Untangling the National Pension Scheme

Aware that the NPS (National Pension System) has not been a super-hit with the workforce, the government has made a series of tweaks to its features to draw in subscribers. But this hasn’t helped its popularity. By end-October 2018, the scheme managed just ₹35,261 crore from voluntary private sector subscribers. This is surely a small sliver of the retirement savings needed for India’s non-government workforce.

Last week, the Cabinet has approved the coveted EEE tax status for the NPS. But it is unlikely that even this juicy tax break will have voluntary contributors thronging to the scheme. Conceived as a low-cost, no-frills market-linked product, the NPS has had one too many bells and whistles added to it over the years, which make it inaccessible to lay folk.

There are four steps the government and the pension regulator can take to make the NPS less complicated, so that it can be bought off the shelf.

Shrink the menu

Today, a private sector worker looking to invest in NPS is asked to make a mind-boggling array of choices. First, he is presented with a Tier I and a Tier II account. Then, he is required to select one pension fund manager from eight on the menu. Next, he needs to decide on his percentage allocation between the four assets — equity, corporate debt, government securities and alternative investments such as AIFs, Invits and REITs. He must use either Active choice or Auto choice to do this.

But in Active choice, he doesn’t have a free hand because the rules, in their wisdom, link his equity allocation to his age. So, at 50, he can set this equity allocation at 75 per cent, but if he is 55, he is permitted only 62.5 per cent. The Auto choice again offers choices of aggressive, moderate and conservative life-cycle funds.

In short, the NPS subscriber’s predicament is like that of a famished diner visiting a fast food joint with an over-large menu. While he’d be quite happy with a plate of idlis , the waiter insists on reeling out the names of 30 other dishes.

Therefore, the first thing that regulators will need to do to make the NPS more appealing to ordinary folk, is to whittle down its menu. Tier II accounts can be done away with. Rather than confuse the investor with an ‘auto’ choice, they can just have an active choice where he is free to set his allocations. Esoteric assets such as alternatives are best kept off the NPS menu. Instead of eight fund managers running active funds, one index fund for each asset class may suffice.

Shift to index funds

The opportunity to earn market-linked returns at an ultra-low cost is the NPS’ most compelling proposition. But in trying to fulfil this promise with actively managed funds, the pension fund regulator has been tying itself into knots. Active fund managers in India charge a fee of 1.75 to 3 per cent a year to manage mutual fund money. But the NPS is seeking their services at 0.01 per cent.

The rock-bottom fee disincentives fund houses who bag the NPS mandate, from allocating their best talent to it. It gives rise to jugaad practices such as channelling NPS money into their mutual fund schemes. It also leads to high churn and mid-way drop-outs in the NPS fund managers.

All this is highly unsettling for the investors who are entrusting the NPS with their life savings. Reshuffling the NPS fund managers every three or five years interrupts the funds’ track record, making it difficult for investors to choose the right one.

It would be best for the NPS to stop looking to hire active managers for peanuts. It should instead call for competitive bids from fund houses to run passive funds that track say, the Nifty 500, the 10-year g-sec and the AAA corporate bond index at low fees, with minimal error.

NPS investors would find it more reassuring to stick with a single fund manager who invests in a predictable basket of securities, than dealing with new sets of managers every 3 or 5 rears. Though NPS’s active managers have so far beaten the indices by 1-2 percentage points, with the maturing of Indian stock and bond markets such alpha will likely narrow.

There’s also no reason why NPS assets should be demarcated for central government and private sector employees, with different sets of rules. Pooling the two will help the fund manager reap scale benefits in managing NPS money.

Offer it through employers

Inertia is often a big factor preventing investors from signing up for financial products. A good way to solve this problem would be to require all private sector employers to offer NPS as an alternative to the EPF to all their employees.

This has several advantages. Employees need not hunt for banks or intermediaries (who seem quite reluctant to promote NPS) to open NPS accounts. The additional costs incurred towards contribution and account maintenance on the NPS can be done away with.

More affluent employees may end up opting for the market-linked NPS over the EPF, thus freeing the government the burden of running a defined benefit scheme for them. For employees who skip the EPF in favour of the NPS, the deal can be sweetened by employers making a matching contribution to their retirement kitty.

Remove end-use rules

A final feature of the NPS that puts off investors is its draconian rules on the end-use of maturity proceeds. Unlike EPF or PPF which allow the investor to use their accumulated retirement corpus in any manner, the NPS stipulates that the investor compulsorily use 40 per cent of his proceeds to buy annuity plans.

This is an unnecessary stipulation. For retirees seeking regular income, annuity schemes from Indian insurers are among the most unfriendly products one can think of. They offer very low returns taxable at the slab rates. They force the investor to lock in for a lifetime into the fixed annuity rates prevailing at his entry. They offer no inflation protection.

Given that the NPS is unlikely to be the only retirement vehicle for an employee, he must be given the choice of clubbing all his accumulations and deciding on income avenues that give him maximum bang for the buck.

Getting millennials to defer their current consumption to save for a retirement that is far into the future is hard enough, without the government trying to dictate how they use that money after they retire.

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