Should You Invest in NPS Post Budget 2016?

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

Budget 2016 has proposed a significant change in the taxation laws for National Pension Scheme (NPS). It has been proposed by the finance ministry to make 40% of your lump sum withdrawal to be tax exempt at the time of your retirement i.e. as you attain 60 years of age. But, does it make any sense to invest in NPS post this amendment or should you continue investing in equity mutual funds or PPF for your retirement years?

We all know that our contribution up to Rs. 50,000 in NPS provides us tax deduction under section 80CCD (1B). Unlike investments eligible for tax deduction u/s 80C, 80CCD (1B) provides an exclusive tax benefit for NPS. So, if you do not contribute in NPS, you need to pay tax as per your respective tax slabs. So, should you save tax by investing in NPS or just pay tax and then invest the remaining amount in equity mutual funds, PPF or debt mutual funds for wealth maximisation?

Honestly speaking, it is not an easy decision to take. To come to a conclusion, I’ll do a couple of comparative analysis here – one, comparing an investment in Equity Mutual Funds with NPS and the second one, comparing an investment in PPF with NPS. We will also have to make certain assumptions here based on which this analysis would come to a conclusion and you are most welcome to agree or disagree with my assumptions here because I am as human as you are and that is why there is enough scope of me committing mistakes as bad as anybody else on this earth.

Here are the assumptions I have made in this analysis:

  • You are 35 now and would retire after 25 years from now.
  • You are in the 30% tax bracket and will have to pay Rs. 15,450 as tax in case you decide not to invest Rs. 50,000 in NPS.
  • Equity Mutual Funds would generate on an average 13% annual returns for the next 25 years.
  • PPF would generate on an average 8.1% annual returns for the next 25 years.
  • NPS with 50% contribution towards equity, 25% contribution towards Government Debt and 25% contribution towards Corporate Debt would generate on an average 10.375% annual return for the next 25 years. To provide more clarity here, I have assumed 12% annual returns from equity, 8% annual returns from government debt and 9.50% annual return from corporate debt.

So, should you invest in NPS for saving Rs. 15,450 in tax?

Scenario I – Say No to NPS in the present scenario, as it is not advisable to invest in NPS even with the exclusive tax benefit it enjoys u/s 80CCD (1B). Your investment of Rs. 34,550 in diversified equity funds should result in a higher retirement corpus for you as compared to Rs. 50,000 invested in the NPS. Here is what you’ll have in your retirement corpus at the end of 25 years from now:

Portfolio I – NPS – 50% of Rs. 50,000 invested in equity index, 25% in Government securities and 25% in corporate debt – Retirement Corpus Rs. 57,43,171

Portfolio II – Equity Mutual Funds – 100% of Rs. 34,550 invested in diversified equity mutual funds – Retirement Corpus Rs. 60,75,621

Portfolio III – PPF – 100% of Rs. 34,550 invested in PPF – Retirement Corpus Rs. 27,70,607

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So, the above calculation clearly shows that investing in diversified equity mutual funds would generate the highest retirement corpus for you, even after paying 30% tax + 0.90% education cess on your taxable income over and above Rs. 10 lakh.

But, there are certain points which you need to keep in mind here which are in favour of NPS. Firstly, from taxation point of view, I think the present situation is not the best one for NPS and it could only improve from hereon. There is still a lot of scope of improvement for making NPS a better product to invest in. Also, I think the present taxation laws are already highly favourable for equity mutual funds. So, let us have a look at some other scenarios and whether it is a ‘Yes’ or a ‘No’ for NPS in those scenarios.

Scenario II – Say No to NPS, if you are in the 20% or lower tax brackets. You should rather invest in equity mutual funds to generate a healthy corpus for your retirement years.

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Scenario III – Say No to NPS, even if you think this government or some other government will increase the exempt portion of your lump sum withdrawal in NPS from the current 40% to 100% or any percentage between 40% and 100% during the next 25 years.

Scenario IV – Say Yes to NPS, if you believe in the theory of “one bird in hand is better than two in the bush”. If you decide not to invest in NPS to save Rs. 15,450 today, you’ll have to pay it to the government and you’ll be left with Rs. 34,550 only to invest. With NPS, your first tax outgo will happen when you retire at the age of 60. Then also, if you withdraw 40% of your retirement corpus as lump sum, it is tax-free and invest the remaining 60% for buying an annuity, you are not required to pay any tax on that 60% as well. You’ll be required to pay tax only on the annuity income you would receive on your investment.

On the other hand, if you decide not to invest in the NPS, you’ll have to pay a tax of Rs. 15,450 to the government and your investment of Rs. 34,550 in equity mutual funds will take a long 25 years to beat NPS as far as a higher retirement corpus is concerned.

Scenario V – Say Yes to NPS, if you fall in the 30% tax bracket and you think this government or some other government will make long term capital gains (LTCG) on equity mutual funds taxable anytime during the next 25 years. Even a 10% LTCG tax on equity mutual funds will make NPS a better retirement product to invest in.

