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Fixed Income

Podcast #19: Investing in NPS? The good, the bad, and the annuity

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“You can beat the NPS and it’s associated tax benefits, if you are able to generate just 1% above NPS returns consistently till retirement, but it’s easier said than done!”

On today’s show, Deepak Shenoy (CEO) and Aditya Jaiswal (Analyst) discuss the New Pension Scheme in detail.

We discuss the NPS from the perspective of a 30 year old who opts for NPS and contributes INR50,000 every year. How much will he accumulate at retirement? What happens if he loses his job after 5 years? How will the forced annuity impact him at retirement? If he doesn’t wants to opt for NPS, how much should his investments earn to beat the NPS returns plus the associated tax benefits of NPS?

Heads-up:

  1. Summary of NPS (first 5 mins).
  2. Defined benefit plans Vs defined contribution plans.
  3. What happens if a 30 year old opts for NPS and contributes INR50,000 every year.
  4. How much do you need to earn to beat the NPS returns (if you don’t opt for NPS and don’t avail the associated tax benefits)?
  5. Evaluating NPS: Liquidity, Risk, Returns and Taxation.
  6. How important is liquidity in a retirement plan?
  7. Who should opt for NPS and who shouldn’t!

 

Transcript:

(The transcript has been sourced from a premium transcription provider. It may contain some inaccuracies)

Aditya: Hello, and welcome everyone to the Capitalmind podcast. This is Aditya, and today we’ll be talking to the about the New Pension Scheme. So as usual I have with me the one and only Deepak Shenoy. Hi Deepak.

Deepak: Hey! Hi. Good morning everyone. Hi Aditya. I hope this is going to be a very interesting session, our first one for 2020, which is on the New Pension Scheme, a very interesting retirement scheme that has been brought out by the government. Around for a while, we thought, let’s take a look and analyze and tell you what we think it’s all about. So over to you, Aditya.

Aditya: So Deepak, I’ll take you through the entire New Pension Scheme and then I’ll start my questions.

Deepak: Oh, cool. Let’s go for it, man.

Aditya: So, when we talk about the New Pension Scheme, there are two plans, Tier 1 and Tier 2. Tier 1 is your Pure Pension Plan, which is also the main plan. And Tier 2 is more of an investment plan. But under both the plans, money is invested in both debt and equity. So let’s start with Tier 1, which is your Pure Retirement Plan. The main benefits of Tier 1 is compared to EPF, PPF, you can expect higher returns due to the equity component. Depends on the equity component you choose. We’ll come to that soon.

And when we talk about the fund managers who are going to manage this NPS, so for government sector employees, there is LIC, SBI and UTI. And for non-government sector, apart from these three, we also have HDFC, ICICI, KOTAK, Birla, and when it comes to allocation, either you go for active choice where a subscriber, say, I can decide my allocation. Say, I can allocate 50% to equity, 25% to, say, government bonds, and rest 25% to corporate bonds.

So here there’s an upper ceiling for equity. You cannot allocate more than 75% to equity. That is one restriction that is there. And then there is another option, which we call as auto choice, where if you don’t know what is the right thing for you, you just fill in your details, and based on your age and risk appetite, they’ll suggest your plan. And they’ll keep revising it as you grow older.

Now, what are the options at retirement? At retirement, you have three options. Either you continue contributing to NPS till 70, or you defer the withdrawal. You don’t have to contribute, just to defer the withdrawal till the age of 70. The third option is exit from the NPS. So what do you get? You get lump sum and you get a monthly pension.

But here is the biggest catch. You can only withdraw 60% of your corpus. So suppose at retirement you have accumulated, say, one crore, you can withdraw only 60 lakhs. For the rest of 40 lakhs, you will have to buy an annuity. So there’s a forced annuity component here. But what if I want to withdraw before my retirement? Do I have that option? You can. In case of critical illness or child’s higher education, you can withdraw only three times before retirement, and that to maximum 25% of your own contribution. So I believe this is a very big limitation here.

But then this NPS also has a lot of tax benefits. This is also included in the 1.5 lakh exemption under section 80 C. Apart from this, on top of this, you get an additional benefit of 50,000, which makes it two lakhs. And on top of this, again, if you’re a corporate employee and if your company is also contributing, then you get 10% of your basic salary as an additional exemption. So there are three components.

