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December 16, 2016

NPS and How to Maximize Asset Allocation

asset allocationsThe National Pension System (NPS), introduced by the Indian government in the year 2004 is mandatory for all government employees except the armed forces personnel.This scheme was extended to the private sector in 2009. It is a portable retirement savings account, which can be efficiently used to provide financial security to senior’s through a pension income.

This scheme offers benefits such as tax deduction of INR 1.5 lacs under section 80CCD (1) of the Income Tax Act (IT). An additional tax deduction of up to INR 50,000 under section 80CCD (1B) of the IT Act is also available. Subscribers also have the flexibility of choosing asset allocation between equity, fixed income instruments, and government securities.

NPS is known as a defined contribution scheme because returns under this scheme are market driven. The NPS interest rate changes based on the performance of the market and the asset allocation chosen by the subscribers.

Asset allocation under NPS

Funds invested in NPS can be invested into 3 types of assets namely equity, corporate bonds, and government securities. There are two investment options available under this plan;auto choice and active choice.

Under auto choice, funds are automatically allocated in a pre-determined proportion based on the age of the subscriber. For example for subscribers under the age of 35 years, funds are allocated as follows: 50% in equity and balance amongst corporate bonds and government securities. As the subscribers age, the exposure to equity is reduced and investment in government securities increase.

Under the active choice option, subscribers may choose the asset allocation as per their preferences. The NPS scheme allows subscribers to allot upto 50% of their contributions to equity. Subscribers may use this option to their advantage to maximize the potential returns. For instance, an Investor approaching retirement age (between 45 to 50 years) may opt for a conservative allocation by investing a substantial portion of his funds in government securities.

Maturity and Annuities

The primary objective of NPS is to create a corpus that is used to buy an annuity plan for regular income during the post-retirement years. At the age of 60, the subscriber may with draw a maximum of 60% of the funds as a lump sum. The remaining corpus is used to purchase an annuity that will provide regular income to the subscriber.

Subscribers may choose not to withdraw any funds and use 100% of the corpus to buy an annuity. However, if the corpus at the time of exit from NPS at the age of 60 years is less than 2 lacs, the subscribers may withdraw the entire amount in lump sum. To determine the potential income, individuals may use an online pension plan calculator.

Joining NPS

In order to join the NPS scheme, the subscribers must submit the NPS application form, along with Know Your Customer documents to a Point of Presence (POP). Upon submitting the documents, the subscribers are issued with a Permanent Retirement Account Number (PRAN), T-Pin and I-Pin. Subscribers are informed of their PRAN application status via email and SMS. They may also know their application status by contacting the issuing bank. However, the subscribers may get in touch with the Central Record Keeping Agency (CRA) which manages the issuance of PRAN, in case the PRAN card is not received.

NPS is focused on offering financial security to the individuals after their retirement. The flexibility available for investors to allocate their contributions in different asset classes allows them to maximize the returns and accumulate a higher post-retirement income.

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February 24, 2012

Historic Interest Rates Good For Mortgages Bad For Pensions

Interest rates continue to fall and have entered all-time low territory. So why is there is no jubilation and lines of people at the banks trying to buy homes or refinance existing loans?

Low Interest Rates Fail To Stimulate Housing

Despite the cheap money, it is still challenging for many homeowners who are underwater on their existing loans and who may have other credit blemishes due to job loss, job change or inconsistent income. Certainly, there are some people who are able to take advantage of the cheap money but not the massive numbers that we saw in boom years long past. Government stimulated initiatives continue to roll out which incentivize banks to refinance struggling homeowners into lower rate loans.

Retirees Suffer From Prolonged Low Interest Rates

There is a scary flip side to the interest rate environment. Pension funds which rely heavily on bonds and other interest rate based securities to generate sufficient invest returns to pay retirees are suddenly not making enough to cover their obligations. Compound that with retirees trying to living off their life savings which barely generates 1% return and you can begin to see the potential epidemic.

Perfect Storm Endangers Pension Funding

The longer we endure this type of interest rate environment, the wider the funding gap of pension plans. This will put pressure on stocks if companies are forced to close pension gaps with current earnings. When you also consider that 1) our massive Baby Boomer generation is retiring right now and 2) the longer life expectancies of Americans due to better health care, you can see how there are several layers creating a perfect storm of massive pension underfundings.

Good News, Bad News Economy

Most subjects dealing with the economy and finances have a pro and con. Just like when you buy and sell stocks, there is a winner and a loser. With economics, there are two sides to every coin. For example, low interest rates help homebuyers but hurt people living on fixed incomes. When interest rates rise, many investors will benefit, but people with adjustable rates on credit cards and other debt will have to pay more interest. Even if you do not understand all the details, as a consumer, it is wise to stay aware that good news in one sector means the potential for bad news elsewhere.

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