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Scenario VI – Say Yes to NPS, if you are hopeful that this government or some other government would allow you to invest more than 50% of your Rs. 50,000 in equity portion of NPS. Personally I think there should an option allowing you to invest 100% of your money in equity. That would make NPS an attractive investment for me to save tax.

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Scenario VII – Say Yes to NPS, if you are hopeful that this government or some other government would give you the liberty to invest 60% of your lump sum withdrawal anywhere you want and make it tax exempt as well.

Scenario VIII – Say Yes to NPS, if you are a conservative investor and don’t want 100% of your investment to be made in equities. With NPS, even 50% of your investment in equity index would result in a healthy retirement corpus which should be very close to the expected retirement corpus with 100% investment in equity mutual funds.

NPS vs. Equity Mutual Funds vs. PPF – Other Factors

NPS - Other Factors

There could be other such scenarios based on which your decision to invest in NPS could change. If you think I have missed any such significant scenario, then please share it here, I’ll incorporate that also to make it an even more comprehensive analysis.

National Pension System (NPS) – Save Tax u/s 80CCD (1B) worth Rs. 15,450

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

We all want to save taxes. We all invest to save taxes. Some invest in PPF, some in ELSS, some in NSC, some invest in 5-year bank fixed deposits. But, we all know the maximum investment limit for saving tax under section 80C is Rs. 1,50,000. So, we all want to save more tax, over and above 80C. But, there are only a limited number of investment options which provide tax exemption other than 80C. One of those options is NPS – National Pension System.

Introduced in Budget 2015, your contribution in NPS can save you tax of up to Rs. 15,450, if you are in the highest tax bracket of 30%. NPS provides an additional deduction of Rs. 50,000 from your taxable income. Interested? Read on.

So, let’s start our journey to know more about this tax saving investment avenue and see whether it truly makes sense to invest in it or it is better to pay tax and invest in mutual funds to earn higher tax-free returns.

How to open an NPS account?

Online Account – There are 2 ways to open an NPS account online – one, directly through NPS Trust’s website and two, through an intermediary, like your bank, ICICI Direct, HDFC Securities etc.

Offline Mode – You can also approach a POS (Point of Service) and get this account opened.

Documents Required – PAN card copy, address proof copy, 2 passport-size photographs, investment cheque and Duly Filled Subscriber Registration Form.

Exclusive Tax Benefit u/s 80CCD (1B)

If you decide to invest in NPS, you can avail a tax exemption of Rs. 50,000 from your taxable income. As the minimum investment requirement is Rs. 6,000, you can contribute any amount between Rs. 6,000 and Rs. 50,000 to save tax.

Which Account is eligible for Rs. 50,000 Deduction – Tier I or Tier II? – Your contribution to Tier I account is eligible for up to Rs. 50,000 tax deduction u/s 80CCD (1B). Tier II account does not entitle you to any tax deduction.

Minimum/Maximum Annual Contribution – As per the NPS rules, you need to contribute at least Rs. 6,000 in this account in a financial year. However, you can do so in multiple instalments and minimum contribution in a single contribution is Rs. 500.

However, there is no upper limit on your contribution to NPS. You can contribute any amount to your NPS account. But, as far as tax benefit is concerned, you can have only up to Rs. 50,000 in tax deduction.

Six/Seven Pension Fund Managers – These are the pension fund managers (PFMs) which are managing the subscribers’ money in NPS at present.

  1. HDFC Pension Management Company
  2. LIC Pension Fund
  3. ICICI Prudential Pension Fund
  4. Kotak Mahindra Pension Fund
  5. Reliance Pension Fund
  6. SBI Pension Fund
  7. UTI Retirement Solutions

Seven Annuity Service Providers – These are the insurance companies which would provide you pension as you retire at 60 years of age.

  1. Life Insurance Corporation of India (LIC)
  2. SBI Life Insurance
  3. ICICI Prudential Life Insurance
  4. Bajaj Allianz Life Insurance
  5. Star-Daichi Life Insurance
  6. Reliance Life Insurance
  7. HDFC Standard Life Insurance

Where your money gets Invested? – Your NPS contribution will get invested in Equity (E), Government Securities (G) or Corporate Debt Securities (C) either as per your own choice (Active Choice) or as per your age (Auto Choice).

Active Choice – Under “Active Choice”, you can have your money invested in these three asset classes as per your own choice. You can allocate your money among these three asset classes (E, G or C), but there is a cap of 50% for Equity (E) investment allocation.

Auto Choice – Under “Auto Choice”, your money gets invested based on your age i.e. the higher your age as the subscriber, the lower would be the allocation for Equity.

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Returns – As NPS is completely market driven, there is no guaranteed/defined return in this pension scheme. Returns get accumulated throughout its tenure and get paid as annuity or lump sum benefit on maturity.

Historical Equity Returns of NPS (Returns as on 31st December, 2015)

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Historical Corporate Debt Returns of NPS (Returns as on 31st December, 2015)

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Historical Government Securities Returns of NPS (Returns as on 31st December, 2015)

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Charges – This account attracts a processing charge of 0.25% of your contribution amount, subject to a minimum charge of Rs. 20, plus service tax as applicable. So, if you contribute Rs. 6,000, then Rs. 20 + service tax will be the charges. In case your contribution is Rs. 50,000, then a charge of Rs. 125 + service tax will be deducted from your account.

