Make judicious investment choices when entering NPS and stick to them | Business Standard News

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While PFRDA will now allow investors to alter their investment choices four times in a financial year, tinkering too frequently may not be advisable except in volatile market conditions

pension, insurance, savings, senior citizen, employment, NPS, PFRDA

The Pension Fund Regulatory and Development Authority (PFRDA) will soon allow National Pension System (NPS) subscribers to change their investment choices four times in a financial year, instead of twice, as permitted currently. PFRDA chairman Supratim Bandhopadhyay announced this recently. Experts say this is a welcome development. “It gives more choice to the subscriber, which he should have, given the volatile times we live in,” says Sumit Shukla, chief executive officer, HDFC Pension Fund Management. While it is good to have this option, investors should not exercise it too often, say experts. “Once an investor has decided on a pattern, he should stick to it for a few years in this long-term instrument,” says Shukla. The only exception to this rule should be made when market conditions are very volatile. An NPS subscriber needs to make several choices. Most investors, who don’t have an advisor to assist them, are at a loss regarding which of the myriad options to choose. Active or auto choice? An investor opting for NPS needs to first decide between these two options. In the active-choice option, the subscriber decides the asset classes in which the funds that he contributes will be invested. Four asset classes are available: equities (E), corporate debt (C), government debt (G), and alternative assets (A). The subscriber also gets to decide the percentage that should be allocated to each of these asset classes. In the auto-choice option, the subscriber has to choose from one of the three life-cycle (LC) funds that are available. The first is the aggressive life-cycle fund (LC75), the second is the moderate life cycle fund (LC50), and the third is the conservative life-cycle fund (LC25). Once the subscriber chooses one of these life cycle funds, the allocation to various asset classes happens automatically. It changes periodically based on the subscriber’s age. Essentially, a decision is being made here regarding asset allocation. Financially savvy investors should choose the active-choice option. It offers one advantage over the auto-choice option: You can keep your equity allocation at a higher level for a prolonged period. “Your equity allocation can stay at 75 per cent up to the age of 50,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors. In auto choice, the allocation to equities reduces from an earlier age. “However, this option of keeping the equity allocation at a higher level will work only for investors who understand that they need not worry about short-term volatility in a long-term portfolio such as retirement saving,” adds Dhawan. This option is also suitable only for those investors who can avoid falling prey to emotional biases, like allocating excessively to equities during a bull run, or pulling all money out of equities during a bear market. Any investor who chooses the active choice option must review his NPS portfolio at least once every six months. On the other hand, someone who does not understand asset allocation, lacks emotional maturity in the face of market movements, or lacks the discipline to review the portfolio at regular intervals will be better off going for the auto-choice option. Which is the right life-cycle fund for you? In LC75, the investor is allowed an allocation of 75 per cent to equities till the age of 35.

Thereafter, the equity allocation begins to reduce. It declines to 20 per cent by age 50 and 15 per cent by age 55 (where it stays put). Allocation to the two types of debt funds begins to increase from the age of 35. In the moderate life cycle fund (LC50), the allocation to equities is 50 per cent till the age of 35. It reduces to 20 per cent by age 50, and to 10 per cent by age 55 (and above). In the conservative life cycle fund (LC25), the equity allocation is maintained at 25 per cent till the age of 35. Thereafter, it declines to 10 per cent by age 50, and further to 5 per cent by age 55 (and above). The choice of a life cycle fund should depend on your risk appetite. “If you are young and aggressive, go for the aggressive fund option (LC 75). On the other hand, if you are somebody who has very little experience of equities, and is likely to be affected by volatility, go for the conservative option (LC 25),” says Arnav Pandya, founder, Moneyeduschool. Selecting the pension fund manager Eight pension fund managers handle the money of investors, according to the PFRDA website. These include HDFC, ICICI Prudential, Kotak Mahindra, LIC, Reliance Capital, SBI, UTI Retirement Solutions, and Aditya Birla Sun Life. Investors have to choose one of them. The same pension fund manager handles the corpus invested in the various asset classes (in other words, you don’t have the option to select a separate pension fund manager for each asset class). “Go with a pension fund manager that has displayed consistency across market cycles,” says Ankur Maheshwari, chief executive officer, Equirus Wealth Management. The good thing now, according to him, is that a lot of data is available based on which investors can take an informed decision. In the case of tier 1 equity schemes, for instance, data is available until May 2009 for some pension fund managers. According to Dhawan, the decision on which pension fund manager to go with should depend on your asset allocation. “If you have allocated more to equities, select a fund manager whose equity fund has delivered good performance,” says Dhawan. Choosing the right annuity plan Seven annuity providers are available. The investor can choose one of them for receiving annuity payouts. “Go with the name that you are most comfortable with. Alternatively, choose the player that will give you the best monthly pension,” says Maheshwari.Pros and cons of NPSAdvantages

  • A targeted retirement saving instrument with restrictions on withdrawal (ensures the money saved for retirement is not used for other goals)
  • Low fund management charge (depends on the asset under management and currently ranges from 0.03 to 0.09 per cent)
  • Freedom to choose your asset allocation (and the auto-choice option for those who can’t)
  • Tax deduction of Rs. 1.5 lakh under Section 80C and additional, earmarked deduction of Rs. 50,000 under Section 80CCD(1B)

Disadvantages of NPS

  • Difficult to withdraw money in case of an emergency (except in limited circumstances)
  • Compulsory annuitisation of at least 40 per cent of the corpus at retirement (reduces flexibility for those who may want a higher lump-sum payout)
  • Rate of return on annuity may be lower than what investors could earn by investing in other instruments
  • Annuity payout is added to the investor’s income and taxed at slab rate
  • Same pension fund manager across all asset classes

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