NPS was launched in the year 2004 by the Indian government as a defined contribution pension system. All employees who joined the Indian government service from 2004 come under this scheme. The previous defined benefit pension system for government employees is a huge financial burden, which the government wanted get relieved of gradually.

NPS is now being made available to the common public from May 2009. Any one can avail himself or herself of this scheme.

THE SCHEME

It is a centrally operated portable pension scheme. Initially there are 23 Points of Presence (POP) consisting of banks and other financial institutions, who act as the front end interface with the public. These POP facilitate account opening and other transactions. NSDL (National Securities Depository Limited) is the Central Record keeping Agency (CRA) and there are 6 fund managers, who will manage the funds. You may open an Individual Retirement Account (IRA) with any of the POP and you will be allotted a unique account number valid for life. So even if you change employer or place of residence, you may continue to operate the same account.

You have the option of contributing monthly or quarterly, but a minimum of 4 contributions in a year is mandatory to inculcate the regular saving habit. There are 3 fund options namely E (Equity), C (Corporate bonds) and G (Government bonds) and you may choose any or a combination of these options to deploy your funds. There is also a default “auto choice” fund which would be a lifecycle fund and the asset allocation would be adjusted according to your age. The equity exposure will be 60% till age 35 after which it will reduce by 3% every year till it reaches zero by age 55. You have the choice of selecting your fund manager and the CRA would transfer your funds to the desired manager.

Initially the NAV (Net Asset Value) will be declared once in a year and you would have the option of changing your fund manager only once a year. The performance of the fund managers will be reviewed every 3 years and replaced if necessary.

The tier 1 account is purely a retirement fund with no withdrawals permitted till age 60. But in case of a critical illness or for the purpose of buying a house, withdrawal is permitted. At the age of 60, you may opt to withdraw up to 60% of the fund as a lump sum and buy an annuity with the rest. There is also a proposed tier 2 account likely to be launched at a later date which would act as a normal investment account, permitting investments and withdrawals at will. But you need to have a tier 1 account if you desire to open a tier 2 account.

Fees and Charges

Account opening charge: Rs.50 per account

Annual maintenance charge: Rs.350 per annum which will gradually reduce to Rs.250 as the number of accounts increases to 30 lakhs.

Transaction charge: Rs.10 per transaction which will gradually reduce to Rs.6 as the number of accounts increases to 30 lakhs.

Fund management charge: 0.0009% per annum on the fund value.
 
Open to NRI

NPS is open to NRI who continue to hold Indian passport. The contribution should be in Indian rupee and the scheme is non-repatriable.

The positives of the scheme

Simple: Once an account is opened, you may continue to contribute till you reach retirement.

Portable: You need not open a fresh account every time you switch employment or residence unlike the present EPF (Employee Provident Fund)

Low cost: NPS offers an extremely low cost retirement plan when compared to the other alternatives. The significance of lower cost will be felt when compounded over a long period of say 15 or 20 years. The following illustration will drive home the benefit of low cost.

Consider the case of an investor who invests Rs.5000 per month for 20 years. With an assumed pre-expense return of 10%, the amount he would receive under NPS and any alternate retirement plan that has a fund management charge of 1% would be:

Tax treatment: The returns are fully taxable unlike EPF and PPF (Public Provident Fund) where the returns are tax free. This obviously looks to be an error and does not sound logical because all similar investment vehicles have to be given the same tax treatment and let’s hope that this would be set right in due course.

Disclosure: Initially the NAV would be declared annually so as to minimize churn between fund managers. Hopefully the disclosure is made more frequently over time enabling better fund manager assessment.
 
What should you do?

Certainly NPS is a good alternative to the investment schemes available right now in India and merits consideration. But stick to your present investment plans for now till there is more clarity on the scheme and the initial hiccups are overcome. I shall update the details once the scheme is up and running.

Check our latest update on this topic posted on 4/30/2009.

Any more questions on this topic, please don't hesitate to ask at our new Q&A section,  Ask All About Money or new website JustAskNRI.com.