When investors consider retirement saving options, the National Pension System (NPS) figures prominently among the choices available. Usually, the tier 1 option is the preferred mode of investing for those seeking to accumulate a corpus for their silver years. But the tier 2 option under NPS, too, is attractive, for investors, given the added flexibility it offers over tier 1. Also, there’s always the opportunity to invest in mutual funds for liquidity and ease of operations. That, then, is a choice that an investor needs to make.
Specifically, the performance of corporate bonds (C) and government securities (G) in the NPS tier 2 schemes and the comparison with their debt mutual funds counterparts gives an insight on how you can structure the debt part of your portfolio investments.
All about NPS tier 2
Before getting into the performance aspect, a quick review of NPS tier 2 may be in order.
Now, the tier 2 option is open only to those already have a tier 1 NPS account. It cannot be opened in isolation.
Unlike the tier 1 option that allows you to withdraw only after turning 60 (barring certain specific exceptional circumstances), you can pull out your money from tier 2 schemes anytime you want, and they are therefore more like mutual funds operationally. There is no requirement to annuitise your corpus in tier 2 as well.
Like tier 1, the tier 2 NPS scheme also has equity, corporate bond and G-Sec options and you can choose the mix or proportion of assets based on your risk appetite and goals. Also, the equity portion can go up to 100 per cent in the case of tier 2, whereas the limit is 75 per cent in tier 1.
There are no separate AMC charges applicable in tier 2, once you have a tier 1 account. And you can also switch the proceeds from tier 2 to tier 1.
On taxation, there is still some ambiguity on tier 2. There is a perception that long-term capital gains made with a holding period of more than 36 months qualify for 20 per cent taxation with indexation benefit. But this is not stated explicitly in the rules.
The Finance Bill has made it clear that gains from all types of debt funds will be added to investors’ income and taxed at the marginal slab applicable, without any indexation, irrespective of the holding period. But what if the equity portion is more than 35 per cent in tier 2 for an investor? Will there be taxation with indexation benefit then?
Given that all of this is just a matter of conjecture, it would be safe to assume that tier 2 NPS gains will be taxed at your slab. That puts NPS tier 2 somewhat at par with debt mutual funds on taxation.
Debt schemes outpace mutual funds
We have left out the equity portion in the NPS tier 2 comparison with mutual funds as the former has only large-cap and index-hugging investments. And for equities in general, mutual funds offer several options for various risk appetites and time horizons, and the added flexibility of withdrawing at any time, apart from the possibility of better returns.
On the debt portion we have taken the category average trailing returns of the C and G options of tier 2 NPS fund managers over one, three, five and 10-year periods and compared them with similar debt mutual fund categories – corporate bond, gilt, gilt with 10-year constant maturity, dynamic bond and banking & PSU debt.
NPS tier 2 corporate bond category has beaten mutual fund categories dynamic bond, corporate bond, banking & PSU debt. The outperformance has been to the tune of 1-1.5 percentage points, which is quite healthy.
Taking the tier 2 NPS G-Sec category, the schemes have outperformed gilt and constant maturity mutual fund categories convincingly across timelines.
What should investors do?
NPS tier 2 funds have easily given more than 8 per cent returns over timeframes of 5-10 years.
In the government securities category NPS tier 2 schemes usually invest in G-Secs that mature anywhere from 2026 all the way up to 2053. Some fund managers also invest in state development loans of large and prosperous States.
When the corporate bonds category is seen, NPS tier 2 schemes invest in the bonds and NCDs of government and highly rated private banks and finance companies. So, HDFC, Bajaj Finance, NABARD, NHAI, NHPC, Reliance Industries, IOC and ICICI Bank are some of the entities whose securities these tier 2 funds invest in.
Therefore, in both these options, there is limited credit risk.
Investors can consider tier 2 corporate bond and government securities options for the debt portion of their portfolio as a part of their larger asset allocation. They could still retain their debt mutual fund holdings. But incrementally, a significant part of their debt investments – say, 24-30 per cent – could be considered via the NPS tier 2 option.