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Exit – As you turn 60, you will be required to use at least 40% (maximum 100%) of your accumulated savings to buy a life annuity from an insurance company. Rest 60% or less, you can withdraw as lump sum amount. If you decide to exit before 60 years of age, you will have to buy an annuity with 80% of your accumulated savings, rest 20% amount you can withdraw as the lump sum benefit. Both, annuity income as well as the lump sum withdrawal, will be taxable.

In case of death before 60 years of age, entire pension corpus will be paid to the nominee of the subscriber.

Should you invest in NPS?

Please check this post – Should you invest in NPS Post Budget 2016?

Also, if you think I have missed to cover any important aspect(s) of NPS, then please share it here, I’ll try to include it in the post above.

Atal Pension Yojana – Government Guaranteed Pension Scheme for the Unorganised Sector

This post is written by Shiv Kukreja, who is a Certified Financial Planner and runs a financial planning firm, Ojas Capital in Delhi/NCR. He can be reached at skukreja@investitude.co.in

Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY)

Pradhan Mantri Suraksha Bima Yojana (PMSBY)

88% of India’s total labour force of 47.29 crore belongs to the unorganised sector, in which the workers do not have any formal provision of getting a regular pension payment on retirement. Moreover, due to increasing labour wages and better medical facilities, these people also face a risk of increasing longevity. So, this work force would require some kind of assured income guarantee to sustain itself in the coming years.

Launching Atal Pension Yojana (APY) from June 1, 2015

To encourage workers in the unorganised sector to voluntarily save for their retirement, the government of India will be launching a new scheme, called Atal Pension Yojana (APY), from 1st June, 2015. Finance Minister Arun Jaitley announced this scheme in his budget speech on February 28th.

This scheme will replace the UPA government’s Swavalamban Yojana – NPS Lite and will be administered by the Pension Fund Regulatory and Development Authority (PFRDA). The benefits of this scheme in terms of fixed pension will be guaranteed by the government and the government will also make contribution to these accounts on behalf of its subscribers.

Under this scheme, a subscriber would receive a minimum fixed pension of Rs. 1,000 per month and in multiples of Rs. 1,000 per month thereafter, up to a maximum of Rs. 5,000 per month, depending on the subscriber’s contribution, which itself would vary on the age of joining this scheme.

The minimum age of joining this scheme is 18 years and maximum age is 40 years. Pension payment will start at the age of 60 years. Therefore, minimum period of contribution by the subscriber under APY would be 20 years or more.

The Central Government would also co-contribute 50% of the subscriber’s contribution or Rs. 1000 per annum, whichever is lower, to each eligible subscriber account, for a period of 5 years, i.e., from 2015-16 to 2019-20, who join the NPS before 31st December, 2015 and who are not income tax payers. The existing subscribers of Swavalamban Scheme would be automatically migrated to APY, unless they opt out.

Who is eligible for Atal Pension Yojana?

Any Citizen of India, aged between 18 years and 40 years, who has his/her savings bank account opened and also possesses a mobile number, would be eligible to subscribe to this scheme.

Government Funding – Indian Government would provide (i) fixed pension guarantee for the subscribers; (ii) would co-contribute 50% of the subscriber contribution or Rs. 1,000 per annum, whichever is lower, to eligible subscribers; and (iii) would also reimburse the promotional and development activities including incentive to the contribution collection agencies to encourage people to join the APY.

Who is eligible for Government Co-Contribution in Atal Pension Yojana?

Subscribers of this scheme, who are not covered under any other statutory social security scheme and are not income tax payers, would be eligible for the government’s co-contribution of up to Rs. 1,000 per annum.

Social Security Schemes which are not eligible for Government Co-Contribution

  • Employees’ Provident Fund (EPF) & Miscellaneous Provision Act, 1952
  • The Coal Mines Provident Fund and Miscellaneous Provision Act, 1948
  • Assam Tea PlantationProvident Fund and Miscellaneous Provision, 1955
  • Seamens’ Provident Fund Act, 1966
  • Jammu Kashmir Employees’ Provident Fund & Miscellaneous Provision Act, 1961
  • Any other statutory social security scheme

Minimum/Maximum Pension Payable – This scheme will pay a minimum pension of Rs. 1,000 per month and a maximum pension of Rs. 5,000 per month, depending on the subscriber’s own contribution per month.

Minimum/Maximum Period of Contribution – As the minimum age of joining APY is 18 years and maximum age is 40 years, minimum period of contribution by the subscriber under this scheme would be 20 years and maximum period of contribution would be 42 years.

Atal Pension Yojana – Contribution Period, Contribution Levels, Fixed Monthly Pension and Return of Corpus to the Nominees of Subscribers

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Internal Rate of Return (IRR) – Thanks to the government funding of Rs. 1,000 per annum per subscriber account for 5 years, your account would generate an IRR of approximately 0.66% per month or 8% per annum. This pension amount per month is fixed and the government has made it clear that if the actual returns on the pension contributions are higher than the assumed returns, such excess return will be credited to the subscribers’ accounts, resulting in enhanced pension payment to the subscribers.