This was all Tier 1. Now what is Tier 2? Tier 2 is very simple. There is no minimum investment requirement. There is no restriction on withdrawals. You can withdraw n number of times, but there are no tax benefits. It’s very similar to mutual funds, and the expense ratio is very, very low. It’s like 0.01%.

I went to the NPS calculator and I did some calculations. I’m 27 years old. If I subscribe to NPS and if I contribute 4500 a month, by the time I reach 60, I would have accumulated around two crores, assuming a return of 12%. I can only withdraw 60% of it, which means I will have to use the rest, 40% or 80 lakhs to purchase an annuity.

So I believe I gave you a very comprehensive overview of NPS. Now I would like to ask a couple of questions. So first of all Deepak, what are your thoughts about NPS? You went through the entire policy patiently, you were listening to it.

Deepak: The problem with the concept of a pension scheme like this has to be understood in the historical context as well, where the government used paying out a certain amount of pension per employee that was retiring. And obviously these pensions can grow to a point where they’re unaffordable. Right now, defense pensions for instance or something called Defined Benefit, there are certain percentage of your last salary when you left. And that will continue because all the old government employees and the defense employees will get a certain percentage, a salary increase by the pay commission amounts every year, and the government has to fund this from their own pockets.

Deepak: So it’s called a Defined Benefit Plan, so your Defined Benefit Plan where the government actually doesn’t actually keep aside money to pay for your pension, but you are entitled to one. However, you can do something called a Defined Contribution Plan. Most of the US 401k plans, for instance, in the US, or many of the other countries, they actually create something called a defined contribution plan where only your contributions are defined in the sense you know how much is being contributed, you’re putting 10% of your income, your employer matches the 10% from their side, and that entire amount is then invested in something. And what you get out of it is dependent on whatever that amount grows to.

Deepak: So taking a rough calculation of 30 years, you have an 82 lakh corpus if you invest 50,000 a year, roughly 82 to 90, depending on whether you invest monthly or not. That will come at the end of 30 years more, that means 60 years. So you get a 82 to 90 lakh rupee corpus at the end, and this sounds like a good money, and I’m saying this is at a roughly 10% annualized return. So should be possible.

Aditya: You took 10% to be on a safer side.

Deepak: Yeah, I’m just taking a safer side, because you can’t invest all your money in equity. Remember you can only lose 75% of your money in equity. So, now what are you’ve done is you’ve saved some money in taxes all of these years, so money was exempt on entry. Your money is further exempt as it accumulates. But it is taxed at exit as an EET kind of a scheme, semi taxed on exit.

Deepak: So you’ve got an 82 lakh rupee corpus that you can now take, and you’re thinking 82 lakhs is a lot of money, I can now deploy that. You can’t deploy all of it. Your problem becomes you have to take 40% of this money. That’s about 32 lakhs and put it into an annuity. So out of 82, 32 goes into an annuity. The annuity is horrible in India. They’ve remained horrible. We wrote an article on the New Pension Scheme when it came out and even that time, the pension rates were horrible. They were about 6.5% to 7% at the time when you could get FDs at 9%.

Deepak: So the way you think about some of these things is just simply saying it’s now accumulating a corpus for my retirement. If that corpus is 82 lakhs, but I can only withdraw 50 of it for my own use and to do something, then it’s not really worth 82 lakhs. So if the 32 lakhs out of the 82 is got to be locked into a pension giving me 5%. But for me, I can actually earn 10% on the same corpus. Right?

Aditya: True.

Deepak: So for me, that 32 lakhs is actually worth 16 lakhs. In a way, if you think about it, if I can do 10% by just putting it in a mixture of equity and debt, and the annuity plans by these insurance providers give me only 5%, then roughly that corpus is worth half.

Aditya: True. It’s a forced annuity.

Deepak: It’s a forced annuity. So you actually have this system that says, “I’m forcing you into a product that is not as good, and also forcing you into savings. The forced saving part may actually be good for a lot of people, because if you’re saved corpus a year for 30 years and you get 82 lakhs at the end of it, it might actually be quite beneficial because it’s like, oh, 82 lakhs coming from nowhere. However, 82 lakhs of 30 years later money at 5% inflation is roughly equal to 80 lakhs to every four, so about 20 lakhs of today’s money.

