New Pension Scheme- the right step?

………….Pratik Shah

Friends

You have heard a lot about the New Pension Scheme launched by the Government of India from 01^st May 2009. There has been lot of articles written advocating on the positives and negatives of the Pension Scheme. I am also penning this article on New Pension Scheme, but, with a different flavor for my blog readers. You can give your comments (both positive and negative) or ask any Questions and I will be happy to reply them.

A) Background

NPS is a defined contribution pension scheme open to any Indian citizen between the age of 18 and 55. In a defined contribution scheme, the individual invests a certain amount in a pension scheme till he retires. At retirement, he is allowed to either withdraw the money that has been accumulated or buy an immediate annuity from an insurance company to generate a regular income, or do both.

Pension fund Regulatory and Development Authority (PFRDA) has appointed National Securities Depository Limited (NSDL) as the Central Recordkeeping Agency (CRA) to maintain the records of contribution and its deployment in various pension fund schemes for the Subscribers. NSDL has setup a CRA system for this purpose. CRA is a first of its kind venture in India which will carry out the functions of Record Keeping, Administration and Customer Service for all Subscribers under NPS. The records of the contributions of each Subscriber will be kept in an account known as the Permanent Retirement Account (PRA) which shall be identified by a Permanent Retirement Account Number (PRAN). CRA shall issue a PRAN to each Subscriber on his/her successful registration and maintain database of each Permanent Retirement Account along with recording of transactions relating to each PRAN.

NPS has been rolled out for all citizens from 1st May, 2009. Hence, various facilities (like opening Permanent Retirement Account, contributing to NPS etc) will be provided to all the citizens (known as ‘Subscribers’ in the NPS architecture) at various locations across India. These processes shall be carried out through the entities known as Points of Presence (POPs) appointed by the PFRDA. POPs’ shall provide the services under NPS through their network of branches called POP Service Providers (POP-SP).

B) Intermediaries and Regulators

There are various intermediaries involved in the entire chain of events. They have been outlined below

PFRDA- Pension Fund Regulatory and Development Authority (PFRDA) is an independent body established by the Government of India on 10^th October 2003. PFRDA is the Regulator for the New Pension System (NPS)

Pension Fund Managers (PFM’s)- Pension Fund Managers are appointed by PFRDA to maintain the Pension contribution of all subscribers through various schemes offered by PFM. Subscribers will have the option to invest their contributions into one or more schemes of the PFMs. The PFMs will be responsible for providing the Net Asset Value of the Schemes offered to NSDL. PFMs will allot units based on NAV as applicable.

The appointed Fund Managers as on date are 

• ICICI Prudential pension Management
• IDFC Pension Fund Management
• Kotak Mahindra Pension Fund
• Reliance Capital Pension Fund
• SBI Pension Fund
• UTI Retirement solutions 

 Annuity Service Providers (ASP)- Yet to be appointed

Annuity Service Providers (ASPs) will be appointed by PFRDA to maintain the annuity contribution of subscribers through their various schemes. Subscribers will have the option to invest their amount into one or more annuity schemes upon retirement/resignation. ASPs would be responsible for delivering a regular monthly pension (annuity) to the subscriber for the rest of his/her life.

Trustee Bank- NPS Trust formed by PFRDA would be responsible for taking care of the funds under the NPS.  The Trust would hold an account with the Trustee Bank appointed by PFRDA. The Trustee Bank upon receiving credits from Nodal offices would transmit the information to CRA for reconciliation. The Trustee Bank shall remit fund to the entities viz. PFMs, ASPs and subscribers on receipt of instructions from NSDL

Point of Presence (POP)- They are entities appointed by PFRDA. POPs’ shall provide the services under NPS through their network of branches called POP Service Providers (POP-SP). You can find them at http://www.npscra.nsdl.co.in/modules.php?name=Content&pa=showpage&pid=190

Central Record Keeping Agency (CRA)

NSDL has been appointed as the Central Record Keeping agency by the Government. National Securities Depository Limited (NSDL) and The Pension Fund Regulatory and Development Authority (PFRDA) have entered into a formal agreement relating to the setting up of a Central Recordkeeping Agency (CRA) for the New Pension System (NPS)

The main functions and responsibilities of the CRA include:

i.  Record keeping, Administration and customer service functions for all subscribers of the NPS.

 ii. Issue of unique Permanent Retirement Account Number (PRAN) to each subscriber, maintaining a database of all PRANs issued and recording transactions relating to each subscriber’s PRAN.

iii. Acting as an operational interface between PFRDA and other NPS intermediaries such as Pension Funds, Annuity Service Providers, Trustee Bank etc.

CRA will monitor member contributions and instructions and transmit the information to the relevant Pension Fund and schemes on a daily basis. CRA will provide periodic, consolidated PRAN statements to each member and discharge such other duties and functions as may be determined by the guidelines, directions and regulations issued by the PFRDA from time to time. CRA is also providing electronic interconnectivity to the PFRDA, other service providers (like banks, post offices and depository participants, among others), pension funds and annuity providers.