Minimum Contribution – A subscriber aged 18 years will have to contribute a minimum of Rs. 42 per month in order to get Rs. 1,000 pension per month starting 60 years of age. For a 40 years old subscriber, his/her minimum contribution would be Rs. 291 per month. The contribution levels would vary and would be low if subscriber joins early and increase if he joins late.

Maximum Contribution – A subscriber aged 40 years will have to contribute Rs. 1,454 per month in order to get Rs. 5,000 pension per month starting 60 years of age. For a 18 years old subscriber, his/her contribution for Rs. 5,000 monthly pension would be Rs. 210 per month.

Can I increase or decrease my monthly contribution for higher or lower pension amount?

The subscribers can opt to decrease or increase pension amount during the course of accumulation phase, as per the available monthly pension amounts. However, the switching option shall be provided only once in a year during the month of April.

What will happen if sufficient amount is not maintained in the savings bank account for contribution on the due date?

Non-maintenance of required balance in the savings bank account for contribution on the specified date will be considered as default. Banks are required to collect additional amount for delayed payments, such amount will vary from minimum Re. 1 to Rs. 10 per month as shown below:

(i) Re. 1 per month for contribution upto Rs. 100 per month

(ii) Rs. 2 per month for contribution upto Rs. 101 to 500 per month

(iii) Rs. 5 per month for contribution between Rs. 501 to 1,000 per month

(iv) Rs. 10 per month for contribution beyond Rs. 1,001 per month.

Discontinuation of payments of contribution amount shall lead to following:

After 6 months account will be frozen.

After 12 months account will be deactivated.

After 24 months account will be closed.

Subscriber should ensure that the Bank account to be funded enough for auto debit of contribution amount. The fixed amount of interest/penalty will remain as part of the pension corpus of the subscriber.

Post-Retirement Rate of Return – Considering a retirement corpus of Rs. 1.7 lakh and monthly pension of Rs. 1,000, this scheme is going to generate a return of 0.59% per month or 7.1% per annum for its subscribers. I think this return is also on a lower side.

Nomination Facility – This scheme will also provide the nomination facility to its subscribers. In case of the subscriber’s death after attaining 60 years of age, the whole corpus generating the pension income to the subscriber would be returned back to the nominee of the subscriber. In case of untimely death of the subscriber before 60 years of age, the balance would be returned back to the nominee of the subscriber.

Where to open APY Accounts – You need to approach points of presence (PoPs) and aggregators under existing Swavalamban Scheme. These agencies would enrol you through architecture of National Pension System (NPS).

Points of Presence & Aggregators

Application Form – Here you have the links to the application form for subscribing to Atal Pension Yojana – Application Form in EnglishApplication Form in Hindi

I think a subscriber should opt for a minimum monthly contribution of around Rs. 167 or so, which would make it approximately Rs. 2,000 annual contribution. 50% of Rs. 2,000 i.e. Rs. 1,000 would be contributed by the government as well. So, the subscriber will get the maximum benefit of government funding.

As mentioned above, the scheme would start from June 1, 2015. So, interested people will have to wait till then to open an account. If you have any other query regarding this scheme, please share it here.

Pradhan Mantri Jeevan Jyoti Bima Yojana (PMJJBY)

Pradhan Mantri Suraksha Bima Yojana (PMSBY)

Application Form in English

Application Form in Hindi

How to plan your investments once you are retired?

This is a guest post written by Manikaran Singal who is a certified financial planner and runs a personal finance blog - Good Moneying.

Retirement is very important and critical stage in one’s financial life. This stage can be made more enjoyable where you relax, spend time with family, pursue hobbies if you have properly planned for that. But it can be most horrifying phase also where your regular income stream is no longer available, with no pension provision and where you have not saved enough to take care of your retirement needs.  Due to the various challenges and risks associated with retirement, we recommend retirement planning should be given its due importance and starts as soon as possible.

Retirement Planning works in 3 steps – Accumulation – Preservation-Distribution.

Accumulation is the stage where we invest to generate a decent corpus which is assumed to take care of us during retirement years. This accumulation we do till retirement.

In Preservation stage we become cautious about our accumulated corpus and we start coming out of risky asset classes and start shifting the corpus into debt, though savings doesn’t stop during this stage also, as our regular income stream is intact.

Distribution is the stage when we make arrangements to use the corpus through interest, dividends and withdrawing capital which we have accumulated.

In the complete retirement planning, distribution is the most important of all, as all our efforts of accumulation and preservation were directed towards this stage only. With a regular income stream no longer available, the savings made over one’s working years now have to provide for all needs. Now your investments need to create a paycheque for you. In accumulation and preservation stages the mistakes can be ignored as you were getting regular income, but at distribution stage, small mistakes can cost huge.

Through this article, I will be discussing with you on the distribution stage of retirement planning and how you can plan your investments once retired.

