The Indian stock market is having a purple patch, with the 10-year returns on the Sensex now nudging 14 per cent. This is an opportune time for the government to make a renewed pitch to woo Indian households, who are already sold on stocks and mutual funds, to the market-linked National Pension System (NPS).
While the NPS has been delivering good returns, some of its archaic features are holding back young employees from committing more of their savings to it. Here are five changes that can make the NPS more appealing.
Make EPF optional
Today, any Indian employee joining the formal workforce is automatically signed up for the Employees Provident Fund (EPF), with 12 per cent of her basic pay compulsorily docked towards this retirement vehicle. With EPF contributions taking up most of 80C investments as well, she is left with little room to squeeze in the NPS.
Data from the latest Periodic Labour Force Survey says that only 21 per cent of Indian workers hold down a regular job, while 57 per cent are self-employed and 22 per cent are in casual jobs. The average earnings of an urban male employee are about ₹22,000 per month. This indicates that most employees may not have the leeway to invest in more than one retirement vehicle.
In theory, EPF is not mandatory for employees drawing over ₹15,000 in monthly basic pay. But in practise, with the law requiring all organised employers to enrol with the EPFO, most organisations bake the scheme into their compensation packages, leaving employees with little choice but to contribute. Amending the law to enable employers to offer the choice of either NPS or EPF, can popularise NPS. It can also solve the EPF’s problem of trying to sustain an 8 per cent plus return on a humongous, mainly gilt portfolio.
Free up end-use
Retirement savings vehicles require investors to make extremely disciplined savings, which are locked up for long periods. Telling that investor that she can’t get her hands on the lumpsum that she has accumulated even after retirement, is an unkind cut indeed.
Yet the NPS does precisely this, by forcing subscribers to convert 40 per cent of their final maturity proceeds into annuities. This stipulation is single-handedly responsible for most employees allocating the bulk of their retirement savings to Public Provident Fund and EPF, which have no such end-use stipulations. The NPS attracts only residual savings to make use of the section 80CCD tax break.
Apart from locking up the investor’s corpus life, annuity products also offer sub-par returns. Today, annuity plans in India offer returns of 6-6.5 per cent per annum. But retail investors accessing RBI’s Retail Direct platform can lock into a 7.4 per cent yield for 30, 40 or even 50 years terms by bidding for Central government bonds. Doing away with the annuity condition can help retirees get more bang for their buck from the NPS, while opening up a new set of buyers for government bonds.
Shelve MARS
With government employees in some States clamouring for the old pension scheme, the pension fund regulator has been toying with the feasibility of adding on a minimum assured return scheme (MARS) to the NPS menu. With this, NPS subscribers will presumably get the option to invest in a capital-protected product, apart from the equities, corporate debt and gilts which are on the menu.
But this may be an unnecessary addition. The entire debate about MARS reveals confusion between the accumulation and payout phases of retirement planning. When an investor is accumulating money towards her retirement which is 20, 30 or 40 years away, her main objective should be to earn an inflation-beating return so that her savings compound at a high rate, to maximise her retirement corpus.
When she is ready to draw on that corpus at retirement, that is when an assured pension makes sense. Today, there are any number of assured pension products that can provide a guaranteed pension to the investor post-retirement. The NPS should focus on the accumulation phase.
Investors keen on assured returns even in the accumulation phase should note that long-term assured return products in India, such as endowment and annuity products from insurers, tend to deliver returns in 4 to 6 per cent range. When financial product sellers are made to guarantee returns, they play it safe by ‘assuring’ an anaemic return.
Make withdrawals easier
If there’s one attribute that millennial and Gen Z savers look for in their investment products, it is flexibility. Career paths of young Indians no longer follow the uneventful trajectories of their parents.
They seldom stay with an employer beyond five years, take mid-career breaks and aspire to entrepreneurship and early retirement.
Any retirement vehicle that wants to endear itself to these workers cannot subject their funds to a lock-in until the age of 60. The NPS allows full withdrawal only at age 60, subject to the annuity rule. It sets onerous conditions for any employee seeking even partial withdrawal before retirement. Premature withdrawals are capped at 25 per cent of the NPS subscriber’s contribution, with only three such withdrawals permitted.
NPS also takes a leaf out of EPF’s book to set paternalistic conditions on the use of this money (marriage, children’s education, purchase of house, reskilling etc). While EPF allows the employee to completely withdraw her balance if she’s unemployed for two months, the NPS doesn’t incorporate this provision.
The NPS would be vastly more appealing to young savers if it allowed withdrawals at a time of their choice, without any conditions. To ensure that subscribers get to experience the return potential of equities, an initial lock-in period of five years can be specified after which exit is allowed.
Tom-tom tax breaks
In India, one nudge that gets even compulsive spenders to save some money, is the availability of tax breaks. The NPS is already very well-placed on this score, though most investors are not aware of it.
Annual contributions of up to ₹2 lakh in the NPS Tier 1 account are exempt from tax. Sixty per cent of the final maturity proceeds (the non-annuity portion) are exempt too. Should the annuity condition be removed, the remaining can be exempted too.
Switches between assets or fund managers within the NPS are not taxed. This is an enormous benefit for investors who need to periodically rebalance their portfolio, and is not available on competing products like mutual funds.
All these benefits are however restricted to the old tax regime. They need to be extended to the new tax regime and widely publicised to woo young employees to the NPS.