Deepak: So today, if you were to retire and somebody gave you 20 lakhs, it’s nice to have, but it’s not going to change your life substantially. So it’s a small amount in comparison, but then a 50,000 rupees a year also in that context may not be a substantial of money. So, it’s like take a part of your long-term retirement savings and put it into some scheme like this because it gives you the tax advantages. But beyond this, it’s another thing, you say, no, 50,000 rupees, you get a tax advantage, maybe this employer contribution thing, which is more complicated, but assuming that you just saved 50,000, or you’d save 30% tax roughly, that’s about 15,000 rupees you save per year. If I did the same thing and I put it at 10% or let’s say I was really smart and I put it at 11% …

Aditya: Rather than putting in NPS?

Deepak: In NPS, I paid the tax on that 50,000 and I took the remaining 35 and put it at 11%. I would have at the end of 30 years only 70 lakhs. You’ve got 82 lakhs, you’re thinking, “82 lakhs is so much better than 70 lakhs, so why should I not put it in NPS?” But remember, I told you that the 32 lakhs out of the 82 was locked into a lower returning annuity, which means that the 32 lakhs actually worth only 16 lakhs. That means 50 lakhs of the corpus, which you can withdraw without any problems, plus what is 32 is actually 16, so it’s actually worth 66 to you. Whereas I generated a 1% extra return, I got 70. So actually it’s better for you to do that if you were able to generate that 1% extra per year.

Deepak: Now, it’s not necessarily true that you can, and many of you may not be able to at all because you’re not professional investors. So don’t really like, “Oh, I am going to take 50,000 every year and put it into something, and that’s something is going to give me 11%, or 1% more than NPS.” It’s difficult, because the NPS scheme that I’m sure you’re going to talk about returns that have come in the past, those returns have been roughly equal to how much the Nifty has given, which means that there has been no significant advantage of using the NPS so far. I’m talking about a marginal, I think the NIFTY over a five year period has returned 9.1%, whereas the NPS has probably returned a 9.2, the best NPS scheme. In equity, has returned about 9.2.

Deepak: So it’s not like the index itself has been beating the NPS itself, and so getting that 1% extra return is quite difficult. But if you were able to do that, then the 1% is really the differential between what you need to earn outside and what you need the NPS to return over a long period of time. So I think it’s a good product for people who cannot save on their own. So it’s a forced saving. It’s a bad product from the annuity perspective, I’m sure we’ll come to more on that. The forced annuity is a problem and it used to be a problem because when people got their money in retirement, they were actually going and spend all of it or get looted. Their friends and their relatives would borrow the money and then leave them penniless, the children sometimes.

Deepak: So this was the one way to force that a person cannot get access to his retirement money, and therefore the annuity pays out every month rather than one bulk lump sum. This works for a lot of people for whom this is their only retirement saving. But like I said, it may not be significant for you, therefore you might not want to use this as a retirement. Plus it forces you to retire at 60. I know most of us living in cities don’t want to retire at 60 they want to retire early say 55, at least get to a point where we say, “Listen, I want to move away, I want to go to a smaller town and a sleepy town, where this money will actually be of use and lie down there and not have to commute so much to work. But I can’t do that because this forces me to stay invested till 60.”

Aditya: True, true. Good that you brought out the liquidity point. I have a friend, I was talking to him about the NPS when I decided to do the podcast. He told me his story that twice he had accumulated a lump sum, he had invested in ELSs, and both the times, after three years he ended up actually spending that money. The first time he had accumulated a significant sum under ELSs, and at the maturity, he actually went and bought a second-hand car. And then, second time also, after three years he did something with that lump sum. So basically he was telling me, “The kind of person I am and the kind of lifestyle that I’m living, I need a product which locks me in badly.”

