What the pension Bill means for you

PFRDA gets teeth, does it mean you should bite into the National Pension System? 

 

 

 

 

 

The Pension Fund Regulatory and Development Authority (PFRDA) received a big push towards becoming a statutory authority when the Lok Sabha on Wednesday cleared the PFRDA Bill, 2011. The Bill now requires to be approved by the Rajya Sabha and signed by the President to become law. 

 

What does the passage of the Bill mean for investors?

 

It gives regulatory powers to PFRDA, which started operations through an executive order in 2003. At first, the National Pension System (NPS), PFRDA’s pension scheme, was extended to central government employees who joined services from 2004. Although it was designed to bring the unorganized workforce into a formal pension system, the government moved its employees to the scheme in order to lower the burden on its coffers from the defined benefit pension programme for its employees. It was only from 1 May 2009 that NPS was made available for the entire workforce. 

 

In the absence of statutory authority, PFRDA does not have the power to penalize the entities it regulates. Once it gains statutory powers and the authority to pull up errant pension sector participants. PFRDA will then be able to ensure better compliance and subscriber protection, said Nagendra Bhatnagar, chief executive officer and trustee of the National Pension System Trust.

 

Not only this, the Bill also stipulates the formation of a pension advisory committee with representation from all major stakeholders to advise PFRDA on important matters of framing of regulations under the proposed PFRDA Act. The Bill also states that the membership of PFRDA will be confined only to professionals having expertise in economics, finance or law. 

 

Changes to the NPS structure

 

The Bill seeks to initiate some structural changes to NPS. NPS is known as an investment vehicle that locks in subscribers’ money till they turn 60. At 60, a subscriber can withdraw about 60% of the retirement corpus and “annuitize” the remaining 40%—buy pension product that gives periodic income. In order to offer subscribers some liquidity, the proposed law allows for withdrawals with limits on the amount and number of withdrawals. The amendment to the Bill states: “Withdrawals not exceeding 25% of the contribution made by subscriber will be permitted from the individual pension account subject to the conditions, such as purpose, frequency and limits, as may be specified by regulations.”

 

Some experts see this is a regressive step. “The idea was to ensure that investors are encouraged to save for their retirement and by giving any window for withdrawals you may not get the desired outcome. Look at EPFO (Employees’ Provident Fund Organization), there are so many withdrawals,” says Gautam Bhardwaj, director, Invest India Economic Foundation and one of the key craftsmen of the original NPS.

 

The other big change to the product is the introduction of a guaranteed return option. According to the amendments to the Bill, a subscriber seeking minimum assured returns will be allowed to opt for investing his or her funds in schemes providing minimum assured returns. Further clarity is awaited on exactly how these products will look like: whether a guaranteed rate of return will be announced every year as is the case with EPF and the Public Provident Fund, or the product will carry a minimum rate of return as is the case with pension products offered by life insurance companies.

 

Analyze before investing

NPS will now become a well-regulated product with tweaks to provide for assured returns and a withdrawal facility. The only missing aspect of the NPS architecture is tax benefit. Although contributions are eligible for tax deduction under section 80C, the 60% corpus a subscriber can withdraw on maturity is taxable. With the implementation of the direct taxes code, this will soon be in line with other long term products such as EPF and PPF which currently enjoy tax-free maturity proceeds.

 

Still, that’s not reason enough for investing in NPS. Potential subscribers will need to analyze their needs before investing. The current rules allow only a 50% exposure to equities and, unlike the original design that mandated investments in index funds, only the equity fund now will be actively managed. For an aggressive investor who wants to target retirement savings largely through equity, NPS may not be the product of choice. Even for conservative investors, retirement savings should be targeted through a basket of investment products. 

 

“NPS is a great pension product but currently it’s not tax efficient. On maturity the investors need to annuitize at least 40% of their corpus which is again a deterrent because it’s very difficult to predict future needs. I would recommend an exposure upto 25% in NPS,” says Suresh Sadagopan, a Mumbai-based financial planner.