How NPS can be dangerous

Too many people in the media are obsessed about fund management costs. This is not a bad thing – after all this is the ONLY thing to which we retail investors have access, right.

Fund managers on the other hand (ok the 3-4 fund managers who I have spoken with and who have over the past decade + have beaten the sensex) feel it is not so.

I am torn between the 2 schools. I know one corrupt fund manager can ruin a fund performance – and all the kings men and kings horses cannot put Humpty Dumpty together again. Many of us know about a fund manager who was very bookish – and ended up with a lot of shit in his portfolio. Poor chap believed the balance sheet and trusted the management. Now of course he is well improved and runs a very successful scheme.

I would agree with ‘cost is the only thing which matters’ school of thought ONLY if it is an index fund. The NPS for example is an index fund – the equity money goes into an index, but the DEBT portion goes into a bond fund. The bond fund could be G sec or Corporate. There is no index bond fund in India. Also there is no Dynamic Index (oops!). If you are observing the UK and US markets you would have watched the NEGATIVE returns on their bond funds. Why? Because interest rates have gone up SIGNIFICANTLY – FROM 1.5 to 2 %. This is huge – it is a 33% jump in rates. If the interest rates go up even further, the bond funds will post HUGE losses (last year the longer term bond fund lost about 7% in London). Now combine this with a 5% FALL in equity markets, your NPS will show a fall of 12% – IMPOSSIBLE for the common man to take. He is used to a 8.78% return on his PPF…

So fund costs is excellent to  monitor ONLY AND ONLY if

– you are sure of the competence of the fund manager

– integrity of the fund manager and his bosses

-processes of the fund house is nice and clean

I, personally, will stay away from NPS. However my answer may be very different if I am an employee and my employer offers me a matching contribution.

My returns double, right? Wrong, it goes up MUCH more…power of compounding.

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6 Responses to “How NPS can be dangerous”

  1. Considering the way it is run, this
    “… my employer offers me a matching contribution.” is my only
    silver lining.

  2. Subra,
    we have scheme, where overall ctc gets reduced by say ‘X’ amount and the same is contributed by employer to our tier I NPS account. Here only additional benefit we get is tax deduction on 10% of basic salary which employer will deposit to our NPS, though that money technically is part of our salary only.
    in this case, as the proceed of withdrawal and annuity as and when comes up remains fully taxable as per the applicable tax, it is not great benefit. And that too particularly if person is likely to be in higher than 10% tax bracket even after retirmeent.
    only benefit is for the people who can not be disciplined on their own to create their retirement benefit. is it correct, or i am missing something?

  3. deferring the tax by 10, 20,…years is a HUGE benefit. And you should worry about tax ONLY in the current scenario..maybe dividend tax will be back, estate duty may be back…so yes it does help those who are not disciplined but it also helps putting the cash away and pay tax ONLY when you NEED the cash, not on a yearly basis like a bank fd…

  4. Thnx Subra. Surely, your input will help to further crystalise our thoughts and take an appropriate decision. The perspective of likely changes on tax structures on various assets/income sources in the time to come is an added input.

  5. i my self being central govt employee since 2000. I know I am assured of govt pension benefits for my entire life still will you suggest me to go for second pension plans especially NPS in particular… for more assured pension. ie pension from 2 sources. pl guide me for that.

  6. HI Subra Sir / Others,

    My employer is starting to provide option to employees to opt (voluntary, not mandatory) for NPS Corporate sector model in which employer will deduct my Special Allowance (which is fully taxable@20.6%) with an amount of Rs 3675 (10% of my basic salary of 36750 per month) and deposit this amount in NPS account which will save me 20.6% of tax as per IT section 80CCD(2). This will save me Rs 9100 per year as income tax savings. However employer will also deduct Rs 500 per month from my salary so as to deposit Rs 6000 per year in my NPS account since 6k is minimum which u need to invest as an employee. This will not save me any tax as I consume 80C anyway with PPF and EPF. Now every transaction in NPS has charges of Rs 23 (charged by POP including sevice tax) so total cost will be Rs (23*24=552) + Rs 350 (Annual maintenence charges by CRA) totalling Rs 900 as charges for an amount of Rs 50100 yearly. This is 1.8% as charges and 0.25% fund management charges so total charges will be 2.05% which seems quite high if compared to mutual fund like QLTE (1.25% only). However saving of 20.6% as income tax should well offset this 2.05% charges.

    Hence I want your expertise analysis as to whenther I should go for this NPS option. The negatives which I have in my mind are taxable pension, taxable lumpsump withdrawl, compulsary annuity, cant exit even if PFRDA increases charges further during next 30 yrs ( 60 minus 30 yrs my present age), limitation of 50% equity, less returns as compared to diversified MF which are tax free after 1 yr.

    Please help me to decide. I dont want to get trapped in a product from which I cant exit for next 30 Yrs. Thanks.

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