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NPS – Should you invest in national pension scheme?- Part III

NPS – is it the best you can do with your money? Know more…

How do I withdraw money?

In a Tier-I account, if you decide to withdraw before the age of 60, you can only take out 20% of the amount. Rest has to be converted into an annuity that pays monthly pension. After the age 60, you can withdraw upto 60%, and convert the rest into an annuity. At the time of withdrawal of your pension (when you are 60 years of age), 60% of your money invested can be withdrawn as lump sum and the remaining 40% is converted into annuity. Tier-II accounts can be withdrawn at any time.

What are the tax benefits of NPS?

Tier-I NPS contribution enjoys the same tax benefit up to Rs 1.5L under Section 80C, along with other instruments like PF, PPF and equity linked savings schemes. In addition, another Rs 50000 contributed to the NPS in a year is tax-exempt. This saves you an additional Rs 15,500 if you are in the highest tax bracket.

Currently NPS falls under Exempt, Exempt, Taxable (EET), meaning that investing in NPS and the interest earned is exempt from tax. But you are taxed during withdrawal of your pension. There is a proposal to make withdrawal also exempt (like it is for PPF), which will make NPS much more attractive.

 

Conclusion

We look at the verdict on NPS based on 3 parameters – returns, ease of transactions and tax efficiency.

On returns, NPS equity schemes have delivered around 9.2%-9.5% since inception in 2009, compared to a Nifty return of around 9.7%. Thus, they haven’t really outperformed the market, the way several mutual funds have. But they have been superior to the PF.

On ease of transactions, NPS fares quite poorly, requiring paperwork to open an account, withdraw, etc. There are steps being taken to make it easier, but there’s a long way to go to make them comparable to mutual funds. That said, NPS is much superior to the PF in this dimension.

Tax exemption on withdrawal will make NPS on par or better than mutual funds. As of now, they are inferior to both mutual funds and PF.

In summary, your money is far better kept in the NPS than in the PF. But mutual funds are probably still the best place for your money, all things considered.

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NPS – Should you invest in national pension scheme?- Part II

How to enrol and operate?

Several public sector banks, a few private sector banks like Axis and ICICI, and a few other intermediaries like HDFC Securities are empanelled distributors for NPS.

The enrolment process has largely been offline so far, consisting of filling a form, submitting proofs of identity & address, and a photograph. This gets you a Permanent Retirement Account Number (PRAN) in about 20 days. For some inexplicable reason, an enrolment (know-your-customer or KYC) done for trading accounts or banks or mutual funds is not automatically valid for NPS and has to be done again. NSDL has proposed an Aadhar-based online enrolment system, which works in paperless form if you have your mobile number linked to your Aadhar. This is yet to be fully operationalized.

After the initial paper enrolment, several intermediaries allow you to make your contributions through online transfer / ECS, and also view your account online.

What are the account and scheme options?

There are two types of account

  • Tier-I is a non-withdrawable account. You can only withdraw after retirement.
  • Tier-II is a voluntary savings facility. You are free to withdraw your savings from this account whenever you wish. You cannot open a Tier-II account without opening a Tier-I first

Key features:

Particulars Tier I Tier II
Minimum contribution required at the time of Account opening Rs. 500 Rs. 1,000
Minimum individual contribution Rs. 500 Rs. 250
Minimum amount balance at the end of financial year Rs. 6,000 Rs. 250
Transaction charges 0.25% of contribution 0.25% of contribution
Minimum number of contribution required in a year 1 1

 

In terms of schemes, there are 3 to choose from – E (equity) being the more risky but potentially more rewarding, G (government securities) being the safest but lowest yielding; and C (fixed income other than government securities) being an intermediate option. You can opt for active choice, wherein you can put between 0-50% in E, and the rest in C or G. You can also let the pension fund manager decide it for you, based on your age – ‘auto choice’.

You can choose to have your account managed by one of 7 pension fund managers.

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NPS – Should you invest in national pension scheme ?

NPS (National Pension Scheme) – Is it worth the hype?

What is NPS?

This is a government supported pension scheme. As with other such schemes, the idea is that you contribute regular sums of money in your working years. This continues to earn returns, and is finally made available to you to take a pension / annuity when you retire. Unlike the so-called defined benefit schemes that government employees enjoyed earlier (where the pension was funded by government and was linked to seniority, last drawn pay, etc), the NPS is funded solely by your own contributions.

