New pension scheme is up for challenge

The benefits of New Pension Scheme (NPS) are no longer confined to government employees. An individual from the unorganised sector can also avail of the benefits with the government opening it to all citizens from May 1, 2009. It was announced in the Budget that NPS will not attract any securities transaction tax (STT) and dividend distribution tax (DDT), which will improve the performance of the scheme further. SundayET brings experts’ view on NPS — whether one should go for NPS or opt for other instruments as a part of retirement planning? But before that let’s understand the nitty-gritty. NPS is more or less like other pension plans where you invest throughout your working career and reap the benefit when you retire by withdrawing the amount. Currently, only tier-1 of the NPS is available, where there is a lock-in period. Investors can invest a minimum Rs 500 per month (i.e Rs 6,000 a year). The age ranges from 18 to 55 years to buy NPS and one cannot exit before the age of 60 years. Also, while exiting one has to buy an annuity. Funds collected by NPS would be invested in three asset classes — equity, government securities and credit risk bearing fixed income instruments. Also, within the equity class, a fund manager will only invest in the index funds and not more than 50% of anyone’s portfolio will be allocated to equity. Investors also have the choice to choose the auto choice option. Under the auto option, if the age of investor is up to 35 years, 50% of his wealth will be invested in equity. Rest of the amount will be allocated to government securities and credit risk bearing fixed income instruments in the ratio of 20:30. However, once, the investor’s age crosses 35 years, participation towards equity and credit risk bearing fixed income instruments will start coming down annually. Finally, at the age of 55 year, the ratio of equity, government securities and credit risk bearing fixed income instruments will be 10:80:10. The major advantage of NPS is that it is much cheaper than a mutual fund or a ULIP. The total cost is merely 0.0009% for NPS. Also, it is easy to invest in and operate. In case, you choose the auto option, your portfolio gets automatically rebalanced depending upon your age. But the major drawback is that NPS is taxable on withdrawal, which means any gain that you make while exiting will attract tax. Sanjay Sachdev, country manager at Shinsei Bank, says, “The NPS is a great product but since it is taxable on maturity, it loses the charm.” Agrees Dhruv Agarwala, co-founder of iTrust Financial Advisors. He says, “NPS has not come at par with other instruments in the same category such as PPF, where the gains on maturity are tax free. Also, the other disadvantage is lack of a distribution channel.” There are other two instruments — mutual funds and ULIPs, which compete with NPS. A part of the money invested in ULIPs gets reinvested in equity and fixed income securities, while rest is used to provide insurance to the investor. Here investors can choose the contribution that they want to make towards equity and fixed income securities. According to Veer Sardesai, MD of Sardesai Finance, the major advantage of ULIP is that on maturity the entire amount is tax-free and the down side is that it has high commission structure and in fact, the cost is the highest in the first couple of years. This expense makes a significant dent in your post maturity amount. Mutual funds, on the other hand, have much lower expense in comparison to ULIPs. According to Sardesai, the first two years of a ULIP can have expenses of 30% per annum or higher, which means that for every Rs 100,000 you contribute only Rs 70,000 gets invested in your name. In comparison mutual funds may charge only 2.25% for their equity products. Mutual funds also enjoy tax benefits akin to ULIPs if one chooses an equity-based scheme. Also, in equity mutual funds the maturity amount is tax free if the investment is made for more than one year. However, generally in the debt mutual funds one has to pay capital gain tax. Ideally, there should be a product where both equity and debt components do not attract any tax. This is where PPF comes in. PPF offers 8% tax-free return and the capital is guaranteed to be protected by the government. In case one has to avail 80C benefit, one can go for a combination of PPF and equity-linked savings schemes. According to Mr Sardesai, the ideal pension fund would be a combination of PPF and index fund, the redemption from both are tax-free on maturity. An index fund has very low cost and replicates the index such as the BSE Sensex or the NSE Nifty.

Source: http://economictimes.indiatimes.com/Features/The-Sunday-ET/Money-You/New-pension-scheme-is-up-for-challenge-/articleshow/4767790.cms