1. First step is to prepare you on the risks front. Like :

a)     Longevity risk: We don’t know for how long we are going to live. Whatever life expectancy you have assumed during accumulation stage may not be correct. If you outlive that age and not used your corpus judiciously you may find yourself in financial soup.

b)     Health risk: At this age probability of health problems is much more. We don’t know till when health remains favorable on our side. And when it gets unfavorable how much of our accumulated corpus it may wash away.

2.     Have a look at your expenses.

This is very important as the ultimate target is about to generate comfortable income stream from the corpus to meet the basic and desired expenses easily. Here you may divide your expenses in 4 parts: Basic/desired/on dependents if any/Loan EMIs if any. Basic would include the family’s general and unavoidable expenses which may include the family gifts on various festivals/occasions, desired is what you want to do after retirement like going on annual or bi annual vacations, pursuing some hobby, some charitable or religious activity etc., On dependents means…situations where children are still studying or are not yet settled in life etc. and Loan EMIs.

3.     Investment Options.

When you have calculated how much is required, now is the time to look out for the options where you may park the lump sum amount to start getting regular income. Here one thing has to be noted that one should not ignore the growth aspect in investments and should give equal importance to that. To add to it, one should not get into wrong products with the lure of making fast money in the name of growth. Just reminding you again that mistakes made at this stage of life may prove very costly.

Make 3 investment buckets by investing corpus in different percentages.

Basic Bucket (50% -60%): Looking at the monthly requirement and pension inflow if any, one has to plan to fulfill the gap, for which one may use the products like Post Office Monthly Income scheme, Senior Citizens savings scheme , bank fixed deposits with monthly/quarterly pay-out options, Immediate annuity etc. I mean use those products which can supplement your monthly inflow. But here do keep in mind the taxability aspect also. All the so called safe instruments are taxable. So where the taxation crosses the acceptability criteria, then you may use Mutual funds Monthly income plans or park the amount in debt mutual funds and start systematic withdrawal plan, but please note in the latter you are withdrawing the capital part of corpus which should be last resort.

Health Bucket (10%-15%): After arranging for your current monthly requirement, put some percentage of your corpus into debt mutual funds or cumulative fixed deposits as a health fund which will take care of your those medical emergencies where expenses jumps over health insurance coverage.

Growth Bucket (20%-25%): Put the balance corpus or at least 20% of the total corpus in equity oriented Mutual funds diversified or index, to cope up with the inflation aspect and After every 5th year transfer the growth portion into the basic bucket, so the monthly income can be supplemented and put it in line with the increased expenses.

Some Do’s and don’ts after Retirement.

  1. Do review your financial situation every year.
  2. Do buy adequate health insurance coverage for yourself and your spouse. Count the annual premium in the basic expenses.
  3. Don’t buy or gift any investment product to any of your family member other than you or your spouse. Avoid gifting child plan to grandchildren etc. Don’t part with your savings in your lifetime. You will be soft emotionally gullible target to the sellers. So beware.
  4. Do keep working even after retirement.

Shocked!! But in many cases it becomes inevitable especially when you still have dependents, or paying Loan EMIs. The idea is not to enter retirement phase with the burden of Debt and dependents, and not to use the nest egg on these areas. Also please understand that stock trading is not working.

  1. Do take good care of your health. If at all you have any health problem better to take proper treatment. Many times I have seen people ignoring the health aspects due to the finances involved in the treatment. But please understand that your health is equally important for your wealth.
  2. Don’t overspend in retirement if you have not over invested while working.
  3. Don’t put your retirement corpus into Real estate due to the illiquid and unregulated nature of investment.

Retirement planning includes much more than just investing. It needs some behavioral adjustments also. The ultimate goal is steady, dependable and lasting income. With careful planning we can balance the needs of inflation protected income and long term growth during retirement.

Three thoughts on investing after you retire

For some reason, lately,  there have been a lot of questions about retirement planning and what to do with the money you get after retirement, and I think this topic deserves a mini series. Today, I’m going to write about three things that have been on my mind about this. Before I begin, for context, here is the full comment that prompted this post.

biswas July 10, 2012 at 7:37 am [edit]

There are many articles on how to plan for retirement.It will be nice if you can discuss on how to plan once one is retired.I am likely to retire in couple of months.I will receive a large lump-sump amount.I don’t know what to do except for FD.An article on this topic will really be appreciated.

As someone whose retirement is still a few decades away it is hard for me to really get into the shoes of someone who is retiring in a couple of months, so I’m going to write about three lessons I’ve learned from my elders who have already retired and made some good and bad financial decisions.

1. Don’t seek excitement in the stock market: A few years ago when online trading had still not caught on, it was quite common to go and sit in your broker’s office and execute trades. I used to go to my grandpa’s broker at the time and was surprised at how many retired folks “play” the market. In the end, none of them made any money, and most lost quite heavily, so if you’re seeking excitement in the stock market, that’s the last thing you want to do with your retirement savings.

2. Lock in your money in big investments: Someone in our family who was retiring soon told us over dinner that his elder brother who retired many years before him gave him this advice, and I think this is perhaps relevant to a lot of families.

His elder brother told him that over the years his retirement savings had been eaten away by giving small gifts and loans to people in need and the fact that people knew he had the money, made them approach him and talk him into sharing it with them.

