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New Pension System
The New Pension System (NPS) is a defined contribution based pension system launched by Government of India with effect from 1st January, 2004. Like most other developing countries, India does not have a universal social security system to protect the elderly against economic deprivation. As a first step towards instituting pension reforms, Government of India moved from a defined benefit pension to a defined contribution based pension system. Apart from offering wide gamut of investment options to employees, this scheme would help government of India to reduce its pension liabilities. Unlike existing pension fund of Government of India that offered assured benefits, New Pension System has defined contribution and individuals can decide where to invest their money. The scheme is structured into two tiers:
- Tier-I account: This New Pension System account does not allow premature withdrawal and is available from 1st May, 2009
- Tier-II account: The tier-II New Pension System account permits withdrawal.
Since 1st April, 2008, the pension contributions of Central Government employees covered by the New Pension System (NPS) are being invested by professional Pension Fund Managers in line with investment guidelines of Government applicable to non-Government Provident Funds. A majority of State Governments have also shifted to the defined contribution based New Pension System from varying dates. 22 State/UT Governments have notified the New Pension System for their new employees. Of these, 6 states have already signed agreements with the intermediaries of the New Pension System architecture appointed by Pension Fund Regulatory and Development Authority (PFRDA) for carrying forward the implementation of the New Pension System. The other States are in the process of finalization of documentation.
Regulator
Pension Fund Regulatory and Development Authority (PFRDA) is the prudential regulator for the New Pension System. PFRDA was established by the Government of India on 23 August 2003 to promote old age income security by establishing, developing and regulating pension funds. PFRDA has set up a Trust under the Indian Trusts Act, 1882 to oversee the functions of the PFMs. The New Pension System (NPS) Trust is composed of members representing diverse fields and brings wide range of talent to the regulatory framework.
Coverage and eligibility
New Pension System was made available to all citizens of India on voluntary basis and is mandatory for employees of central government (except armed forces) appointed on or after 1 January 2004. All Indian citizens between the age of 18 and 55 can join the New Pension System.
Tier-I is mandatory for all Govt. servants joining Govt. service on or after 1.1.2004. In Tier I, Govt. servants will have to make a contribution of 10% of his Basic Pay, DP and DA which will be deducted from his salary bill every month. The Govt. will make an equal matching contribution. Since 1 April 2008, the pension contributions of Central Government employees covered by the New Pension System are being invested by professional Pension Fund Managers in line with investment guidelines of Government. However, there will be no contribution from the Government in respect of individuals who are not Government employees. The contributions and returns thereon would be deposited in a non-withdrawable pension account.
In addition to the above pension account, each individual can have a voluntary tier-II withdrawable account at his option. Government will make no contribution into this account. These assets would be managed in the same manner as the pension. The accumulations in this account can be withdrawn anytime without assigning any reason. It’s estimated that 8 crore citizens of India are eligible to join the New Pension System.
Operational structure
New Pension System is designed to leverage network of bank branches and post offices to collect contributions and ensure that there is seamless transfer of accumulations in case of change of employment and/or location of the subscriber. It offers a basket of investment choices and Fund managers. Dhirendra Swarup is one of the founders.
There will be one or more CRA, several PFMs to choose from which will offer different categories of schemes. The participating entities (PFMs, CRA etc.) would give out easily understood information about past performance & regular NAVs, so that the individual would able to make informed choices about which scheme to choose. PFMs would share this common CRA infrastructure. The PFMs would invest the savings people put into their PRAs, investing them in three asset classes, equity (E), government securities (G) and debt instruments that entail credit risk (C), including corporate bonds and fixed deposits.
Contribution guidelines
The following contribution guidelines have been set by the PFRDA:
- Minimum amount per contribution: Rs. 500 per month
- Minimum number of contributions: 1 in a year
- Minimum annual contribution: Rs 6,000 in each subscriber account.
If the subscriber is unable to contribute the minimum annual contribution, a default penalty of Rs.100 per year of default would be levied and the account would become dormant. In order to re-activate the account, subscriber will have to pay the minimum contributions, along with penalty due. A dormant account will be closed when the account value falls to zero.
Investment options
Under the investment guidelines finalized for the NPS, pension fund managers will 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 instruments. The subscriber will have the option to actively decide as to how the NPS pension wealth is to be invested in three asset classes:
- E Class: Investment would primarily be in Equity market instruments. It would invest in Index funds that replicate the portfolio of either BSE Sensitive index or NSE Nifty 50 index.
- G Class: Investment would be in Government securities like GOI bonds and State Govt. bonds
- C Class: Investment would be in fixed income securities other than Government Securities
* Liquid Funds of AMCs regulated by SEBI with filters suggested by the Expert Group
* Fixed Deposits of scheduled commercial banks with filters
* Debt securities with maturity of not less than three years tenure issued by bodies Corporate including scheduled commercial banks and public financial institutions
Credit Rated Public Financial Institutions/PSU Bonds
Credit Rated Municipal Bonds/Infrastructure Bonds
In case the subscriber does not exercise any choice as regards asset allocation, the contribution will be invested in accordance with the ‘Auto choice’ option. In this option the investment will be determined by a predefined portfolio. At the lowest age of entry (18 years) the auto choice will entail investment of 50 % of pension wealth in “E” Class, 30% in “C” Class and 20% in “G” Class. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in “E” and “C” asset class will decrease annually and the weight in “G” class will increase annually till it reaches 10% in “ E”, 10% in “C” and 80 % in “ G” class at age 55. The following table will illustrates this auto choice more clearly-
| CLASS | TILL THE OF AGE 35 YEARS | AT AGE 55 YEARS |
| E | 50% | 10% |
| C | 30% | 10% |
| G | 20% | 80% |
Investment charges
New Pension System levies extremely low Investment management charge of 0.00010% on net AUM (Asset Under Management). This is extremely low as compared to charges levied by mutual funds or other investment products. Initial charge of opening the account would be Rs. 470. From second year onwards the minimum charge would be Rs. 350 a year. As per the offer document of NPS, annual and transaction charges would be reduced once the number of accounts in CRA reaches 10 lakh.
Withdrawal norms
If subscriber exits before 60 years of age, he/she has to invest 80% of accumulated saving to purchase a life annuity from IRDA regulate life insurer. The remaining 20% may be withdrawn as lump sum. On exit after age 60 years from the pension system, the subscriber would be required to invest at least 40% of pension wealth to purchase an annuity. In case of Government employees, the annuity should provide for pension for the lifetime of the employee and his dependent parents and his spouse at the time of retirement. If subscriber does not exit the system at or before 70 years, account would be closed with the benefits transferred to subscriber in lump sum. If a subscriber dies, the nominee has the option to receive the entire pension wealth as a lump sum…..
Tax Treatment
The offer document of New Pension System does not specify the tax benefits in elaborate manner. It specifies “Tax benefits would be applicable as per Income Tax Act, 1961 as amended from time to time.” As per current provisions, withdrawals under the NPS attract tax under the EET (exempt-exempt-taxable) system, which means that while contributions and returns to the NPS are exempt up to a limit, withdrawals would be taxed as normal income (EET).
To make the New Pension System more attractive Government has announced two major Income tax concessions for contributions made in New Pension System in the budget 2011.
While the NPS subscribers are directly benefited from one of these Income tax concessions, the second one is beneficial to the employers who contribute for NPS each month equivalent to employees contribution in Tier I.
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