I have always stressed on the issue that Retirement Planning is a must in the context of personal Financial Planning. Thankfully the fruits of long term financial planning, which have been available only in the organized sector, will now be available to the unorganized sector, the self employed as well as all others who don’t come under the ambit of any pension system. In a reform long overdue, the Pension Fund Regulatory & Development Authority (PFRDA) has finally put into motion the New Pension System (NPS).

At present India has nearly eight crore elderly people, which is one eighth of world’s elderly population. This segment of population is growing at a rate of 3.8% per annum as against a rate of growth of 1.8% for the overall population. Vast majorities of this population is not covered by any formal old age income scheme and are dependent on their earnings and transfer from their children or other family members. These informal systems of old age income supports are imperfect and are becoming increasingly strained.

Only about 12 per cent of the working population in India is covered by some form of retirement benefit scheme. Besides the problem of limited coverage, the existing mandatory and voluntary private pension system is characterized by limitations like fragmented regulatory framework, lack of individual choice and portability and lack of uniform standards. High incidence of administrative cost and low real rate of returns characterize the existing system, which has become unsustainable.

There are other voluntary pension schemes available for general public but these schemes cover a very small segment of the total population. Life Insurance Companies and Mutual funds are offering these plans. The other popular scheme is Public Provident Fund (PPF). Government is managing this scheme. A fixed rate of return is offered under the scheme. In addition, tax benefits are being offered for making investment in the Public Provident Fund account.

The existing system of pensions which leaves more than 88 percent of Indian workforce uncovered is unlikely to act as a social security umbrella for the ageing Indians. Improvement in healthcare facilities leading to increase in life expectancy, evolution of nuclear family systems and rising expectations due to increase in per capita income, education etc. are some of the factors likely to compound the problem in future. The new pension system is a significant step in the direction of addressing this problem. Spread of NPS is seen by many as the direction in which the pension reforms need to move to find a viable and sustainable solution to the problem of old-age income security.

NEW PENSION SYSTEM (NPS)

The new pension system has something to offer for all investors. It is launched for the general public from 1st May 2009. Under this scheme, people, who invest money in the pension fund during their working life, will get back the money partly as a lump sum and partly as an annual payment or pension.

It has the following objectives:

• To provide old age income
• Reasonable market based returns over a long term
• Extending old age security coverage to all citizens

Who can join the New Pension Scheme?
Any Indian citizen between 18 and 55 years can open NPS account. At present, only tier-I pension account of the scheme, involving a contribution to a non-withdraw able account, is open. Subsequently tier-II savings accounts, which permit voluntary savings that can be withdrawn at any point of time, can be opened. But to be eligible to open a tier-II account, you need a tier-I account.
Where to open the NPS Account and the authorities involved:
Existing bank branches and post offices will be used to collect contributions. Six pension fund managers will devise schemes and manage funds. A central record keeping agency has also been appointed. All these institutions will be regulated by PFRDA. The biggest advantage is the scheme’s portability across jobs and locations.

Contributions:

After registration, you will receive a Permanent Retirement Account Number (PRAN). Minimum number of contributions is 4 per year. There is no maximum limit. Minimum investment limit is Rs. 6,000 per annum i.e. at least Rs. 1, 500 per quarter or Rs. 500 per month. You can invest as much money as you wish. Your investments are not guaranteed and they will depend on your contribution and the investment growth at the time of exit.

Where will the money be invested?

The fund will be invested in three asset classes:
Class E: Equities. Here money will be invested in 30 stocks of BSE or 50 stocks of NSE. The investments will be made in the same proportion as weightage of stock in that particular index.
Class G: Investment will be made in debt securities issued by the Central as well as State Governments.
Class C: Investments primarily in debt securities issued by entities other than Central & State Governments.
Investors will have the option to decide about the type of funds and the amount of money to be invested. If you are unable to choose between any of these options, you can go for the Auto Choice Lifecycle Fund. In Auto Choice Lifecycle Fund, 50% of the amount in your pension account will be invested in equity, 30% in corporate bonds and the remaining 20% in government securities. After 36, the proportion of investments in equity and corporate bonds will decrease annually, while the investment in government securities will increase. As this scheme is on the lines of one already operational for central government employees, it is important to note that it yielded an average return of 14.5% in 2008-2009 under its operations.

How to withdraw the money from the account?

The normal retirement age is fixed at 60 years. At 60, you will be required to use at least 40 per cent of your accumulated savings to buy a life annuity from an insurance company. Annuity is regular payments may be yearly, half yearly, quarterly or monthly depending on your choice. If you want to exit before 60, you can withdraw 20 per cent of the accumulated savings but buy an annuity with the remaining 80 per cent. If the pensioner dies before 60, the nominee will receive the lump sum or can continue with the account if he wishes to.

Who will manage the fund?

The investors will have the option to shift their fund from one fund manager to another. The Pension Fund will be managed by six Fund Managers - SBI, UTI Asset Management, ICICI Prudential Life Insurance, Reliance MF, IDFC Mutual Fund and Kotak Mahindra.

Charges involved:

When compared to any other type of investments, the distinguishing feature of the NPS is it’s shockingly low cost. The fund management charges of NPS are only 0.0009%. Other than the fund management charges, there are various other expenses which it charges. Even after taking all these expenses into account, the NPS scores better over other pension products offered in the market. Why is low cost important? Because the magic of compounding over the long term horizon of the NPS will magnify the beneficial impact to the investor.

What’s not so good about investing here?

There are some downsides too. One, that tier-I is really a pension scheme not an investment scheme. i.e. You can’t withdraw the money till you are sixty years old, except fir critical illness or buying a house. That means it scores low on liquidity. This problem doesn’t arise in tier-II accounts as here the subscriber would be able to deposit or withdraw from the account anytime. Secondly, the gains at the time of withdrawal will be treated as taxable. This is one loophole which the government has to consider, because when NPS is compared to PPF or Employee’s Provident Fund (EPF) it is evident that PPF and EPF score better as regards taxation as at withdrawal they are not taxable.

In conclusion, New Pension System seems to be better than whatever “Retirement Solutions” are currently available in the market. It will not only bring retirement planning to all the citizens but also completely transform the investment scenario in the country.

Retirement is wonderful if you have two essentials — much to live on and much to live for.

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This entry was posted on Friday, June 5th, 2009 at 12:24 am and is filed under Mukesh Dedhia's published articles. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.