He suggested that one way of avoiding this situation is to put your money in places and in chunks where it really hurts to give them away, breaking a fixed deposit of Rs. 5 lakhs is a lot more painful than writing a check for Rs. 50,000 from your savings account. Sounds like great words of wisdom to me.

3. No one knows any secrets: A friend’s dad only invests in post office schemes and bank fixed deposits and he is never tempted to make great returns on a swanky new insurance product or the stock market or anything else that’s hot at the moment. His philosophy is simple, there is only so much money you can make with money, so don’t get sucked into dreams of doubling or tripling your money in a year or two. No one knows any secrets.

When you think of all the smart people that invested with Madoff and never chose to question his returns, it’s obvious that there was an implicit assumption that somehow Madoff knew a secret that the rest of the market didn’t. That kind of thinking is at least part of what led them to believe in the Ponzi scheme. I think it’s wise to assume that no one knows any secrets, specially when dealing with all your retirement savings. Playing it safe is better than assuming that someone has access to a golden goose that he’s willing to share with you.

Finally, since I didn’t talk about any products, here is a link to an older post with a list of some safe investments that seem appropriate for this situation.

Download Excel Based Retirement Calculator

Reader Pattu  has developed a retirement calculator for his own use, and was interested in sharing it with other OneMint readers as well. I took a look at it, and liked what he’s done, so I’m sharing the calculator here.

Download Retirement Planner

He has also described his thought process, which I’m sharing below.

Retirement planning is a complicated financial goal. When you save for a new car, exotic holiday or even for the education of your children, all or most of the accumulated corpus would get spent when the time for the goal arrives. So it is easier to calculate the corpus required for such goals.

When it comes to retirement planning the corpus calculation is complicated because the corpus does not get spent in one shot. Typically it is allowed to grow at some post-retirement interest rate (usually underestimated for safety) and monthly withdrawals are made from it. For complete financial independence during retirement, these withdrawals or pension must increase according to the post-retirement inflation rate.

So the retirement corpus calculation has to take into account not only the years to retirement, present inflation rate but also post-retirement inflation, number of years in retirement and post-retirement interest rate on the corpus.

Given these input parameters, retirement planning consists of two major steps.

 

1. Calculation of the corpus required:

(a) Compute projected future monthly expenses at the start of retirement. This amount can be taken as the initial monthly pension which will be withdrawn from the corpus.

(b) This monthly pension amount is assumed to increase every year according to the rate of inflation, while the corpus is assumed to grow at some constant interest rate. Using these inputs the corpus is calculated using Excel’s present value calculator (PV).  The inputs to the PV function, the formulae used are a bit technical and can be found here.

(The site also has a nice annuity calculator which will be of interest to people close to retirement).

Since the withdrawals are indexed to inflation, the corpus will decrease each year and become zero at the end of the retirement period given as input. A typical rise and fall of the corpus is shown here.

Retirement Corpus
Retirement Corpus


2. Calculation of the monthly investment amount required:

Once the corpus needed is known this calculation is similar to any other financial goal. It uses the number of years to retirement, estimates of present inflation and annual interest rate, annual increase in investment if any, and amount accumulated so far if any.

The excel based calculator does the above tasks and present an annual cash flow chart of the monthly investment made, monthly expenses, the growth of the retirement corpus prior to retirement and its decrease post retirement. Annual salary is also shown for reference.

Please note:

1. The calculator has been repeatedly tested and checked. However no guarantee is made that it is free of errors. Like every other tool it serves only as an estimate for the monthly investment required and depends on the input parameters. It is meant to be used for education purposes only.

2. For simplicity the pre- and post-retirement inflation rates are taken to be the same. Use a reasonably high value to be safe. A financial expert suggested using 8-9%

3. The pre-retirement interest rate is taken as constant. Since equity allocation would decrease as retirement approaches this would change. The calculator can easily be modified to take into account variable interest rate. Contact me if you need to look at such a calculation.

Download Retirement Planner

Bugs, comments and suggestions are welcome.

Pattu

pattu@iitm.ac.in

Update: Fixed a divide by zero error bug.

How much pension will I get from the NPS?

A question that pops up quite frequently in comments is how much pension will I get from NPS, and I think it’s not clear to a lot of people that the NPS itself won’t give them a pension.

There are two things that you need to keep in mind:

  • NPS doesn’t pay a pension directly.
  • There is no fixed rate at which your money will grow.

NPS doesn’t pay a pension directly

The way NPS works is that you invest regularly in the scheme and the scheme invests that money on your behalf.

At the age of 60 you will get the money and it will be up to you to invest it and generate an income for yourself. In this regard you can think of it more like a provident fund than a pension.

Under NPS there is no fixed rate at which your money will grow

When you open the NPS account – you will be asked to select a fund manager and your money will be invested by this fund manager. You will also be asked whether you want to choose an Ultra Safe, Safe or Medium approach, and based on your selection the fund managers will spread your money between debt and equity instruments. The rate of growth will depend on the performance of the fund managers and the choices you make, so to that extent it’s not like a bank fixed deposit where they tell you that you will get 8 or 9% interest regardless of anything else.

