National Pension System: Nascent Steps Towards Better Social Security for Senior Citizens

India’s demographic dividend offers a huge opportunity for economic propulsion of the country. This opportunity can fast transform into a threat if employment options are not created for the youth and they end up having no savings to take care of their life as senior citizens. Add to this the advancement of medical science due to which longevity has increased from a mere 45 years at the start of the 20th century to about 75 years in the new millennium. While a small part of the population is covered under employer-sponsored pension plans, the un-organised sector, which accounts for a majority of the jobs, needs a face-lift for pension reforms.

In response to these demographic changes, the National Pension System was introduced compulsorily for all Central Govt. employees joining from 1st April 2004 onward. The benefits were extended to the common masses as well by allowing voluntary enrollment through flexi-pay plans. 

This lesson aims at exploring the different types of pension plans, why NPS had to come into the picture and the details about NPS plans.

by Swati Sinha
1 year, 8 months ago

Pension planning has become the need of the hour for those who want to walk into the sunset with their head held high. There are various factors which arise post retirement apart from regular household expenses that make retirement planning a must: 

  • Create real estate for self and successors     
  • Late parenthood which brings along problems of higher education & marriage expenses for children post-retirement     
  • Increasing healthcare expenses and lack of government sponsored healthcare plans 
  • Maintaining lifestyle
  • Rapid movement from the joint family structure prevalent earlier, into nuclear families

Sometimes it's hard to tell if retirement is a reward for a lifetime of hard work or a punishment "

- Terri Guillemets
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Worldwide pension plans are distinguished into two types. Defined benefit pension schemes are those wherein the amount of pension receivable is fixed on the basis of certain factors such as number of years of service, age of retirement etc. Usually for calculation, a certain pre-determined formula is used which is based on the last remuneration received during active employment. The pension amount payable is a certain percentage of the last drawn salary. These schemes are usually employer sponsored and owing to uncertainty in life span of pensioner and their survivors, poses a challenge to future liability calculation for companies.

In contrast Defined contribution Pension schemes define the amount of contribution to be made for creating a pension fund. However, the end result i.e. the actual pension amount receivable during the commutation period is unknown. The amount receivable mainly depends on the fund management of the pension corpus during the pre-retirement years. 
To summarize: 
  • The risks of lower investment return and hike in annuity prices are borne by the concerned beneficiaries under a Defined Contribution Pension scheme, whereas the employer bears these risks for Defined Benefit Pension scheme.    
  • The progress of the fund is very clear under Defined Contribution Pension scheme but the ultimate benefit is unknown to everyone concerned.        
  • There are certain subsidies which may be provided by the government to employers in Defined Benefit Pension scheme but such subsidies are virtually absent in the Defined Contribution Pension scheme.
  • What you pay is what you get in case of Defined Contribution Scheme whereas the Defined Benefit system functions on cost to company basis. 

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Although defined benefit plans come with the comfort of knowledge of the amount of pension, they have several drawbacks which put these plans at a disadvantage. Firstly, from an employee’s point of view, in DB plans, the employee does not have any control on the investment decisions and management of the fund. So, employees are bereft of an opportunity to actively participate in fund management and in some cases of getting better returns.

From an employer’s perspective, the problems are manifold. Firstly, even in years when the earnings or profit margin of the company have been hit, the contribution towards the plan still needs to be made. Secondly and more importantly, increased longevity has become a bane for employers who are unable to have ascertained financial calculations in place, thus, causing an incalculable amount of risk to the company’s balance sheet.
The problem gets magnified when the employer is a government run body and it is the tax payer who ultimately ends up bearing the burden of social security for an ageing population.

DB plans run by the Government have been deserted, and it has adopted NPS - a DC pension plan for all its employees who have joined service from 1st April, 2004 onwards.

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 The National Pension System was introduced in order to counter the various problems arising due to the lack of a structured, well-defined and uniform system. Designed on the lines of the 401(K) plan of USA, NPS makes customers accountable for gradually building their post-retirement funds.

Various problems were posed by the different Defined Benefit Schemes run by various government bodies for its employees. The OASIS (Old Age Social & Income Security) Project was commissioned by the government to study the existing system and provide inputs for a framework that could overcome the flaws of the system in place. The NPS, a defined contribution pension structure, was launched with various objectives to be met such as:     

  • The contribution of the government and hence the upfront liability of government on pension payment will be defined
  • Give choice to customers – to contribute towards their pension fund voluntarily in addition to compulsory contribution
  • Facilitate portability of labour force without any adverse effects on their retirement corpus. 
  • To ensure transparency and fair-play in management of pension funds.
  • To build a model which is suitable to cover all government employees in the beginning but can be replicated later to accommodate other citizens.

Current employee benefits offering some form of social security are mainly statutory:  Employee Provident Fund (as per the EPF & MP Act - 1952) - wherein 12% of employee’s contribution is towards EPF and out of employer’s contribution @ 12%, 8.33% gets diverted to the EPS and the balance 3.67% goes in EPF Gratuity (Payment of Gratuity Act- 1972)at [(15/26)* number of years of service * last drawn salary] is payable for employees who have completed atleast 5 years in service.

