NPS allows withdrawals, but you shouldn’t use a long-term product for short-term needs
The Pension Fund Regulatory and Development Authority (PFRDA) received a big push towards becoming a statutory authority when Lok Sabha on Wednesday cleared the PFRDA Bill, 2011 and Rajya Sabha passed it on Friday. The Bill now needs to be signed by the President to become law.
What does the Bill say?
The Bill gives regulatory powers to PFRDA, which started operations through an executive order in 2003. At first, the National Pension System (NPS), PFRDA’s pension scheme, was extended to central government employees who joined services from 2004. Although it was designed to bring the unorganized workforce into a formal pension system, the government moved its employees to NPS to lower the burden on its coffers from the earlier defined benefit pension programme. It was only from 1 May 2009 that NPS was made available to the entire workforce.
In the absence of statutory authority, PFRDA does not have the power to penalize the entities it regulates. Once it gains statutory powers and the authority, it can pull up errant pension sector participants. “PFRDA will then be able to ensure better compliance and subscriber protection," said Nagendra Bhatnagar, CEO and trustee of the NPS Trust.
Changes in NPS structure
Withdrawal from tier I account: The Bill seeks to initiate some structural changes to NPS. The tier I account of NPS locks in subscribers’ money till they turn 60. So if you wish to withdraw before 60 you will need to annuitize at least 80% of the corpus. At 60, a subscriber can withdraw about 60% of the retirement corpus and “annuitize" the remaining 40%—buy a pension product that gives periodic income. The proposed law allows for withdrawals from the tier I account with limits on the amount and the number of withdrawals. The amendment states: “Withdrawals not exceeding 25% of the contribution made by subscriber will be permitted from the individual pension account subject to the conditions, such as purpose, frequency and limits, as may be specified by regulations."
Some experts see this is a regressive step since NPS has a tier II account, too, that allows for liquidity, and therefore, they see no sense in changing the spirit of the tier I account. Tier II account works more like a savings account from which you can withdraw whenever you wish. There aren’t any tax benefits on the tier II account though.
“The idea was to ensure that investors are encouraged to save for their retirement. By giving a window for withdrawal, you may not get the desired outcome. Look at EPFO (Employees’ Provident Fund Organization), where there are so many withdrawals. Moreover, there is already a tier II account which is liquid," said Gautam Bhardwaj, director, Invest India Economic Foundation and one of the key craftsmen of the original NPS.
But the thought of offering an option to withdraw from the NPS is not new. Dhirendra Swarup, member-convener of Financial Sector Legislative Reforms Commission and the first chairman of PFRDA, said, “Low surplus incomes underscore the need for some liquidity. I remember that PFRDA had suggested to the government that withdrawals be allowed for treatment of terminal illnesses and for construction or purchase of one dwelling unit during the entire accumulation phase. I am not aware whether the withdrawal now permitted under the Bill is for specific purposes." The amendment to the Bill does mention that withdrawals will be allowed for specific purposes, but we are yet to understand what these will be.
Introduction of guaranteed return option: According to the amendments to the Bill, a subscriber can opt for investing in schemes providing minimum assured returns. Further clarity is awaited on exactly how these products will look like: whether a guaranteed rate of return will be announced every year as is the case with EPF and the Public Provident Fund (PPF), or the product will carry a minimum rate of return as is the case with pension products offered by life insurance companies.
Again PFRDA did toy with the idea of offering guaranteed returns in the past. “The original design of NPS did envisage a guarantee. However, the guarantee was to be ‘bought’ by the individual from the fund manager," says Swarup.
But offering guaranteed return could potentially hit returns as we have seen in the case of pension plans offered by insurance companies where the investment portfolio has largely moved to debt. “In the early stages of the scheme and to allay the apprehensions of the investor, it is not a bad idea to provide an option of minimum guarantee return. But in the present form, this provision will put pressure on the fund managers and they might be encouraged to invest primarily in bonds and fixed income instruments rather than in equities. It must be ensured that this does not lead to cross-subsidization. It would have been ideal if this guarantee was ‘priced’," says Swarup.
Analyse before investing
NPS will now become a well-regulated product with tweaks to provide assured returns and a withdrawal facility. The only missing aspect in its architecture is tax benefit. Although contributions to NPS are tax deductible under the overall section 80C, the 60% corpus that can be withdrawn on maturity is taxable. With the implementation of the proposed Direct Taxes Code, it may come in line with other long-term products such as EPF and PPF which give tax-free maturity proceeds.
However, look deeper before you invest. The current rules allow only 50% exposure to equities and, unlike the original design that mandated investments in index funds only, the equity fund now will be actively managed. For an aggressive investor, who wants to target retirement savings largely through equity, NPS may not be the choicest product. Even conservative investors should have a combination of products for their retirement corpus. “NPS is a great pension product but currently it’s not tax-efficient. On maturity, the annuitization of at least 40% of the corpus is a deterrent because it’s difficult to predict future needs. I would recommend an exposure up to 25% in NPS," says Suresh Sadagopan, a Mumbai-based financial planner.
Remember that withdrawals are necessitated by short-term needs and for such needs, you shouldn’t look at a long-term product like NPS.