How to calculate pension amount from NPS?

Keeping these things in mind it should become clear that you can only get an idea of how much pension you can generate and not an accurate answer.

So, how do you get that idea?

Suppose you have the following question:

I am 28 years old – how much pension will I get if I invest Rs. 2,000 every month?

CAMS has got this great corpus calculator which allows you to input the parameters and tells you how much your final corpus will be.

In this case I’ll put in the following numbers:

  • Contribution Amount: 2000
  • Periodicity: Monthly
  • Rate of Interest: 9.5% (Assumed)
  • Number of Years: 32 (60 – 28)

The calculator shows me a value of Rs. 50,05,164.

Now, this is the amount that you will get at the end of 60 years, and you will have to invest it in order to get a pension. You could create a bank fixed deposit with it or buy an annuity. NPS requires  you to buy an annuity from 40% of your money in the Tier 1 account compulsorily, but there is no such restriction on the Tier 2 account, so you can keep that in mind while opening the NPS account.

Conclusion

The first thing you should keep in mind is that NPS won’t pay you a pension directly, the second point is that the rate of return is not fixed either, and the third thing is when you get the NPS money you will be free (to an extent) to invest it, and generate an income for you as you see fit.

 

Your salary will increase with inflation too

I got this email early last week (slightly edited):

I would like to know something about annuity. I am 49 yrs old, suppose I am investing Rs. 100,000 yearly till i attain 60 years and NPS is showing growth in total of 1600000.
40% will be 6,40,000.
Now explain to me how annuity of 6,40,000 will help me for rest of my life?/for how long?/how much?
I am still confuse about retirement plan.
If I calculate inflation and I retired at the age of 60 yrs and live up to 75 years. What so ever I save for my retirement plan appears to be peanuts.
Thinking daily on “life after retirement” a am spoiling my today.
If you have some better idea about retirement please guide me.

To me the heart of the problem is the sum that this person expects to accumulate when he is 60, and not the annuity itself because if you can accumulate a decent sum at the time of retirement, then you can do an annuity, fixed deposit, plan your withdrawal rate, whatever, but if you don’t have a lot at that age, then what is the point of thinking about anything else?
In that sense, I think this is slightly different from the earlier discussions we’ve had on this topic here.

In an economy like India where the inflation rate is quite high it is only reasonable to be worried about how inflation will eat into your retirement nest, however the other side of the coin is rarely talked about, if ever at all.

Your salary should also increase to match inflation and you should at least be able to increase your savings by the inflation rate or even if it is a smaller number, there should be some increase right? But this is too often not accounted for even when it’s quite clear that it can be quite a big number.

Let me give you an example: If you invest Rs. 1,00,000 per year for 12 years, and get 8% per annum returns on your investment, at the end of the 12 years you will have a corpus of Rs. 18,97,712, but if you increase your investment by 8% every year by age 60 you will accumulate about Rs. 25 lakhs, and one more year will make this sum go to Rs. 30 lakhs.

I’ve done these calculations here so you can see how I reached that number.

The key is not to be despondent, and start doing the right thing – better late than never right?

Poll results: How much money do you need per month to retire in India today?

In the last poll I had asked you how much money do you need per month to retire in India today, and 48% of you (190 votes) said between Rs. 20,000 and Rs. 50,000. To my surprise, the next biggest segment was the more than Rs.1,00,000 segment with 20%, and you can see the rest of the results below.

(click for bigger image)

How much money do you need to retire

In this post, I am going to be what I think is called a party pooper, and say that a lot of you believe that you’ll need lesser money than you spend today during your retirement, but you are probably wrong.

For starters, if you’re salaried and not in your forties yet, then you are probably far away from what is going to be your peak income. Your income might look like a reasonable sum to you today, but wait till you start making a lot more, and see Parkinson’s second law kick into effect:

expenditures rise to meet income

Now it’s true that you will have more responsibilities at that time than today, and a lot of those will not be present during your retirement, but it’s just as likely that there are some unforeseen liabilities as well; how is that percentage going to work out? How do you calculate something like that anyway?

Next up, when you think that you will need lesser money during retirement than today, that automatically implies that you need to save less today, and that in turn implies more money to splurge; think about it – aren’t you much more likely to lull yourself into making some assumptions that make spending easier today? After all, delayed gratification is hard, really hard.

That said, I believe that a lot of you are way ahead of the game just by thinking about retirement, and planning for retirement. Starting retirement planning early means that you develop a long term approach to retirement, think about various alternatives where you can invest your money, not fall in credit card debt, and give yourself the benefit of compounding which makes a huge difference.

As long as you are not looking at huge debt, saving a decent amount by being frugal (but not stingy), and making good investment habits, whatever your number is – you will be alright.

So don’t fret too much about the number, which is too far out in the future, and so variable that it’s hard to predict, and focus instead on developing good financial habits. And thank you all for your wonderful comments!

A primer on the New Pension Scheme (NPS)

I’ve wanted to write about the New Pension Scheme (NPS) a lot sooner, but never got around to it. Reader Gaurav sent me some great material on it, and got me started.

