Make judicious investment choices when entering NPS and stick to them

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

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 the two permitted currently. PFRDA chairman Supratim Bandyopadhyay announced this recently.

Experts say this is a positive development. “Subscribers will have more choice, which they very much require in these volatile times,” says Sumit Shukla, chief executive officer, HDFC Pension Fund Management.

Subscribers should, however, not exercise this option too frequently. “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 markets turn very volatile. Financial planners say a six-monthly review of the NPS portfolio should suffice.

An NPS subscriber needs to make several choices at the time of entry. Most investors, who don’t have an advisor to assist them, are at a loss regarding which of the myriad options to choose.

Active choice is for savvy investors

The NPS subscriber can invest in four asset classes: equities (E), corporate debt (C), government debt (G), and alternative assets (A). If he goes for the active-choice option, he gets to decide the asset classes in which the funds he contributes will be invested and the percentage that will be allocated to each of them.

In the auto-choice option, on the other hand, the subscriber has to choose one of the three life-cycle (LC) funds. 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). Each of them has a different asset allocation, which keeps changing with age. Once the subscriber chooses a life-cycle fund, his asset allocation happens according to the prescribed pattern for that fund.

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. “It 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.

“This option of keeping equity allocation at a higher level is suited only for subscribers who understand they should not worry about short-term volatility in a long-term instrument such as NPS,” adds Dhawan.

Subscribers who go for the auto-choice option must avoid falling prey to emotional biases, like allocating excessively to equities during a bull run or pulling all money out of equities in a bear market. They must also review their NPS portfolio once every six months.

On the other hand, those who don’t understand asset allocation, lack emotional maturity in the face of market movements, or don’t possess the discipline to review their portfolios regularly will be better off going for the auto-choice option.

Life-cycle fund: Go by risk appetite

A subscriber who opts for LC75 gets an equity allocation of 75 per cent to equities till the age of 35. Thereafter, it begins to reduce and goes to 20 per cent by age 50 and 15 per cent by age 55 (where it stays put till 60). Allocation to the two types of debt funds (C and G) begins to increase from age 35.

In the moderate life-cycle fund (LC50), equity allocation 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 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 could be affected by volatility, go for the conservative option (LC 25),” says Arnav Pandya, founder, Moneyeduschool.

Fund manager: Look for consistency

Investors have to choose one of several pension fund managers (PFM) like LIC, SBI, UTI Retirement Solutions, HDFC, ICICI Prudential, and so on. The same PFM handles the corpus invested in the various asset classes (subscribers don’t have the option to select a separate PFM for each asset class). “Go with a PFM that has displayed consistency across market cycles,” says Ankur Maheshwari, chief executive officer, Equirus Wealth Management. According to Dhawan, your asset allocation should guide your choice of PFM. “If you have allocated more to equities, then select a fund manager whose equity fund has delivered good performance,” says Dhawan. Pandya suggests choosing a PFM that has displayed consistency across asset classes.

Annuity plan: Choose on basis of rate of return

At retirement, the subscriber has to choose from one of the several annuity providers that are available. “Go with the name you are most comfortable with. Alternatively, choose the player offering the highest monthly payout,” says Maheshwari.

In addition to the tier I account, subscribers can also invest in a tier II account. It does not offer any tax benefit but is completely liquid. Financial planners say investors should avoid investing in it until there is clarity on the taxation of gains from this account.

                                                  

Pros and cons of NPS

 

Advantages 

• 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