Simplify the NPS

In yet another bid to rationalise the National Pension System (NPS), the Pension Fund Regulatory and Development Authority (PFRDA) proposed tweaks to it last week. There are three material changes. Private sector subscribers will henceforth be allowed to opt for a maximum equity exposure of 75 per cent in the Active choice instead of 50 per cent. They will be able to partly withdraw from the scheme for acquiring qualifications or starting a business. The funds can now invest in single-A rated corporate bonds with a 10 per cent cap. All this make the scheme more attractive to subscribers. But the frequent chopping and changing of NPS rules and the addition of many bells and whistles to its original features, are detracting from the scheme’s strong performance, and rendering it too complex for lay investors.

Raising the maximum permissible equity allocation for subscribers under the Active choice to 75 per cent is a wise move, given that the earlier 50 per cent cap was set too low for young workers who dominate the NPS subscriber base. A retirement vehicle is primarily intended to generate inflation-beating returns over the long run. Given that inflation in India tends to be structurally high and that long-term returns from equities are moderating (the 20-year Sensex return is 11.3 per cent), a higher equity allocation gives the subscriber a better shot at hitting his targeted corpus. Similarly, allowing NPS managers to invest in lower-rated bonds can pep up returns too. While these two measures are unambiguously positive for NPS investors, successive relaxations in premature withdrawal rules may not be. The NPS was originally designed with a long lock-in period mainly due to the adverse experience with EPF, where frequent ‘advances’ left a majority of subscribers with a depleted retirement kitty. But after several tweaks to the rules in the past year, NPS now allows investors to partly withdraw after three years, scarcely enough time for a market-linked vehicle to deliver results. If the objective was to grant investors flexibility, that is not fully met either, because of the bureaucratic list of end-use conditions that the investor must meet, to apply for withdrawal.

Overall, simple design and ultra-low cost were the stand-out features of the NPS in its initial years. But, today, a retail investor wishing to open an NPS account has to choose between two kinds of accounts, two modes of allocation, three life-cycle funds, four asset classes and eight fund managers. Apart from the management fee, he may shell out nine other types of charges for transactions. Simplifying the NPS architecture, sweeping all costs under one umbrella and doing away with the compulsory annuitisation component of 40 per cent at maturity may be the best way to ensure that the scheme benefits from its good performance record, and gains further traction with savers.

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