NPS is also being viewed as an attractive employee benefit option and many private sector employers are showing interest in offering NPS to employees.
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Pension Fund Regulatory & Development Authority is the regulatory body for NPS. The PFRDA was established by Government of India under the aegis of Ministry of Finance, based on the recommendations of the OASIS Report.

Pension Funds/Pension Fund Managers are responsible for management of the retirement savings of subscribers under NPS. They have to strictly invest in accordance with the investment guidelines issued by the PFRDA. As of now, the following are the appointed Fund Managers:

Fund Managers for NPS Scheme for government employees:      

  • LIC Pension Fund Ltd.    
  • SBI Pension Funds Pvt. Ltd.    
  • UTI Retirement Solutions Ltd.

Fund Managers for NPS Scheme for all citizens:

  • ICICI Prudential Pension Funds Management Co. Ltd.
  • SBI Pension Funds Pvt. Ltd.
  • UTI Retirement Solutions Ltd.
  • Kotak Mahindra Pension Funds Ltd.
  • Reliance Capital Pension Fund Ltd.
  • DSP BlackRock Investment Managers Ltd.             

Central Recordkeeping Agency is responsible for administration, record-keeping
and customer service pertaining to data of NPS subscribers. On the basis of service requests received from subscribers, the CRA passes on the instructions to the PFs. Since the CRA keeps track of NPS account activity, it periodically also sends consolidated statement to the subscribers. NSDL is the authorised CRA of NPS accounts.

Trust is responsible for safeguarding the interest of all beneficiaries/subscribers. The trust is a registered owner of all NPS assets.

Trustee Bank is the bank where the banking account is held by the NPS Trust. The Trustee Bank facilitates fund transfer across various entities of the NPS – ie. subscriber, PF, annuity service provider etc.  Bank of India is the appointed Trustee Bank

Annuity Service Provider is responsible for delivering a regular monthly pension to the subscriber. Using the banking details received from the CRA and the specified sum from the trustee bank, the pension amount is paid to the subscriber.

Point of Presence is the interface between the subscriber and the other entities of the NPS architecture. The POP performs multiple functions such as new subscriber
registrations, verification of KYC documents, receipt of funds from subscribers and transmitting them on to the designated entity.

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The Tier I scheme is compulsory for Central Govt. Employees (excluding Armed Forces) who have joined services from the 1st of April, 2004 onwards. This scheme was initially implemented only for the organized sector and was further modified to extend the services to other citizens interested in voluntary enrollment from the 1st of May, 2009 onwards.

The various features/benefits of the Tier I Plan can be summarized as follows:

For Government employees:
A compulsory contribution of 10% of the basic pay and dearness allowance is deducted from the salary and a matching contribution is made by the Govt. towards the pension fund.

Tier I Plan for all citizens:

Minimum Contribution Rs. 500 per month

Minimum Contribution Rs. 6000/- per annum

Tier-I contributions (and the investment returns) cannot be withdrawn.

Government employee or any other citizen can exit at or after the age of 60 years from the Tier-I of the scheme. On maturity, 60% of the accumulated funds can be withdrawn as lump-sum, whereas, 40% of pension wealth needs to be compulsorily invested to purchase an annuity plan approved by IRDA. This annuity plan will serve the purpose of providing pension for the lifetime of the employee and his dependent parents/spouse.

In the case of Government servants who leave the Scheme before attaining the age of 60 (Voluntary Retirement), the mandatory annuitization would be 80% of the pension wealth.
Fund Management Charges for Govt. Employees is 0.102% and for all citizens - 0.25% subject to maximum of Rs. 25000.

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A Tier II Account can be opened only after a subscriber has compulsorily opened Tier I account. While the non-withdrawal feature of a Tier I account ensures that a corpus is built keeping in mind the long-term objectives of the scheme, a Tier II account offers flexibility through withdrawal facility.

  • Minimum contribution at the time of opening account - Rs. 1000/-
  • Minimum amount per contribution - Rs. 250/-
  • Minimum number of contributions in a year – 4 (Minimum one contribution if a subscriber joins in the last quarter)
  • Minimum Account Balance at the end of FY - Rs. 2000/-
  • Penalty of Rs. 100/- to be levied on the subscriber for not maintaining the minimum account balance and/or not making the minimum number of contributions.

Salient features of Tier II account are as follows:

  • No limits on number of withdrawals.
  • Facility for separate nomination and scheme preference in Tier-II.   
  • The subscriber would have the same choice of Pension Fund Managers (PFM) and schemes as in the case of Tier I account for all citizens.
  • Contributions can be made through any Point Of Presence (POP)
  • Facility of one-way transfer of savings form Tier II to Tier-I.
  • Bank details will be mandatory for opening a Tier II account.