 You can visit them at  http://www.npscra.nsdl.co.in/

 C) Account Opening for NPS

The NPS offers two accounts: Tier I and Tier II.

Tier 1

This is a non-withdrawable account and investments in this keep accumulating till you turn 60. Withdrawal is allowed only in case of death, critical illness or if you are building or buying your first house. In case of death the nominee can get 100% of NPS wealth in a lump sum. He can however continue with the NPS in case he wishes to.

Tier II

 Tier II account, on the other hand, will be a voluntary savings account which will allow you to withdraw money as and when you want to. While the Tier I account was made available from May 1, 2009, the facility of Tier II account is being offered from December 1, 2009 to all citizens of India including Government employees mandatorily covered by NPS.

Both Tier I (Pension Account) and Tier II (Savings Account) will be pure retirement savings products, the only distinction being that Tier I is a non-withdrawable account while Tier-II is a withdrawable account to meet financial contingencies. The Tier-II would enable the existing Permanent Retirement Account (PRA) holders to build savings through investments over and above those in the Tier I pension account. An active Tier I account will be a pre-requisite for opening of a Tier II account.

Key features of Tier-II account

• No additional CRA charges will be levied for account opening and annual maintenance in respect of Tier II. However, CRA will charge separately for each transaction in Tier II, the charges being identical to the transaction charge structure in Tier I.
• There will be no limits on number of withdrawals.
• There will be facility for separate nomination and scheme preference in Tier II.
• The subscriber would have the same choice of PFMs and schemes as in the case of Tier I account in the unorganized sector.
• Contributions can be made through any POP/POP-SP.
• There will be facility of one-way transfer of savings form Tier II to Tier I.
• Bank details will be mandatory for opening a Tier II account.
• No separate KYC for Tier II account opening will be required; the only requirement is a preexisting Tier I account.

 Minimum contribution requirements:

1. Minimum contribution at the time of account opening – Rs. 1000/-

2. Minimum amount per contribution – Rs. 250/-

3. Minimum Account Balance at the end of FY – Rs. 2000/-

4. Minimum number of contributions in a year – 4

(Minimum One contribution in case a subscriber joins in the last quarter)

5. Penalty of Rs. 100/- to be levied on the subscriber for not maintaining the minimum

Account balance and/or not making the minimum number of contributions.

 Charge Structure for PoPs:

1. New account opening charges (Tier 1 & II both) – Rs. 40/-

2. Tier II activation for existing subscribers of Tier I – Rs. 20/-

 Recently a composite form has been rolled out which enables a user to open both Tier1 and TierII accounts at one time. The form can be accessed from

http://210.210.122.247/NSDL/html/admin/modules/Forms/UOS-S1-Subscriber-Registration-Form-(CAF).pdf

Once the form is submitted to the POP’s and the processing is done by the CRA, you will be given a permanent retirement account number (PRAN). The PRAN will be the primary means of identifying and operating these retirement accounts

 D) Taxability

 Presently the NPS Scheme is covered under the EET (Exempt-Exempt-Tax) method, which means that the maturity proceeds will be taxed. Unlike PF, VPF, Post Office Schemes which are under EEE (Exempt-Exempt-Exempt) method, NPS does not have that advantage. The PFRDA is trying hard to get NPS also under the EEE bracket. If this happens NPS would pick up very fast and will be a good alternative option as compared to Mutual Funds or ULIP’s especially due to its low cost model.

 On the other hand, Finance ministry has already expressed its intention through the draft direct tax code to move all long term financial products to the EET method. If this is materialized, then there would be a level playing field for all such products

 NPS contribution is eligible for deduction u/s 80CCD with an upper aggregate limit of 1 lakh. Withdrawals from Tier II account will be taxable to the extent of Interest component and Principal contribution only if claimed as tax deduction earlier.

Currently, the only way not to pay tax is to buy immediate annuities using the entire amount at maturity, which is not bad because you were anyway accumulating the corpus to generate a pension. Thus, if you do not withdraw and buy annuities of 100% of the amount then it will not be taxable.

 E) Contribution and Unit Allotment process

The minimum amount that needs to be invested per contribution is Rs 500. A minimum of four contributions need to be made per year. Other than this, a minimum of Rs 6,000 needs to be invested per year. This means those who plan to invest the minimum amount of Rs 500 need to make 12 contributions per year. There are no upper limits on the amount of money that can be invested as well as the number of contributions that can be made. You need to decide on the frequency of your contributions across the year, at your convenience.

The investments can be made through cash, local cheque or a demand draft at the chosen point of presence. The money you invest in NPS will be managed by professional fund managers. It is important to remember that at the point of filling up the form, the choice of one of these six pension fund mangers needs to be indicated.

PFRDA, the pension fund regulator, will declare the value of your investment every year in April. At that point of time, if you are not satisfied with the performance of your fund manager, you can switch to another fund manager between May 1 and May 15.

The NPS currently offers three investment funds to choose from:

Option E (Equity): Investments will be made in SENSEX or NIFTY stocks or in a Index Fund. The investments in stocks will be made in the same proportion as the weightage of the stock in the particular index.

