NPS currently allows subscribers to invest up to the age of 75 with an exit option any time after the age of 60 years of age. However, many soon to be retirees are extending the investment beyond the age of 60 years of age. Here’s why.
The government recently revealed that 83% of NPS subscribers who have reached the age of 60 choose to continue investing beyond maturity. Instead of opting to receive the pension and withdraw part of the NPS corpus, subscribers are extending the accumulation phase well into retirement. The pension vehicle currently allows subscribers to invest up to the age of 75. Is this a sound strategy for retirees? What should subscribers expect in this phase?
At present, rules permit NPS subscribers to withdraw up to 60% of the accumulated corpus upon maturity. At least 40% of the corpus is required to be put in an annuity product for regular pension. However, four out of every five subscribers are choosing to defer the vesting age. According to experts, deferring annuity makes sense now. At current low interest rates, the pension from annuity component would be very low. Annuity rates are expected to rise over the next few years, when interest rates rise.
According to NSDL, a central recordkeeping agency under NPS, based on current annuity rates, a 60 year old male subscriber with a Rs 25 lakh corpus would at best fetch a monthly pension of Rs 17,306. Those with a lower pot size would fetch even less. NPS was extended for the private sector only in 2009, even though government employees have been subscribing since 2004. “Subscribers would not have accumulated a sizeable pension pot in such a short time span,” points out Amol Joshi, Founder, PlanRupee Investment Services.
Besides, while NPS is not taxed in any form during the accumulation phase, the annuity component is fully taxed. For retiring subscribers, extending beyond 60 can make a material difference. “The flexibility to extend NPS beyond the age of 60 allows the subscriber to benefit from uninterrupted compounding and build on accumulated savings,” contends Sumit Shukla, CEO, HDFC Pension Funds. Subscribers who extend NPS investment beyond age of 60 can exit any time before age 75. Further, the separate tax benefits under NPS is a strong pull for continuing contributions. NPS subscribers can continue to claim additional tax deduction for investments up to Rs 50,000, over and above the Rs 1.5 lakh window of Section 80C. Suresh Sadagopan, Founder, Ladder7 Financial Advisories, asserts, “If you do not need immediate payout upon retirement, it makes sense to let the NPS pot grow.” Particularly, continuing with NPS makes more sense if you continue to draw high income post-retirement— in the form of pension or any other source, like a part-time job or house rent. This can be deployed into the NPS to boost corpus for later retirement years.
NPS plans have fetched high returns in recent years
But subscribers extending now should come with the right expectations and mindset. Given prevailing conditions in both equity and bond markets, be prepared to persist with NPS contributions for at least 5-7 years. On the equity side, the astronomical returns of the recent past cannot be extrapolated into the next few years. NPS equity plans have fetched 16.7% annualised return over the past three years. But in the near-to-mid term, equity returns are likely to remain modest, accompanied by high volatility. So do not expect your NPS pot to grow larger on the strength of its equity bets in the next 2-3 years.
The bond segment of NPS is also likely to deliver modest returns. The NPS government bond plans and corporate bond plans have yielded 9.5% and 10% annualised return, respectively, over the past three years, on the back of softening bond yields. But expectations are that interest rates and yields will rise in the near term. When this happens, prices of bonds with longer maturity will take a hit. NPS invests in long term bonds in both its government bond plans as well as corporate bond plans. Given the twin headwinds, be ready to remain invested in NPS for a long time.
Further, it is vital to get the NPS asset mix right in context of your age and risk profile. Experts say it is essential to maintain some equity exposure even in retirement years. Without equities powering the portfolio, your accumulated savings will get eaten up by inflation very fast. At the same time, retirees cannot afford to take too much risk given limited time frame. NPS allows subscribers beyond 60 maximum allocation of 50% in equities under the Active choice. If already carrying sufficient equity exposure via equity funds, NPS subscribers can limit allocation to this space. Else, keep healthy exposure to this segment within NPS. Sadagopan recommends retirees to maintain up to 30-40% exposure to equities in this phase.
Experts maintain equity funds are the best option to facilitate cash flow in a tax-friendly manner. SWP from equity funds would yield tax-efficient cash flow compared to NPS annuities. Any withdrawals from equity funds that translate into capital gains in excess of Rs 1 lakh in a year will be taxed at 10% whereas NPS pension will be taxed at applicable slab rate. “The NPS is tax-friendly during the accumulation phase but not when drawing pension,” observes Joshi. Meanwhile, retirees should also make full use of Senior Citizen Savings Scheme and Pradhan Mantri Vaya Vandana Yojana limits for fixed income.