Why new NPS could be the best way to save for retirement

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About NPS scheme

The NPS schemes managed by the Kotak Pension Fund have churned out terrific returns in the past one-year and three-year periods.

All three tier I funds of Kotak have been the best performers in their categories, but this feat has gone largely unnoticed.

The pension fund manager, too, is uninterested in highlighting the spectacular 12.05% returns generated in the past three years by its C class fund, which invests in corporate bonds. During the same period, the best medium-term income fund churned out 9.2%.

With a fund management charge of 0.0009%, a NPS pension fund manager gets Rs 9 for managing a corpus of Rs 10 lakh for a year.

The average mutual fund gets close to Rs 20,000 for the same job, while a unit-linked pension plan charges almost Rs 30,000.

This is poised to change. Fresh guidelines issued by the PFRDA have revised the structure of charges of the NPS, which will make the scheme more remunerative for distributors and pension fund managers.

After the terms of the six pension fund managers expire in October this year, new pension fund managers will be appointed as per the revised guidelines.
The upward revision of the fund management charges will remove a major bottleneck that has prevented the spread of the NPS. Even after three years, the scheme has attracted barely 46,000 voluntary investors.

The bulk of its 24.27 lakh subscribers is central and state government employees (16.2 lakh), for whom the NPS is compulsory, or the 7.4 lakh NPS Lite investors, who got drawn by the Rs 1,000 government subsidy. Distributors are not interested in selling the low-cost scheme because the commission earned doesn't justify the effort.

Admittedly, the revision in charges will affect the returns of the investors. The outperformance of NPS funds is chiefly because of the low charges of the scheme.

Irda relented, but wanted insurers to compulsorily offer annuities. Annuities are investments that provide a stream of income for the investor after his pension plan matures. While insurers were offering the investment leg of the pension plan, not many offered annuities as well.

At the same time, capital market regulator Sebi is nudging mutual fund houses to launch pension products. Fund houses have sought permission from the Finance Ministry to float these, with Reliance Mutual Fund having sought approval for a pension fund.

A couple of such mutual funds already exist, but these are not really pension products. Your investments in the Templeton India Pension Plan or the UTI Retirement Benefit Plan will fetch you tax benefits under Section 80C, but there is little to differentiate these funds from any other scheme.

Comparison of Returns. 
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Also, these funds have a fixed asset allocation for all investors. Whether you are 21 years old or nearing retirement, your asset allocation will not differ. In the NPS, however, the asset allocation can be defined by the investor.

If he doesn't do so, the default option of the scheme automatically allocates the money according to age, shifting money out of risky assets as the person grows older.

"The Templeton India Pension Plan follows a 60:40 allocation to debt and equities. If allowed, we might consider introducing new options with different asset allocations in the same fund.

Another big concern is the higher charges of these funds. In a mutual fund, the distribution cost is the largest component of the total cost structure.

"Pension being a retail product requires strong distribution support and, thus, a higher expense ratio. Fund houses will find it difficult to match the cost structure of the NPS," says Shashwat Sharma, partner, KPMG. The average mutual fund charges roughly 2% per year.

Assuming that the NPS charges will be capped at 0.25%, the difference can add up to a sizeable figure over the long term (see graph). Clearly, the NPS is the cheapest and best way to plan for retirement.