Aditya: For some people they want it. They actually like these kinds of products. He was like, “I will just put 5,000 per month and 60,000 a year. That doesn’t means a lot to me.” But then I asked him the same question that you just discussed with me, that, “What if you lose your job after 10 years?” So in NPS, if you stop contributing at any point of time, say you were contributing 5,000 a month, and then for some reason you stopped it for four months, in order you to continue it from the fifth month, first of all you’ll have to make up for the last four months which you didn’t pay. So if you want to start from the fifth month, you have to pay 25,000. So what if you lose your job? And what if you know you want to retire at 50?

Aditya: So I believe it depends on person to person. What is the importance of liquidity in your retirement portfolio? That is a call that every individual has to make himself.

Deepak: In fact, I believe strongly that people should use this as only a part of their overall retirement strategy, not a complete or 100% of it. So where you might require, if you’re looking at spending something like a lakh a month, like I have said, lakh a month of today’s money, only 20,000 a month will come from … not even 20,000, yeah about, we did a rough calculation, and if you’re 30 today and you spend say that 50,000 rupees a year, you will get a corpus, which you deploy it say 10%, you might get around a little bit less than 20,000 rupees per month as annuity, including the annuity portion. Outside the annuity you should apply 10%. You will get a roughly 20,000 rupees a month.

Deepak: So you’re spending a lakh month, you’re getting 20,000 a month of income. The remaining annuity has to come from some other source so you can think of it as I will put a little bit of money here and I will build it up toward retirement corpus, but it’s going to be only 15-20% of my overall retirement corpus, whereas the rest of it has to come from my other savings like ELSs, like targeted retirement savings concept. Some of it can be for saving through, say, an insurance plan or a bunch of other options around long-term retirement. I think the important thing is discipline, because the more disciplined you are about saving this money, the more likely it is that you make this over longer term.

Aditya: Okay. So a lot of people are asking about the risk. This is a market linked retirement plan, isn’t it? So can you tell us what is the risk here, whether it’s high, low, or moderate? Say me being young, I go ahead and when I create my NPS, I put equity as 75% and rest I put in, say, government bonds. So what is the level of risk here compared to, say, EPF?

Deepak: I think EPF has more or less guaranteed its returns, or sort of guaranteed its returns on a yearly basis. They have a large corpus. They also have new incoming funds. If that new incoming funds were to stop, could they continue to return this 8% a year every year? I don’t think so. If the government say, “Listen, you can choose between NPS and EPF from next year,” then the EPFO will start announcing 5% yields, because they can’t afford it. They can’t afford for a lot of people to stop putting in money. Remember all government employees already on NPS, so there’s no government employee contributing to EPFO, only private employees are and in the next few years I’m almost dead sure that the government will make it a choice between EPF0 and NPS. Whatever you choose, your employer can choose that and then continue to contribute on your behalf into that, into the equivalent scheme.

Deepak: If that happens, the EPF0 will not announce the 8% returns that it is announcing today. And therefore your EPF long-term returns will suffer. So I think the EPF is also risky from that angle, but it’s a little less risky because it has only 10% equity and a 15% equity at at most. Most of the rest is government bonds. The government bonds yields also falling.

Deepak: So you can have a risk in terms of falling yields, so your returns will fall as a percentage. You can have a risk on capital in NPS, because how much ever you invest will actually fall if the markets fall. So if you have a 10-year period of nothingness or low returns from year, the EFT’s at 12,000 today, and it can fall to, say, 10,000. If it falls to 10,000, you’ve immediately lost 20%. Of course it’s not big deal because you can’t touch that money anyhow, and you have to wait for another 20 or 30 years before you can actually touch the money.

Deepak: That 20 or 30 years is exactly a point at which the markets would or should have turned around. We have not seen a 10-year period in India where a person has actually lost principal, not considering inflation, but just lost principal per se. So in that context, historically we have not seen that, but Japan, which is actually seeing a declining population, has seen a 30-year period of the markets being lower than their highest point. So there is a precedent, but we don’t fit into that bill because Japan has a declining population, India has a growing population, so unlikely that India’s inflation goes to negative territory, unlikely that India sees a GDP dip because of this. And so therefore if GDP grows at about 5% or 6%, inflation’s about 3% or 4%, you’re going to get 9% growth no matter what. So I think roughly the risks in long-term equity investing are relatively smaller than we think. In fact, the risk is greater if we were to not invest and to keep the money in a fixed a deposit or a savings account, than to put it into long-term investments like the NPS.

