Have you considered investing your money in National Pension Scheme (NPS)? If you have, was it to fulfil your retirement needs or was it to save additional tax on ₹50,000 every year? If your reason to invest in NPS is tax benefit, then your investment approach is incorrect. The dangling carrot of tax benefit should not be looked at in isolation. Here is what you should know about NPS and how you should use it to build your retirement kitty effectively:
Before you put your money in any investment instrument, it is important to understand it. Firstly, know that NPS is a defined contribution pension plan. Your money will be pooled in a pension fund. You can make an annual contribution till you turn 60 years of age and the minimum age requirement to invest is 18 years. If you invest in NPS, you can avail a deduction of ₹1.5 lakh under section 80C and also an additional deduction benefit of ₹50,000 under section 80 CCD. If you are in the highest tax bracket, it means a savings of ₹15,600 a year. Managed by Pension Fund Regulatory and Development Authority (PFRDA), NPS is not like a public provident fund (PPF) account where everyone just has one option—you invest and get a predetermined interest rate. In case of NPS, you have to make a choice. There are two accounts—tier 1 account, the pension account, which gives tax benefit and is mandatory to open for NPS, and tier 2 account, an optional account with withdrawal flexibility. Once you open an NPS account, you have to contribute a minimum of ₹1,000 in tier 1 account.
NPS gives you options in the form of fund manager and the type of investment choice. There are eight pension fund managers to choose from such as HDFC Pension Management Co. Ltd, Reliance Capital Pension Fund Ltd and UTI Retirement Solutions Ltd.
In terms of investment choice, you can opt for either active choice or auto choice. In active choice, you can create your portfolio with equity, corporate bonds and government securities. If you opt for auto choice, the fund manager will create a portfolio with the same option, but the percentage of investment in each asset class will be pre-decided.
At any point, the maximum investment shouldn’t be more than 75%. “For equity, till two years ago, PFRDA had limited the choice as there was a condition that you could invest only in Nifty stocks. Then they amended the guidelines and included broad-based stocks. As there is a Nifty hangover, in most portfolios, there is a Nifty bias," said Sandip Shrikhande, chief executive officer, Kotak Pension Fund.
HOW TO USE NPS IN YOUR PORTFOLIO?
Firstly, don’t look at NPS in isolation only for tax benefit. “People who put only ₹50,000 to save tax, if you continue investing for 20 years, the corpus is not going to grow significantly to meet your entire retirement needs," said Shrikhande. You should instead link the NPS investment to your retirement plan.
“Using NPS is a means to build a retirement fund. However, if you are in your 30s, simply using NPS will not work because the asset allocation changes. Someone in 30s will be fairly aggressive. Now, if you have a cap on how much you can invest in a particular asset class to restrict yourself, you can’t be flexible. So it would be better to have a basket of mutual funds to choose from. For someone who is younger, it is restrictive. Look at it as an add-on product for tax saving," said Priya Sunder, director and co-founder, Peakalpha Investments.
Consider using NPS as one of the retirement investment tools, but don’t depend on it entirely.