NPS Vatsalya: Pension plan that starts early for child's financial security

Scheme gives access to a variety of investment options but may not suit people who desire liquidity in their investments

In an attempt to promote retirement savings from an early age, the government has launched NPS Vatsalya. It is a new initiative under the National Pension System (NPS) that allows parents or guardians to build a retirement corpus for their children. They can begin investing in this scheme from the child’s infancy and continue until they become 18, after which the account will seamlessly morph into an NPS Tier-1 (All Citizens model) account.

Features

As with the NPS for adults, investors will have access to a variety of investment options. “The option to invest through auto choice or active choice can be utilised here as well,” says Kurian Jose, chief executive officer (CEO), Tata Pension Management.

All the asset classes available in NPS for adults will also be available. “The guardian will be able to choose between equity, corporate debt, government securities, and alternative investments,” says Rajesh Khandagale, head-NPS, KFin Technologies.

The guardian may also select any one of the pension funds registered with the Pension Fund Regulatory and Development Authority (PFRDA).

The main difference lies in the account’s operation. “Until the child reaches the age of 18, NPS Vatsalya requires a guardian to manage it,” says Khandagale.

NPS for adults offers Tier-I and Tier-II accounts. “NPS Vatsalya offers only the Tier-I account,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.

Long-term compounding

The key advantage of NPS Vatsalya is the ability to start early. “You do not need to wait until the child turns 18 to begin investing for their retirement. The long investment horizon – from infancy until the age of 70 – will enable the invested corpus to benefit from compounding,” says Arnav Pandya, founder, Moneyeduschool. He adds that parents planning children’s long-term financial security can start saving for their retirement.

According to Khandagale, a scheme like this can also instill saving habit in children. When children see investments being made in their name, they are likely to continue saving for retirement through NPS once they take charge of the account.

Most existing schemes for children have a limited tenure. “They usually end after a specific tenure or when the child reaches a certain age – children’s insurance plans, Sukanya Samriddhi Yojana, etc., with children’s mutual funds being an exception. Now, one more option is available that can serve as a long-term retirement tool for children,” says Dhawan. He adds that, in the past, parents have used the Public Provident Fund (PPF) similarly, where they handled it until a certain age and then handed it over to their children.

The annual contribution requirement of just Rs 1,000 makes it easy to open and continue with NPS Vatsalya.

“Contributions can start at as low as Rs. 1,000 a year, making it financially accessible for families of all means,” says Preeti Chandrashekhar India Business Leader, Health and Wealth - Mercer, a business of Marsh McLennan.

Low on liquidity

As with NPS for adults, liquidity could be an issue for investors in NPS Vatsalya.

“It provides flexibility through partial withdrawals to meet educational and medical expenses. After three years of account opening, parents or guardians can withdraw up to 25 per cent of the total contributed amount,” says Chandrashekhar. A maximum of three withdrawals are permitted.

Once investors have crossed the three-year lock-in period, they can make partial withdrawals of up to 25 per cent of their contributions. A maximum of three withdrawals is allowed for education, specified illnesses, disability and other reasons.

When the child turns 18, they can exit. If the corpus is less than Rs 2.5 lakh, they can withdraw the entire balance as a lump sum. However, if the accumulated corpus is equal to or greater than Rs 2.5 lakh, then at least 80 per cent of the corpus must be used to purchase an annuity. The remaining 20 per cent can be withdrawn as a lump sum.

Receiving 80 per cent of the money as an annuity payout may not be very useful at this age when parents need large sums for children’s marriage and education.

“The conditions for partial withdrawal and complete exit make the product restrictive compared to, say, a mutual fund, where you can withdraw whatever amount you like at any point,” says Dhawan.

First, the parents should contribute to the scheme, and then the child must continue doing so until retirement. “If the child does not, or is unable to continue contributing, then you would be in a difficult situation because you would only get 20 per cent back as a lump sum, and the balance would come gradually in the form of annuity payouts,” says Pandya.

The equity schemes available here are likely to be tilted towards large-cap companies. “The inability to build a portfolio tilted towards mid- and small-cap companies, which can offer attractive returns over the long term, is another shortcoming of this scheme,” says Dhawan.

Pandya points out that one will have to wait and see how seamless the conversion from NPS Vatsalya to Tier-1 NPS account is when the child turns 18.

Should you opt for it?

This scheme is suitable for parents who wish to secure their child’s financial future. “Individuals seeking a long-term investment option for their children with the potential for higher returns may opt for NPS Vatsalya,” says Khandagale.

Pandya says parents who wish to instil the saving habit in their children may also consider it.

According to Dhawan, people seeking flexibility in investment mode (auto choice and active choice) and asset mix (equities, corporate debt, government securities, and alternative assets) may find this scheme appealing.

However, this scheme is not suitable for people who desire liquidity in their investments. Dhawan adds that people who want 100 per cent equity exposure should also avoid this scheme, as the maximum available here is 75 per cent. He adds that people who want exposure to mid- and small-cap stocks should also steer clear of it.

“Investors who prioritise tax benefits may be deterred since according to our current understanding, NPS Vatsalya doesn’t offer any additional tax advantages over and above NPS,” says  Chandrashekhar.

Pandya advises that parents who are uncertain whether their child will continue with the scheme after turning 18 may also avoid it.

If you decide to open the scheme, invest regularly. “You also need to invest a meaningful amount each year if you wish to build a substantial corpus for your child’s retirement,” says Pandya.

When selecting the asset mix, parents should consider their risk tolerance. “If you look at past returns, equities are likely to have performed the best. That does not mean you should take the maximum equity exposure available. You should also consider your risk appetite,” says Dhawan.

Along with this instrument, you should also save for your child’s other goals (such as marriage and education) in more liquid instruments. “Remember that if you fall short on your child’s education or marriage goals, you will not be able to access the entire corpus in this account,” says Pandya. Dhawan emphasises that those opting for this scheme should combine it with other liquid instruments, such as mutual funds.

Finally, now that an instrument has become available through which parents can save for their child's retirement, the former should get their priorities right. "Parents should focus first on their own retirement, then their children's education and marriage, and only then on their children's retirement," says Dhawan. Most importantly, parents should not end up compromising on their retirement goal.