Option G (Govt Securities): Investments will be made in debt securities issued by the central as well as the state governments.

Option C (Corporate Debt): Investments will primarily be made in debt securities issued by entities other than the state and central government, liquid funds of mutual funds, fixed deposits of banks etc

At the time of filling the form, you need to indicate what proportion of your money should be invested in which asset class. You can choose to invest a maximum of 50% in the equity option, i.e. asset class E and a maximum of 100% in the other two options.

Subscription Process flow

These pension contributions will be invested in various schemes of different Pension Fund Mangers appointed by PFRDA. The Subscriber’s contributions will be invested as per the scheme preference opted by the Subscriber. The Subscribers shall submit their contributions towards NPS at any of the POP-SP of any POP. POP-SP shall accept the contributions of the Subscribers and shall upload the contribution details to the NPSCAN system. On the basis of contribution details uploaded by POP-SP, CRA will provide fund transfer instructions to the trustee bank as a part of settlement process. Trustee bank will transfer the funds received from POP/POP-SP to different PFMs as per the details provided by CRA.

POP/POP-SP shall prepare Subscribers’ Contribution File (SCF) for the clear funds and upload it to NPSCAN system. SCF will contain details such as POP Registration number, POP-SP registration number, PRAN of the Subscriber, amount of the Subscriber contribution, etc.

The flow is as under

• Subscriber approaches the Point of Presence (POP)- Service provider and fills in the Subscription Contribution Form (SCF). Online submission is not yet activated by NSDL. He mentions his PRAN No, Subscription Amount, Fund Manager and the Choice of Scheme. Also, hands over the cheque/DD/ Cash to POP-SP. Copy of PAN Card is must if contribution is more than 50,000. The deadline for T+1 processing is 5.30 p.m on the T Day
• Each Subscriber under NPS shall submit NPS contributions to POP-SP alongwith instruction slip called as NCIS in the format as prescribed by PFRDA (enclosed as Annexure I). NCIS shall contain the details such as PRAN, name of the Subscriber, phone no., mobile no. and payment details. NCIS will have two parts; POP-SP shall keep the first part of NICS for their record and handover the perforated part to the Subscriber as an acknowledgement for receipt of fund
• Staff of POP-SP converts the SCF in a systemic format using File Preparation Utility (FPU) provided by NSDL. The same is validated using File Validation Utility (FVU) provided by NSDL to check for any breaks in the format. Once it is validated POP-SP uploads the form in NPSCAN (New Pension Subscriber Contribution Accounting Network) system. This is the central system of the CRA. Only SCF with clear funds are uploaded in the system
• On successful upload, a File Reference Number will be generated and on acceptance of the file a Transaction Id will be generated by NPSCAN.  
• On acceptance of the file a Contribution Submission Form (CSF) will be generated which will be printed and provided to Trustee Bank on transfer of funds. 
• POP/POP-SP will deposit the total amount as per Contribution Submission Form at the Trustee Bank. If funds are transferred through electronic transfer such as NEFT/RTGS, POP/POP-SP should ensure POP/POP-SP Reg. No. and Transaction ID is provided by Initiating Bank (Accredited Bank of POP/POP-SP) in the electronic instruction. 
• Trustee Bank sends the Funds confirmation notice (FRC) to CRA within three working days. This notice is uploaded in NPSCAN based on which the subscription shows ‘ Matched Status’ ( i.e Funds received for the subscription) 
• CRA sends the details of matched records to respective Pension Fund Manager (PFM) as decided by the subscriber 
• PFM will invest the money as per the scheme selected by the subscriber. The PFM will allot the units to the subscriber based on the NAV for the Fund prevailing on that date. 
• Custodian of the PFM will settle the transaction in the market on behalf of the fund 
• Subscriber gets a consolidated portfolio on periodic basis, as determined by PFRDA

 Retirement process

NPS by default sets the retirement age at 60. Once you attain that age, you can use the money that has accumulated to generate a regular pension for yourself. In order to do this, you have to compulsorily buy immediate annuity from a life insurance company with 40% of the money that has accumulated.

Since a minimum of 40% needs to be used to buy an immediate annuity, a maximum of 60% of the money accumulated can be withdrawn. However, unlike other tax-saving instruments like Public Provident Fund (PPF) and Employees’ Provident Fund (EPF), wherein the amount at maturity is tax-free, in case of NPS this amount is taxable.

F) Charges

 The NPS works on a low cost model especially the Fund management fees are the lowest in the world.

 Custodian Fee- 0.0075-0.005% of AUM

 Fund Management Fee- 0.0009% of AUM

 Other Charges- Account Opening, Account Maintenance charges to CRA, etc

 The fixed charges would go down further once the number of subscriber base increases.

 Conclusion

 By now you would have got a fair idea of the NPS scheme and its advantages and disadvantages. Given the tax arbitrage enjoyed by other products like ULIPS, PF’s etc NPS is not highly recommended. However, it is a good concept to promote long term savings and at the same time get an opportunity to earn higher returns through investments linked to equity markets. Budget 2010 should talk about promoting this scheme and I am sure government will bring about changes to make this scheme favorable for citizens of India.