Aditya: Okay. So I was looking at the NPS returns, five-year returns, it’s a Himalayan task because there are so many EMCs here, UTI, SBI, ICICI, HDFC, so I just took the best ones. So, as we know that in NPS we can invest under equities, corporate debt, and government bonds. So I just took the best performance, so when I looked at equities, HDFC pension fund under an NPS was the best performer of it, 9.21% five-year-returns, and then under the government one plans, LIC pension fund returned 10.58%, which is decent, and then corporate debt plan under that, the ICICI Prudential pension fund returned 9.39%. These are the five-year returns. So when I look at the returns, what do you think about the performance of NPS so far, say for the past five years?

Deepak: I think, though, from a perspective of adjusted returns with respect to their own mutual funds, we’ve seen HDFC showing us smaller dip. ICICI’s blue chip fund, perhaps has done better than ICSI’s own pension investment fund, which is strange because the pension funds actually have a much lower expense ratio than these. So it’s like if you use the same management team and you have lower expenses, shouldn’t you be showing higher returns?

Aditya: Exactly.

Deepak: But for some strange reason, that’s not happening. Also, I think the problem would be if their fund managers showed better returns in the pension fund, then who’s invest in the mutual funds? So that’s another problem that they might be having.

Deepak: But having said that, having said all of this, there is still doubt about why aren’t these pension products actually giving you even more superior returns than a plain vanilla? I mean, they are very low cost. I agree completely. To a certain extent, the index returns of 9.1 approximately versus the fund returns of 9.2, this is more or less NIFTI plus dividends. So it doesn’t really attract me as an investor to say, “Okay, this is substantially better,” but okay, as long as they continue to give me index returns, I’m still kind of happy.

Deepak: What is a problem in the longer term is of course the fact that about five years ago, if you had done the same analysis, you would have found that the mutual funds are actually beating by a substantial margin. Instead the performance has come down and one has to lo at why, and if those motivations for bringing the returns down are because they have ample money and they don’t really need to show this kind of performance any more to be able to get more money. And their management fees are very low so they don’t have any incentive to outperform.

Deepak: Then we might actually see worse performance going forward. So that, I think, is a risk that we are seeing over here from a performance angle. The other angle of course of this whole thing is the fact that you have a limited choice of fund managers. You would rather have a retirement account, in this retirement account going to buy this mutual fund and you could do that. You could buy a mutual fund, you could buy stocks. This is what the US does, and we talked about at some point in Capitalmind called the MERA which is My Empowered Retirement Account, that we said instead of using these pension plans and NPS kind of things, create a concept called retirement account, and in that retirement account buy any financial product. You just can’t take the money out. You could do the same thing, do annuities, do whatever, but you could have people invested in multiple financial products, including mutual funds, including ETFs, including a bunch of debt products as well, which have done better, and I think that might be a better solution to the performance problem and to some of the hindrances that depending on a few fund managers and their benevolence, because they’re actually charging you very low management fees.

Aditya: True. So we looked at the liquidity, risk, taxation and returns. I also wanted to talk about, it seems very funny to me, I want to talk about the annuity. See, when I look at the annuity under NPS, what the NPS is asking me is at the age of 60 you take 40% and you buy an annuity, but this is not a special annuity under NPS. If I have one crore or if I have X corpus, I can buy that annuity today itself. So under NPS I’m not getting anything special. I believe many people don’t know this.

Deepak: Yes. In fact, LIC and a bunch of insurance companies had annuity products forever. If you think about there’s something called an immediate annuity product, which, an annuity is simply something that pays you off on a yearly basis. So a house is and annuity if you put it out on rent. It pays you monthly and you have some costs of maintaining it, which is relatively small compared to the rent you’re getting. So the issue really with an annuity coming in from a financial services provider is they have after guarantee it for a certain number of years.

Deepak: Now, an annuity product is simply this, you give me so much money, I will give you 6000 rupees a month. So we calculated, and we did this in the office, we said, if you have a crore of rupees today, what are the annuity providers giving you? Of all your options of annuity with this, and something called annuity for life. Annuity for life means you get a certain amount per month untill you die, and then there’s nothing else.

Aditya: You bought the annuity?

