3 Reforms The NPS Could Benefit From

The opening up of the NPS (National Pension Scheme) to non-government employees in 2009 was a welcome move indeed. Finally, a wider section of the populace had access to a defined contribution retirement planning solution that holds much better potential for generating retirement wealth for them, compared to traditional instruments such as life insurance, provident funds, or bank deposits.

Compared to other traditional, low return instruments, the primary benefit from electing to channelize retirement savings to the NPS arises from their potential wealth creation from equities. And yet – the composite amount mobilized by the Tier-1 equity funds across all 7 pension fund managers works out to a meagre 2,881 crores as of 5th July 17 – nearly 8 years after the architecture was opened up!

Fact is, a few key structural issues are preventing the NPS from realising its true potential. Here are three key reforms that the NPS direly needs at this stage, in order to become a more value creating retirement-planning avenue for a wider section of tax-conscious, middle income retirement savers.

The forced annuity purchase must be scrapped
Present rules mandate that as much as 40% of the final corpus accumulated through the NPS must be used to purchase an annuity from one of seven ASP’s (Annuity Service Providers) at the end of the tenor. While the PFRDA’s unquestionably noble intent here is to ensure that the final corpus is put to its intended use of generating income for retirees, the fact remains that an annuity is a very poor choice for generating retirement income. Most annuities will likely provide between 7 lakhs and 8 lakhs or annual income (at present rates) on a 1 crore corpus – with the amount being even lower for plans with “return of premium” clauses. Considering that it’s highly unlikely that pensioners will fritter away their precious retirement corpus on anything other than meeting their monthly fixed expenditures, the PFRDA should ideally permit retirees to invest the complete proceeds in a manner that they deem fit. After all, multiple avenues for generating much higher returns exist – with better liquidity, too.

A 100% Equity option needs to be introduced
Undeniably, a large chunk of India Inc’s general lack of retirement readiness can be attributed to our old habit of being over-conservative with our long-term savings. According to estimates, over 60% of Indian retirement savers channelize their retirement savings into Life Insurance and Bank Deposits. Regrettably, the NPS does precious little to fix this issue. Although the PFRDA did introduce a new Life Cycle Fund called LC-75 last year, the fund itself caps equity allocation at 75%, mandatorily tapering it down by 4% per annum thereafter, once the investor crosses 35. When a goal is as far away as one’s retirement, the occasional shocks dealt by volatile equity markets tend to get absorbed through rupee-cost averaging, smoothening out long term returns eventually. The NPS should ideally come up with a 100% equity option that’s permitted until at least the age of 50 – with a staggered reduction in equity allocation over the last ten years of the investment horizon.

Complete proceeds must be made tax-free
While EPF proceeds are completely tax free, NPS proceeds are not. Per current norms, only 40% of the final accumulated corpus can be withdrawn tax free, with another 40% requiring the purchase of an annuity that’ll provide a fully taxable income, and the remaining 20% being taxable. In order to remove the disparity between the guaranteed return EPF and the variable return NPS, the entire proceeds from the NPS should ideally be made tax-free