Saturday, October 6, 2012

New Pension Scheme (NPS)

Investor’s Query: Can I have your advice on NPS? Is it worth investing?

Mr. Gerard Colaco: In my opinion, the New Pension Scheme (NPS) is not worth investing in, for the following reasons:

1. Even for a very long time horizon, a maximum of only 50% allocation to equity is permitted, even if the investor wants a higher equity allocation.

2. While much is made of the very low fund management charge, there are multi-level charges at various offices and levels of the NPS system, the cumulative effect of which is that the NPS is a far more expensive system than appears at first glance.

3. Liquidity is a cardinal principle of any investment. In the NPS you will not be able to withdraw until the age of 60 except if you contract a critical illness or you are buying or constructing a house.

4. The worst clause is that even if you have invested for decades and built up a big corpus, when you withdraw, 40% of that corpus has to be compulsorily used to purchase an annuity from a life insurance company, when withdrawal is done after the age of 60. But, if withdrawal is done before that, then a staggering 80% of the accumulated capital is to be used to buy a life annuity and the balance of 20% can be utilised by the account holder for any purpose. Annuities are high-cost, low-return products of life insurance companies, excellent for the agents and companies that sell them, and terrible for the poor wretches who buy them.

5. The entire income stream from the NPS - the lump sum and the pension - is fully taxable, except the portion actually used to purchase the annuity. Contrast this to investments in equity and equity mutual funds which at least at present are exempt from long-term capital gains tax. The PPF also does not suffer any tax on withdrawals.

A N Shanbhag, one of India's finest writers on personal investment, has this opinion of NPS in the 31st edition of his book "In the Wonderland of Investment": "The disadvantage of taxability on withdrawals and annuity receipts, or on death, is so overwhelmingly large that it is difficult to accept that the advantage of low cost will counterbalance this."

I will not touch the NPS in its current form or recommend it to anyone.