Deepak: Yeah. You’ve paid on crore for this annuity and then you get 6000 a month for the rest of your life. So, it’s like I’ve paid one crore, but I’m getting only 6% per year back. Is that fair for a long period of time? So, if I looked at a 30-year government bond, what does it do? It does the same thing. You pay one crore for it. It pays you some money per year. But the government bond, the government bond is the safest instrument in India to invest in. The government bond pays 7 lakhs rupees per year. So 7% per year versus the annuity of one crore with an LIC or with a insurance company paying you only six lakhs. So you get one lakh more in a government bond.

Deepak: But what’s better? The kicker is after 30 years, you get your principal back. That means if you survive from 60 to 90, at 90 you will get your money back. If you don’t survive, your next of kin will get the money back. The equivalent annuity option is called an annuity with return of principle. And there, for one quarter you only five lakhs, so you’re getting 5% return on an annuity product, where the government one, the safest thing in the country is giving you seven. That means annuity product providers are ripping you off. There is no competition. They don’t care. And they’re giving you a guarantee for 30 year.

Deepak: What they could do is take your money, put it into a government bond, one crore they put into a government bond, they can get seven lakhs, they’ll pay you five, they’ll keep two as their profit for doing no work at all. Why is this allowed? I mean, you can take 10%, I understand. It’s for your job to be an insurance company, all that. But if you’re just doing a pass through product, I could buy that product. No. Why do I need you?

Aditya: And you keep ripping me of till I die.

Deepak: Yes, it’s just amazing that we allow … And I mentioned this when NPS came out and when it was allowed for non government employees. This was, I think, nearly 10 years of ago, but it still continues. And I had an argument with somebody and he told me, “Deepak, over time, the government employees will force the annuity providers to give better returns, because government is involved in this.” I said, “I’m not sure if this is your experience of the government, but my experience of the government is things don’t improve unless you fire everybody and hire a new team.

Aditya: And this is clearly a market linked product, so I don’t think that’s going to happen.

Deepak: Yeah. I just simply don’t see it. In fact insurance has gotten worse, if not better. So what was 8% risk-free at that time is now 7% risk-free. That time they used to get 6%, 6.5% in annuities, today you get 5% in annuities. So other differential rates, which have been risk-free, 8% has fallen to risk-free 7% today, so the differential is 1%, but the risk free and the annuity rates have fallen down from 6.5 to five, which is a one and a half. So they actually gotten worse in a way.

Deepak: So I think this is not such a great thing to have. This annuity protection product is not a good thing. Returns-wise, to put it this way, 40% of your money is earning 5%. And 60% of your money is earning 10%. Your blended return of this two is roughly 8%. So it’s like saying I am investing in a product that gives me a 20% lower return. Myself, I could do 10, but if I do it with this blend, I will get eight. It’s literally two percentage points lower, which is in rupee terms, if I could get 10 lakhs by listing my myself, I have to put it into NPS and I’ll get some money at 5%, some money at 10%, I’ll get only eight lakhs. So I’ll get 20% lesser money by going through the NPS over the long term with no liquidity, with no flexibility, I have to prove I want my own money back, I can’t retire earlier … And all of these things just make it a very rigid, inflexible product.

Deepak: For listeners of this podcast, you might actually wonder and say, “Listen, we’re telling you so many things, credit card, overdraft, don’t buy a house, all this financial chicanery that’s going on. Why?” If you understand all of that, does this NPS thing really make sense? I don’t think so, but yes, you could, for instance, talk to your maids and your household help and your drivers, they may not need the tax benefit. The forced saving is actually where it’s very useful for them, because for them it’ll be very nice to have this income when they are retired. And so the unfortunate problem is, the whole system requires so much paperwork that half of them won’t be able to even finish the first part of everything.

Aditya: And I believe for maids and drivers, again there’s a problem, if they lose their job, then they’re screwed. So that again, everything comes back to liquidity in this case, and in very simple terms, people should understand this, you are buying an annuity pension for yourself. The government is not giving you anything. You are taking your corpus and you’re buying an annuity from ICII or HDFC, and you’re buying your pension for yourself, isn’t it?

