Can you save with the National Pension Scheme?
The National Pension Scheme (NPS) may seem like a nice offering, but with its transaction costs, where it stands in terms of tax and its overall complexity, is it for you?
At first glance, the National Pension Scheme (NPS), launched five years ago, seems to be a well designed product. With a management charge of just 0.25%, it is one of the cheapest investment options in the world. The scheme has more than 50 lakh investors, assets worth over Rs42,205 crore and a steady stream of monthly investments. But if you think it sounds lucrative and is the answer to your retirement goals, think again.
The response to this scheme has been surprisingly poor. Only 2.3 lakh investors have voluntarily joined the NPS since it was opened to the general public on May 1, 2009. This is a miniscule fraction of the government target of around 20 crore investors.
Low returns, hidden costs and poor marketing are only some of the many reasons for the tepid response to the NPS.
Returns on investment
The return an investment gives you is often the only factor used to judge its potential. Let’s start with this critical indicator. The NPS allows you to invest in a combination of equities, gilt and bonds. As per stipulation, the allocation in equities cannot be over 50 percent.
Even the most aggressive NPS funds (50% investment in equities) have, on an average, yielded only 8.50% over the last five years.
Assurance and safety
Lower returns do not necessarily mean greater safety; equity is often associated with risk. However, gilts and bonds also carry their fair share of risk and can depreciate the value of your investment.
In fact, poor returns on NPS funds were largely because bond yields rose sharply in July 2013, reducing the value of the long-term bonds in their portfolios.
The risk of default is also something to consider. NPS norms allow a minimum credit rating of BBB for the bonds in their portfolio. The lower the rating, the higher is the interest offered by the bonds. A BBB rating is on the borderline – 2 notches lower and the bonds are classified as ‘junk bonds’. The norms are a lot stricter in case of equities. Only Nifty stocks are allowed in the portfolio.
Poor quality bonds put the whole investment at risk and when the investments turn into NPAs (or non-performing assets) then you end up paying the price.
The NPS is regarded as one of the cheapest financial products in the world. The fund management charges amount to a miniscule 0.25%, up from 0.0009% last year. This is will soon be reduced to 0.1%. But they do not take into account the expense ratio of the index funds and mutual fund schemes in which the fund has invested.
However, every transaction in the NPS has a fixed minimum cost – 0.25% of the investment, or Rs20, whichever is higher. There is also a ceiling of Rs2,500 to this cost. This automatically discourages SIP investments as you end up paying between 1-2% more for every instalment.
Availability of the scheme
If you go to a bank to open an NPS account, chances are you will be dissuaded from doing so and will instead be advised to opt for a pension plan from an insurer. At a post office, you will most probably end up telling them about the NPS.
Theoretically, the scheme is available across the country. However, in reality it is neither sold nor marketed very actively. The reason: the low commission it offers. The bank that manages to sell a NPS scheme will get a trifling Rs100 on the transaction as compared to a 30-35% commission it would get if it sold traditional insurance.
Although the scheme allows you to withdraw up to 60% on maturity as against the 33% by a normal pension plan, the advantage is nullified by the fact that the amount is taxable. The pension from the annuity is also taxed, while the contribution to the scheme is eligible for deduction for up to Rs1 lakh.
Finally, the biggest reason for its unpopularity is its complicated structure. Right from opening an account to managing and handling it, there are many procedures involved, all which are extremely off-putting to many investors. Few understand it and fewer still invest in it.
So, for whatever reason, if you are thinking of joining up for the NPS, think again. To know more about the tax implications of the NPS, go here.