off.

The NPS also has a more progressive equity exposure among these instruments, and the upper limit is 75 per cent of the AUM. In contrast, only 15 per cent of annual contributions can be put into equity for the EPF. 

The EPF has a “held to maturity” strategy, where the majority corpus is in the form of long term exposure to debt, and a typical member’s money is pooled into a single fund. The NPS, on the other hand, is a more progressive and conventional instrument with a “mark to market” strategy, with each subscriber owning units similar to a mutual fund.  

Over a longer term—and pension can be the best example of it—equity gives higher return in comparison to debt investments. Though the latter is a safer bet in general, risks to equity returns smoothen over time. 

Over a 15-year horizon, there is a 93 per cent chance to have returns of more than 10 per cent per annum, while on a 10-year outlook, 80 per cent, according to analysis of BSE data by Crisil in a report. Similarly, the volatility in S&P BSE Sensex, which is more than 15 per cent in the 1—5 year horizon, falls to about 5 per cent at the 15-year term. 

This is where experts are divided over the efficacy of EPFO being able to give healthy returns to prospective middle-age subscribers. Recently, EPFO decided to give a reduced rate of interest upfront to members at 8.15 per cent for FY20, and to pay the remainder of 0.35 per cent later, subject to positive short term returns on equity investments. 

“The management of EPFO is opaque in comparison to the NPS. Its investment matrix is more debt oriented—giving smaller returns—and less transparent, too. Further, equity investments are for the longer term, so attributing a part of the rate of interest to equity portion subject to returns is unusual,” said a fund manager who did not wish to be named.

Though there are many countries with majority pension fund investments in debt, experts said that for a developing economy like India, equity investments are the way to go at this stage. Experts concurred on the view that NPS is the most progressive among the available retirement money management options in India. 

In one more area, the NPS is gaining traction, and that is the superannuation fund. Many corporates have begun to shift from the latter to NPS, and the speed has only increased in recent quarters, Bandyopadhyay of PFRDA said. Over time, he expects that NPS to be the most popular and the leading retirement money manager in the country. 

The Atal Pension Yojana, which vows to give old age security to the most under-privileged, is gaining popularity. More than widening, observers said that it needs deepening, or a strong growth in the ticket size of contributions, and ultimately in the pension amount. Strong nominal growth in the economy is key to its success. 

The PPF, which is a preferred instrument among the salaried class for five decades for middle-age lump sum cash management, has a corpus of close to Rs 7 trillion at the end of FY20. In recent years, the annual net accretion has been inching towards Rs 1 trillion. At 7.1 per cent return at the moment, it is managed by the central government, through the National Small Savings Fund (NSSF). 

The NSSF has been investing in loans to central government to the tune of Rs 2.5 trillion, or more than 1 per cent of GDP, in recent years. The PPF subscribers do not have any flexibility in terms of asset allocation. 

The NPS, on the other hand, has a daily audit of the net asset value (NAV) declared by the seven fund managers, has given better returns among all pension instruments, and is the most transparent about the returns, experts said.