Deepak: Yeah. I mean, when you buy an external pension product like an HDFC pension plan or any of these other things, it’s a different proposition, because you can control a lot of parameters here. What you can’t control is taxation and can vary substantially over the next years. We see this 50,000 being extra support for him because it was not there in the early years. It was only the last two years. So if you thought about it for the last 10 years, and I put a tax benefit calculation on it, eight years out of those last 10 years, I didn’t have that benefit, only two years I did. Tomorrow it could go away, because the government decides that, “Listen, we don’t need all these extra things.”

Deepak: So the tax benefits are ephemeral. They may not last. Your annuity, how much of it is tax and how much of it is not tax, that can also be changed the over a period of time. The annuity rates can change, so some parts of this are not in your hands, but the amount invested at the age at which you can take out the money, those are some things I think you should have some level of control over, and pure-play pension plans from insurance companies are not very interesting. Mutual funds are better. They of course offer liquidity at all times. You may be able to do a mix. What we can suggest is put your money into a corpus and take a loan from that corpus. That is like an overdraft. That way, that corpus remains invested. You never take out because if you take it out you’ll have the loan instead. The loan, since the units are pledged against the loan, don’t take the loan at all. You just leave the loan as an empty account, but that forces you to continue to have to save.

Deepak: Maybe there will be tomorrow products that’ll allow people to do this automatically, but we do feel that in the long-term that forced saving is not the right way to present things. This is a nanny state, they tell you that you’re are not smart enough to manage your own money. That is a concept of the past and should not be applied to India’s future.

Aditya: Yeah, and one more thing Deepak. Taxation and withdrawal, when you withdraw the corpus, that 60% corpus is tax free, but whatever you earn as annuity will be added to your tax slab and will be taxed at your tax slab rate. Now, I was discussing his with a friend, now he casually told me, “So what, when I’ll be at 65 anyway, I’ll be in a very low tax slab.” I believe that’s a misnomer because if you are someone who spends say 50,000 a month today, and if you are making your retirement plan, keeping inflation into consideration, you would want to spend around 1.2 to 1.5 lakhs at 60. So at that time, you will be in a higher tax slab. And if you are at a very high tax slab and, say, that annuity pension, pension that you’re getting, will be added to your income and you will be taxed on that. Then I believe that’s also something that you should take into consideration.

Deepak: Absolutely. It’s terrible. Think about it, 5% returns and also taxed at 30% is like 3.5%. Why would you bother with this plan? Because it doesn’t suffice your entire pension needs. You don’t have a choice but to take it, and it’s treated as income. Now, what I would suggest to people is go invest in a mutual fund. By the time it is 30 years, you would have actually gotten so much inflation benefits out of the capital itself that drawing out a certain amount of money per month will actually tax it at maybe, if you take out 5000 rupees a month, or say 20,000 rupees a month, the taxation on that 20,000 rupees a month for you as long term capital gains will roughly be around between 150 and 200 rupees per month, less than 1%, because of long-term taxation benefits. Whereas if you get the same thing as an annuity, the 20,000 rupees at 30% taxation, assuming that your past the 10 lakh barrier, like I said, you’ll have other sources of income.

Deepak: If you’re past the 10 lakh income barrier after 60, you’re paying 30% on that. So you’ll pay 6000 rupees of tax on a 20,000 income in an annuity versus 200 rupees. 200 versus 6000 is a huge amount of money, 5800 rupees more in taxes to the government for your own money being forced to invested in an annuity that is subpar returns. So it’s almost like why are we doing this product? And also, by the way, there’s another bad thing. If you want to exit the NPS before, and by the way, if you don’t invest 6000 rupees a year, the NPS is kind of stopped or it’s considered-

Aditya: It becomes dormant.

Deepak: Dormant, dormant. So if you can’t invest for any reason whatsoever and you want to exit, you have to put 80% of your money into the annuity. It’s not, 20%, it’s not 40%. It’s 80%. So only 20 percent can be taken out.