Charge Structure for PoPs:

(a) New account opening charges (Tier-I & II both) - Rs. 40/-

(b) Tier-II activation for existing subscribers of Tier-I - Rs. 20/-

No additional Central Record Keeping Agency (CRA) charges will be levied for account opening and annual maintenance in respect of Tier-II. However, Central Record Keeping Agency (CRA) will charge separately for each transaction in Tier II, the charges being identical to the transaction charge structure in Tier- I. 

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All citizens (whether Resident or Non-Resident) between the age of 18 to 60 years are eligible to open a NPS account. There are three type of NPS account which can be opened - only Tier I, Both Tier I & II together, Tier II account for existing Tier I subscribers.

To register for an NPS account, the customer needs to fill the application form and submit it along with KYC Documents - Identity Proof, Address Proof, Date of Birth Proof and photograph. At the time of submission of application form, the customer needs to specify the preferred scheme and asset allocation. The initial contribution is collected at the P-O-S. After all necessary back-end processing, the CRA sends the PRAN Card along with necessary passwords to the customers. Permanent Retirement Account Number (PRAN) is a unique number allotted to every individual who joins the NPS. PRAN is allotted by CRA. PRAN is common to both Tier I & Tier II. One individual is eligible for one PRAN only. PRAN, a 16 digit number, remains the same throughout the term of the account, irrespective of changes in job, location of account, or change in pension fund manager.
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For Govt. Employees: 

Govt.Securities                                                                           upto  55%

Corporate Bond/PSU Bonds                                                        upto  40%

Equity including equity-linked schemes of Mutual Funds                upto  10%

For All Citizens: As per the investment guidelines, pension fund managers manage three separate schemes, each investing in a different asset class. The three asset classes are equity, government securities and credit risk-bearing fixed income
Active Choice: The subscriber can exercise the option to actively decide as to how the NPS pension wealth is to be invested in three asset classes:
E Class: Investment is primarily in Equity market instruments. These investments are linked to the performance of BSE SENSEX or NSE Nifty 50 index. High risk, high return.

C Class: Investment in fixed deposit of commercial banks and other debt securities. Medium risk, Medium return.

G Class: Investment made in Government securities like GOI bonds and State Govt. bonds. Low risk, low return.

Auto Choice: This option takes into account the age of the subscriber and with pre-defined ratios of the 3 asset classes that ensures exposure to equity is maximum for lower age subscribers and least for those approaching retirement age.

In case the investment choice is not specified in the registration form, the auto choice option is a default. 

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In taxation parlance, NPS is granted the status of Exempt, Exempt, Taxed (EET). NPS
is covered under Section 80CCD of Income Tax Act, which says that the aggregate limit of deduction under Sec 80CCD along with Section 80C, 80CCC shall not in any case exceed Rs 1 lakh.

As an incentive to employers, as per Section 80CCD (2) of income tax act W.E.F 1st  Apr, 2012, contributions made by them towards NPS accounts of employees up to 10% of the salary (basic and dearness allowance) can be deducted as ‘Business Expense’ from their Profit & Loss Account. Contribution made by subscriber also in NPS a/c in a financial year will be eligible for tax benefits up to Rs 1 lakh u/s 80CCD, subject to overall Limit of Section 80C.

Maturity benefits of NPS are however, taxable. The lump sum withdrawal amount is taxable currently but under proposed Direct Tax Code regime, this amount may become tax-free. Also, the annuity is taxable as this is treated as income in the hands of the customer. 
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There are other options which are available to customers which may be considered as an alternative to NPS. A comparison of these products is as below:

As seen above, the investment objective in NPS follows a balanced approach – equity component ensures that the funds are able to overcome inflationary trends and debt components ensure that investor funds are not exposed to high risk. The Tier I account which does not allow withdrawal of funds is a blessing in disguise as it helps preserve funds for meeting the long term objectives. The low cost of administration and fund management is another attractive feature of NPS. Also, recent reports have suggested that NPS is giving better returns than pension plans offered by insurance companies as well as the benchmark SENSEX and NIFTY. 

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Though many countries had adopted pension reforms before India did, nevertheless NPS is a step taken in the right direction. For those of us who always thought that retirement and thus, pension is a too far ahead for us to plan right now, it is high time that we start building a pension corpus of our own. After all, we definitely want to hang our boots up, some day and envisage a truly golden retirement life.

Retire from work, but not from life"
(NPS is fetching near double-digit...) NEW DELHI: The National Pension System (NPS) is fetching near ...
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1. Why Pension is a MUST?
2. Types of Pension Schemes - Defined Benefit & Defined Contribution Schemes
3. Why Defined Benefit Schemes are not Sustainable?
4. National Pension System: Steps towards an inclusive Pension Plan
5. New Pension System Architecture: Spokes of the Wheel
6. NPS Tier I Account
7. NPS Tier II Account
8. Procedure for Opening NPS Account
9. Choice of Investment Options under NPS
10. Taxation of NPS
11. How NPS Stands Against Other Products
12. Conclusion
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