The genesis of the this scheme was a realisation that the Provident Fund (PF) was woefully inadequate to meet the retirement / pension needs of a vast majority of people. Two major welcome departures of the NPS from the PF are:

  • It allows you the option of investing your contributions into market-linked schemes, which can earn a much higher return over the long term, compared to the government-pegged PF
  • The scheme has a wider distribution network through banks

In the equity segment, NPS has given a return of 9.20% since its inception in 2009

 

Who can enrol for the for the National Pension Scheme?

You can enrol if you are

  • A citizen of India (resident or non-resident)
  • Between 18 to 60 years of age at enrolment

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Tax optimisation and load planning methodology

Tax optimisation and taking care of the exit load is crucial to your portfolio. Read on to understand more.
In India, tax rules vary by type and tenure of investment products. They are also often tweaked and modified from year to year in Union budgets. As things stand currently, stocks / equity is taxed leniently: 15% if sold within a year and 0% if sold thereafter. All types of bonds (barring a few identified tax free bonds) are taxed at 30% if sold within 3 years or 10% if sold thereafter. This makes tax optimisation an important concern.

To minimise your load and ensure tax optimisation, our investment philosophy usually works as follows:

  1. Money you need for emergencies or within a few weeks / months is invested into what are called liquid funds. These often yield as much or better than fixed deposits, but are easily breakable without load.
  2. Money needed within a year is put into shorter term bond (debt) funds. Most of these do not have loads if you exit more than a month after investing.
  3. Money needed over the longer term is put into stocks / equity or longer term debt funds to maximise their returns potential.
  4. If you need some money urgently, our algorithms work to sell those products that minimize your tax / load outflow.3

Research Criteria & Methodology : Synopsis

Research Criteria and Methodology. Read to know more about how we select the best funds for you.

We have a robust and tested research methodology to recommend the best set to you. We cover a range of factors:

  1. Minimum 3-5 year track record
  2. Performance and returns over multiple time horizons: 1yr, 3yr and 5yr (additionally 6m for debt)
  3. Performance in bull and bear markets, and during upward and downward movement of interest rates
  4. Performance of fund manager in other schemes, and over time
  5. In case of equity, diversified portfolio with limited exposure to mid and small cap stocks (which are inherently more risky)
  6. In case of debt, funds with limited or no exposure to private sector corporate debt (especially real estate and construction, but also other sectors like paper, logistics, FMCG, NBFC, etc). Other than sovereign debt, we usually only consider funds with banking and / or PSU debt in the portfolio
  7. In case of debt, less or more exposure to the yield curve, based on the tenure of the investment

 

We usually exclude products like Unit Linked Insurance Plans (ULIPs), stock trading, derivatives, post office schemes, etc. These products only enrich the broker and not the investor. The products that are generally most suited to long-term investing are mutual funds, PSU bonds (e.g. NABARD, Indian Railways, Power Finance Corporation), blue-chip stocks held long term, PPF and New Pension Scheme.

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Goal-Based Investing – How Does It Work?

Investing with a goal is very important. Read to know why.

Your goal / objective form the starting point for all our research and algorithms to rally behind.

Through a couple of simple questions, we learn from you the timing and amount of the goal. This allows us to compute what investments would make most sense, to minimize your monthly investment towards the goal.

Having said that, it is perfectly legitimate for you to not know the exact timing of a goal – for e.g. overall ‘wealth building’ is a goal. We use heuristics to determine the best allocations in such situations.

A couple of guiding principles enable us to determine the best products:

  1. The farther away the goal, the more risk you can take to try and earn a higher return. Conversely, a goal that is near requires investing in safe instruments
  2. Goals that are far away are affected by inflation – for e.g. it would be difficult for you to estimate what your toddler’s higher education would cost 15 years from today. We again use heuristics to estimate what the goal could look like in today’s terms (i.e. after adjusting for inflation)

We then help you invest one-time or monthly amounts towards this goal in the best instruments chosen. Our reporting then helps you monitor progress towards achieving the goal.

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Fixed Deposit : Choose the Best Option

Fixed Deposit schemes are offered by various institutions. It is very important for you to choose the best. Read on to know how.

Which fixed deposit should you go for?

In fixed deposits, safety is paramount – not half or 0.75 percent of extra interest.

The slightly higher rate of interest doesn’t really matter in the larger scheme of things, while an unsafe FD can give you sleepless nights later.Convenience and good service would be the second factor to look for.