The stuff that he sent me was an entire post in itself, but I thought I’d add to it, and create a comprehensive post on the New Pension Scheme.

First off, you can call it New Pension Scheme, National Pension System, New Pension System or NPS, anything you like. They’re all the same; I’ve seen different articles call them different names, so that might get a bit confusing, but you’ll soon get used to it.

Next up, some of the things this post will address, are:

  • What is the New Pension Scheme?
  • What are Tier I and Tier II accounts in the NPS?
  • What are the three categories in the NPS?
  • Fees and Expenses related to the NPS?
  • What is the minimum amount needed to invest in the NPS?
  • What are the tax implications of NPS?
  • How can I open a NPS account?
  • Why hasn’t this become popular?

What is the New Pension Scheme?

The NPS was introduced by the government last year to give people a way to get a pension during their old age. Employees of the government sector already get a pension, so this scheme was introduced as a social security measure that enables people from the unorganized sector to draw a pension as well.

The working mechanism is quite simple – you contribute a certain sum every month during your working years, which is then invested according to your preference. You can then withdraw the money when you retire, which is currently set at 60 years old.

When I say you invest according to your preference, I mean that there are a couple of different options that you need to select from. These options pertain to your preference on withdrawal, and asset allocation.

What are Tier I and Tier II accounts in the NPS?

The NPS is meant to be a pension scheme, so it is geared towards giving you a steady stream of income on your retirement.

That means that NPS makes it difficult to withdraw your money during your working years or till the age of 60 in this case.

Tier I and Tier II are two options under the scheme where you can invest your money, the primary difference between them is how they differ in allowing you to withdraw your money before retirement.

NPS Tier I

There is severe restriction on withdrawing your money before the age of 60, because it is necessary to invest 80% of your money in an annuity with Insurance Regulatory Development Authority (IRDA) if you withdraw before 60. You can keep the remaining 20% with you.

When you attain the age of 60, you have to invest at least 40% in an annuity with IRDA; the remaining can be withdrawn in lump-sum or in a phased manner.

Here are the details of how your money can be withdrawn in a NPS Tier I account.

image

Death is another way of getting the money, but that might come in the way of other plans you have.

NPS Tier II Account

The first thing about the NPS Tier II account is that you need to have a Tier I account in order to open a Tier II account.

The Tier II account makes it easy for you to withdraw your money before retirement because there is no limit on the withdrawals you can make from the Tier II account.

You need to maintain a minimum balance of Rs. 2,000, and you can transfer money from the Tier II account to Tier I account, but not the other way around.

There is a Rs. 350 CRA (Credit Record Keeping Agency) charge which is not present in the Tier II account, but the rest of the fees remain the same.

Asset Allocation and Categories in the NPS

There is an Active Choice option, and an Auto Choice option. If you select Auto Choice then your money is invested in a certain percentage in the various classes based on your age.

Here are the three investment classes:

ClassRisk ProfileDescription
GUltra SafeWill only invest in Central and State government bonds.
CSafeFixed income securities of entities other than the government
EMediumInvestment in equity related products like index funds that replicate the Sensex. However, equity investment will be restricted to 50% of the portfolio.

In the Active Choice you can select how much of your money will be invested in the different classes with a cap of 50% in Class E.

Now, there are pension funds that will manage your money, and in either of these options you have to select the fund manager who will manage your fund. So even if you select the Auto Choice, you still have to tell them which fund manager you want to manage your money.

Fees and Costs related to the NPS

I talk about expenses a lot here, and the expenses on the NPS are really low. The annual fund management charge is 0.0009%, which is probably the lowest in the world.

There are some other expenses associated with the NPS, but as you will see all of them are quite low as well. Here is a list of the other expenses.

image

What is the minimum amount needed to invest in the NPS?

For a Tier I NPS account you need to contribute a minimum of Rs. 6,000 per year, and make at least 4 contributions in a year. The minimum amount per contribution can be Rs. 500.

Minimum amount for opening Tier II account is Rs. 1,000, minimum balance at the end of a year is Rs. 2,000, and you need to make at least 4 contributions in a year.

What are the tax implications of NPS?

The revised Direct Tax Code proposes to make the NPS tax exempt at the time of withdrawal. Initially NPS was going to be taxed at the time of withdrawal, and that had put it at a disadvantage to other products like ULIPs and Mutual Funds. But the revised code proposes it to be exempt from tax, and that really adds to its lure.

How can I open a NPS account?

You can open a NPS account by going to the bank branches of the banks that are authorized to sell this.

image

Conclusion

This is quite a good option for people who wish to invest for their retirement, and the government has done good to come up with such an option. It is still early days for the scheme so there are going to be some teething troubles, and I am sure you have come across several articles that write the NPS off completely, or suggest major changes.

While it has not gained in popularity the way you would’ve expected with the low cost structure, a primary reason of that is there is no real incentive for anyone to push this to consumers, so it has not gained any real traction.

That being said, the scheme is a good initiative, and given enough time, the chinks should be ironed out in its favor.

As a final word – a big thank you to Gaurav who sent me all the material, and pushed me to write about the NPS. Thanks Gaurav!