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NPS: Not cheap

PFRDA (Pension Fund Regulatory and Development Authority) has opened the NPS (New Pension Scheme) for general public. Note that it has been “New” for last 2 decades and has materialized only now.

The idea of NPS is extremely noble: India lacks social security of any kind, so the unorganized sector badly needs a useful retirement savings scheme. But the current implementation leaves a lot to be desired. Only saving grace is, that there is no one to hard sell the scheme yet. The appointed intermediaries have no interest in selling the scheme, instead, they have competing products of their own to sell. Since not many people will open an NPS account until some sellers are motivated, not many people will be disappointed that NPS is not cheap.

The promises of fund management charges of 0.009% sounds very cheap. Much cheaper than mutual funds which can charge up to 2.5% fund management charges per year (most charge less than 2%). But there are other problems that we now proceed to analyze.

Target Audience:

Our first step is to understand the target beneficiaries of NPS. Most organized sector workers of lower-middle to middle class (income higher than 1.5 lakhs a year) don’t need NPS that badly because they already have EPF,  government pension(government employees who joined service a decade ago) and other loyalty funds from their employer such as superannuation. Though they can still use NPS to get some equity exposure as their other investments are likely to be largely fixed income investments giving lower returns (less than 9% post tax).

The prime beneficiaries for whom NPS could have been a godsend are unorganized sector workers who do not have access to any retirement scheme. They are also typically poorer than organized sector workers, and people with incomes 75000 – 1,50,000 could have taken advantage of this scheme (if it were sold well, but that is a separate topic). Let us concentrate on such people for our analysis. Yes, I am less concerned with “high” income people, earning more than 1.5 lakhs a year as they can better fend for themselves.

Why I am leaving out people earning less than 75000 per year? Depending on circumstances (rural/urban ; family situation etc.) they may not have any invesible surplus. Even for such important a task as retirement planning. So they could not have taken advantage of NPS even if NPS were perfect.

I know there are exceptions to the generalities I quoted above. There are people in unorganized sector that earn crores a year. There are people earning 50,000 a year who can afford to save because of low expenses. But, like I said, they are exceptions rather than the rule and hence can be ignored for the larger analysis.
Disadvantages of NPS for our specific target audience:

  1. Compulsary investment of 6000 a year:
    A commitment of investing Rs. 6000 every year is tough to make. More so because our target audience has unstable sources of income. Rs. 6000 is anywhere from 8% to 4% of the annual income of our target audience and hence they might be very scared to make such commitments. Especially since the penalty of Rs. 100 per quarter if this minimum investment is not made is very high. On the flip side, it can be argued that this penalty keeps them disciplined; though I wouldn’t buy this argument for much. Retirement planning takes mammoth discipline anyway. Since it is important that our target audience starts some investment right away to take advantage of the power of compounding, to start with we should make our schemes very flexible, and low on penalties.
  2. Charges (9.33% entry load):
    Fund management charges are low enough, but the fixed charges are high. In a bad year, when you barely manage to invest 6000 in the requisite 4 yearly installments, you incur the following charges:
    A. Account opening charge of Rs. 50 (only required for the first year)
    B. Annual maintenance charge of Rs. 350
    C. 4 transactions, Rs. 10 fees to CRA for each. Total Rs. 40.
    D. Registration with PoP (Point of Presence, kind of the investor’s broker): Rs. 40. This will be required not just the first time, but everytime the PoP is changed for some reason (e.g. migration from one location to another)
    D. 4 transactions, Rs. 20 fees to PoP for each. Total Rs. 80.
    Other charges are negligible; but these charges total to Rs. 560. This is 9.33 percentage of the investment for the year (Rs. 6000). Consider it kind of an entry load for NPS.
  3. Expensive modes of withdrawal:
    The funds are reasonably high return : 50% stock market index funds & 50% debt, progressively moving towards majority debt as the individual grows older. But remember that taxes will kill the returns. Unless an annuity is purchased from a life insurance company. Annuity rates given by LIC are on the lower side (those by ICICI Prudential are even lower).

In conclusion, we can say that the high returns from stock markets will be eroded because of high charges and annuity inefficiencies. This article is not to totally condemn the designers of NPS but just to show that more needs to be done. The charges will be reduced only when there are millions of investors in NPS; which will be never if these defects are not rectified. Which brings us to our original point: there is no one to explain all these nitty-gritties to an investor in our target audience. No significant people of our target audience is going to invest in NPS anyway, so all the above rant was for academic purposes only. Government employees, and organized sector workers’ EPF will be replaced with NPS which is good thing.

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