Proposed NPS tweaks will offer greater flexibility, say analysts

But systematic withdrawal plan carries risk that retirees may overdraw

At an average of 62 per cent, the one-year return of tier-1 equities schemes of the National Pension System (NPS) looks attractive. And a few features are likely to be added to NPS soon that could enhance its popularity.

Don’t deviate from asset allocation

The 62 per cent return is on a par with that delivered by the Nifty (61.7 per cent) over the past year. This is not surprising. Though pension fund managers (PFMs) are allowed to do active fund management, many may still mimic the index.

According to Jharna Agarwal, head, Anand Rathi Preferred: “NPS funds have not generated significant alpha. Open-ended equity mutual funds have given better returns.” Returns of large-cap funds have ranged from 39-64 per cent (average 56.5 per cent). Mid-cap funds have fared better (64.4-109.8 per cent, average 79.9 per cent). NPS investors have got what they would have in a Nifty50 index fund (average return of direct plans: 59.4 per cent).   

Avoid increasing your equity allocation in NPS. “Stick to an asset allocation that matches your risk profile instead of increasing equity exposure based on one-year return,” says Manish P Hingar, founder, Fintoo, an investment and tax advisory firm.

Don’t chase past returns

Those who have not invested in NPS yet should not take the plunge based just on the past year’s return. They should weigh its pros and cons. NPS offers the benefit of low cost (0.03-0.09 per cent fund management fee). It is illiquid, which ensures investors end up with a retirement corpus. It offers a tax benefit of Rs 50,000 under Section 80CCD(1B). And it provides the benefit of tax-free rebalancing.

At the same time, an investor’s money gets locked in for a long time. NPS also does not offer flexibility at retirement: 40 per cent of the corpus must be invested in an annuity.

Invest if you meet a few criteria. You should ideally be in the 30 per cent tax bracket, have sufficient funds so that investing in NPS does not crowd your other investments, and you should not need the money before superannuation. Next, let us evaluate the new features.

Systematic withdrawal plan (SWP): The Pension Fund Regulatory and Development Authority chairman announced recently that instead of having to invest in an annuity at retirement, investors will get the option to go for an SWP (though this will require legislative changes).

An annuity offers one big advantage—a guaranteed income for life. An SWP will give investors the flexibility to withdraw more or less each month based on their needs. “The big risk is that retirees could overdraw from their corpus and thereby run out of money,” says Deepesh Raghaw, founder, PersonalFinancePlan, a Securities and Exchange Board of India-registered investment advisor. 
 

Deciding on a prudent withdrawal rate is not easy. A person could live longer than expected. If he draws more in a year when the market is down, he would end up making the loss in his depleted portfolio permanent.

Inflation-indexed annuity: Currently, annuities pay a constant sum throughout the retiree’s life, whose value gets eroded by inflation over the years. An inflation-adjusted annuity will hence be a boon. “Such a product is, however, likely to have a lower starting rate of return than a normal annuity,” says Raghaw.

Withdraw corpus till Rs 5 lakh: Investors with a corpus of up to Rs 5 lakh (up from Rs 2 lakh earlier) will be able to withdraw the entire amount at retirement. Financial planners say it is okay to do so as the annuity one would get from 40 per cent of that corpus would anyway be paltry.