Deepak: So you’re 55, you’ve lost a leg or something, and you’ve said, “Listen, I need money urgently. Give me some money. I’ve got one crore stored in my NPS plan.” “Here’s 20 lakhs. That’s all you can access.” The remaining 80 lakhs we used to buy an annuity, which we have said is a crappy product. So there is just no reason almost now, why? Because even the liquidity that’s offered, it’s offered at such a negative way that it’s almost like the government’s saying, “Listen, you better retire at 60, because we say so. The interest rates you will get are defined by us. You will get subpar interest rates compared to government bonds itself, and you go and buy that annuity. You have to go buy an annuity, I’ll force you.”

Deepak: And the other part, let’s say you move to the US. The US will consider India’s pension fund as a passively managed product. The US taxes you on gains made by the NPS product on a yearly basis. So if the NPS is a fantastic year, 20% it makes in one year, and you are a 50 lakh rupee corpus, that 20% adds up and makes you 10 lakh rupees, you’re going to pay income tax on that 10 lakhs in the US because the US doesn’t care whether your NPS product is an Indian retirement product. Really.

Deepak: So the way I’m looking at it this is considered equated to mutual funds in a way, and perhaps the rules and definitions may change over time, but you may actually end up paying tax on this income even though you can’t realize it, you can’t exit the product, you can’t stop the product. It will continue to gain these returns, and because of FATCA, your returns will be or can be reported directly to the US government if you become a US resident for taxation. And you will need to pay. I don’t know whether you will actually pay because a lot of people just say, “We’ll see what happens.” But a lot of that is where the problem is also, because you’ve got a locked-in a product that you can’t do anything about.

Deepak: The UK has now recently changed certain rules which allow a UK long-term retirement product to be moved into an Indian long-term product like the NPS, but not the NPS itself, because there are some requirements that we don’t fulfill as an NPS authority versus some private insurers do fulfill. So you can move it to an ICICI insurance, but not to NPS per se. But those rules will take time.

Deepak: So there are lots of other hidden consequences of investing in NPS, especially if your life is fluid, and whose life is not fluid? Nobody knows where they’re going to be in 10 years. You don’t know whether your job takes you elsewhere, and where elsewhere does and so locking yourself into long-term products within India when you don’t know the future of your overall things, I think is a little bit of folly. And financially speaking, it’s just great for income tax saving at a 50,000 rupee per year level.

Aditya: So, Deepak, before we end the podcast, I would want you to tell us who should subscribe to NPS and who should not subscribe to NPS?

Deepak: I think basically you want to save that tax on 50,000 rupees per year, you invested in NPS, It’s as good as that. Don’t invest any more, all right? Because the product, because of the 40% annuity requirement is a horrible exit product. What you see is not what you get. So what you might see is 82 lakhs, what it actually means to you is 66 lakhs. So it’s a what you see is not what you get kind of product.

Deepak: Also, the flexibility in the product is relatively low. You cannot go more than 75% equity, and I think you have to have a minimum of certain amount in government bonds. There is a certain flavor that makes it attractive, and that flavor is the forced saving. So it continues to make sure that you save on a regular basis. It’s very useful for people who would otherwise spend their money. So it’s useful for them to force them into a saving habit. However, they will never see any gratification untill they turn 60, so they will never appreciate what you say untill probably after you have died, because if I’m 45, I advise a 30-year-old, by the time he’s 60, I’m 75, I probably don’t remember what I’ve said to him in the first place.

Deepak: So it’s really a game where you have to be willing to play it for the really long term. If you have that mentality that the NPS is a good product, some of you can’t afford to not do it because your government employees, in which case what isn’t your choice is not something you should worry about. Just leave it and let it be, and it’s done as well as mutual fund so far. Even though you may get a lousy annuity, you at least, for all these years the government has paid in as much as you’ve paid, which is a great thing, and it gives you a slightly higher income in the longer term.

Aditya: Okay. So that’s it, Deepak. Amazing discussion. Thanks a lot for your time, and I hope the viewers enjoyed the podcast.

Deepak: And I really hope all of you had fun. We had a lot of questions on Twitter. I hope we answered a few of them, at least. The big thing that I want to say here is we’re always available, @astuteaditya on Twitter and deepakshenoy, we are at @CapitalMind_in, all on Twitter. We are capitalmind.in on the Web, capitalmindwealth.com to help us build the rest of your retirement corpus beyond the NPS. And of course, tweet to us, talk to us, we are always listening. Happy New Year, 2022, all of you.