We therefore advise going for a nationalized bank or one of the larger private banks – ICICI, HDFC, Axis or Kotak. Slightly less safe are deposits in cooperative banks.

Corporate fixed deposits can be quite unsafe– it really depends on the company you are investing in. Many companies tend to advertise their deposits and lure you with higher interest rates, so beware!

What term should you choose?

Fixed deposits longer than three years are not useful. The returns they give are poor, and often lower than inflation. For long term investments, you would rather go for equities, which can give better and inflation beating returns over the long term. On the debt side, PPF and public sector bonds (like NABARD or Indian Railways) are better for long term investments.

Below three years, the tenure you should go for really depends on when you think you need the money. Since there is a penalty for premature withdrawal, you might as well choose the tenure so that you are unlikely to break the deposit midway.

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Savings : Why is it important to maintain an appropriate ratio?

Savings, though of immense importance, is often neglected to a great degree. Read on to know why it is so important.

When we save we store up for our future. Saved money when invested earns for itself. Take the farmer for example. Out of the bountiful yield he receives from months of hard work he keeps aside some seeds for sowing in the next season. What would happen if he and his family merrily ate up all the harvest? What he could have afforded out his own produce now he would be forced to buy for a cost.

Saving is akin to that. But we need to save much more than seeds! In fact due to the eroding effect of inflation a sizeable chunk of earnings might have to go to your savings kitty every month.

However a quick reminder of why maintaining a healthy savings rate is important, might change your outlook of savings from probably being an imposition activity to be avoided or minimized to one that you will be glad to do.

Need for adequate savings

There are only two reasons why you need to have enough savings. The first is that someday, years down the line, your monthly cash inflows will stop as you retire from work. You would require funds from a different source to keep you and your spouse going for the decades to come.

Second, certain needs that are expected to come up along the way are too bulky to manage with just monthly or even annual income. Unless you planned and saved for them you would be forced to resort to loans.

For instance you cannot buy a house or a vehicle like you’d buy things from the grocery store. Or you cannot enroll your child in a college unless you have arranged the funds. Sure you can borrow without saving and repay from your monthly inflows but this would leave you with less money in hands to spend for your regular needs.

How much savings is enough?

Your ideal savings rate depends on how much money you require in future for lifestyle needs as well as for fulfilling the big liabilities. Of course nobody knows the future and it might not be possible to accurately plan for every single rupee of your future goals but you can estimate the amount based on your current lifestyle.

Thus your ideal savings rate depends on your 1. Life-stage, that is whether you are single, married or have kids to support etc and 2. Financial liabilities, that is if you are paying off loans, paying rent etc. Going from a merry single to being married, having kids and paying home loan EMIs, your savings rate would lay between 15% and 50%.

How much you earn is not important; if you just somehow manage to save at the appropriate rate your future needs will be met comfortably. The earlier you start, lesser will be the monthly amounts you’d have to keep aside for future goals because you have more years to save and get there! Budgeting and tracking of expenses is one simple yet effective tool to achieve your targeted savings rate.

How do I achieve my monthly savings target?

Now this is the million dollar question. Being able to maintain a healthy savings rate does not mean you would be pushed to live a miser’s life. But depending on your current lifestyle you might have to cut down a bit here and there. Since we are talking long term, say 15-20 years away, even small cut-downs can add a lot more than you would imagine.

If you happen to be one of those who think that in your situation getting to the ideal savings rate is next to impossible, think again. There are many practical ways of cutting down on spending without losing the fun of spending.

For instance buying groceries and other provisions in bulk can make much difference. Making use of public transport or better still walking (depending on distance, of course) instead of private vehicle will be good for your purse, health and the atmosphere as well!

You might find it useful to remember the distinction between saving and spending- though it might sound like a silly thing. But sometimes it’s difficult to distinguish – what is buying a house? What about buying a car? The latest model LED TV?

 

It is important to distinguish between needs and wants. It a useful habit you need to cultivate to have a balanced financial life in the long term. Needs are the basic necessities you can’t do without. When you have identified your needs like rent, telephone, utilities you will know how much you have left to spend on wants. Wants are basically desires you’d like to spend on.

 

It is not wrong to satisfy your wants but just remember not to do it at the cost of your needs or the likely consequence is – you will fall in debt. If you want to succeed in living happily within your means don’t dress up your wants as needs.

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