NPS assured return scheme likely to offer modest return, go equity-heavy

For a long-term goal like retirement, NPS subscribers should ideally opt for an equity-heavy portfolio

Two developments have occurred that will affect National Pension System (NPS) subscribers. One, the Pension Fund Regulatory and Development Authority (PFRDA) will launch an assured return scheme soon. Two, the Rajasthan state government has opted out of NPS and reverted to the old pension scheme.

Option for conservative investors

The PFRDA is obliged to launch an assured-return scheme because the PFRDA Act requires that one such option be provided.

Such a scheme may appeal to some. “Not everyone can deal with the market-linked returns NPS offers. An assured-return scheme may appeal to conservative investors,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor.

However, the assured return will come at a cost. “The rate of return offered by the assured-return scheme is likely to be modest,” says Gautam Bhardwaj, co-founder and director of pinBox Solutions, Singapore, and member secretary of the Oasis committee, whose landmark report kickstarted pension reforms in India.  

Experts fear an assured-return scheme may not offer more than 4-6 per cent. NPS funds have offered higher returns since inception.

Pension fund managers (PFM) will want to avoid a big gap developing between the returns they earn and the assured return. “PFMs will want minimal volatility in their portfolios to be able to make good the guarantee. Hence, they will invest a large portion of their corpus in government bonds, which will in turn depress returns,” says Bhardwaj.

A lower return will mean a smaller retirement corpus. “A one percentage point higher return over a 30-year horizon increases the retirement corpus by about 20 per cent,” adds Bhardwaj.

Reversion to old pension scheme

The Rajasthan government’s decision to revert to the old pension scheme means its employees will get a guaranteed pension for life. The pension amount is a percentage of the employee’s last-drawn salary at retirement. It is also revised upward periodically. “The amount varies from one state to another. State governments generally offer more generous pensions than the central government under the old scheme,” says Raghaw.

Whether the old scheme will offer a higher pension than the NPS is hard to predict as the outcome depends on a number of variables: the exact percentage of last-drawn salary and periodic revisions offered by the government, returns earned by the NPS state government funds, and so on.

Heavy burden on state finances  

Reverting to the old scheme could impose an unsustainable fiscal burden on the state due to the growing number of retirees, higher per capita liability caused by pay and pension revisions, and increasing longevity.

The key risk of a defined benefit pension system is that a state government may fail to honour its liabilities. “Even developed countries have reneged on their pension promises. This has taken the form of raising the retirement age, lowering the rate at which pension is revised, and so on,” says Bhardwaj.

In NPS, the contributions are made upfront by employees and the government. “The money is held in employees’ individual accounts by the NPS Trust, providing confidence that their pension rights won’t be infringed,” says Bhardwaj.

Returns of NPS funds have been sound, aided by its low fee structure.  

Go equity-heavy over long term  

State government employees have little say in their government’s decision to revert to the old pension scheme. Subscribers do, however, have a choice in whether to opt for the assured-return scheme. “Over 30 years or more, equities are likely to outperform other asset classes. Subscribers stand to gain by having a higher allocation to equities in NPS. The only caveat is that they should not be perturbed by the interim volatility,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.  

Hands-on investors should go for the active-choice option where they can decide the asset allocation. Others may opt for one of the three lifecycle funds that matches their risk profile. Only highly conservative investors should opt for the assured-return scheme after checking out its rate of return, once it is announced.