NPS Tier 2 – Alternative to Savings Account, FDs or Debt Mutual Funds?

Whether we can use NPS Tier 2 account as an alternative to savings account, FDs or debt mutual funds? This is the question recently asked by a blog reader. His reasons are very much valid. Let us see whether it is suitable or not.

The reason for his question is valid. Hence, thought to discuss more on this in a separate post.

What is NPS Tier 2 Account?

NPS is the retirement product also called as Defined Contributory product. There is no defined benefit. You contribute to this product (in the case of Govt. employees, your employer too). Your retirement corpus depends on the amount you contribute and the income generated from this contribution.

Such accumulated retirement corpus can be withdrawn once you retire and can be utilized to buy an annuity (pension product). You are allowed to withdraw part of it before you can buy an annuity. We can explain the same as below.

This is regulated by Government body called as Pension Fund Regulatory Development Authority (PFRDA). PFRDA appointed fund managers, who manage your fund. There are various options of investment to choose based on your risk appetite.

An individual with the age limit of minimum 18 years and maximum 60 years of age can join NPS. Now, NRIs are also allowed to open NPS account.

Once you open NPS account, then you will be allowed a PRAN (Permanent Retirement Account Number), a 12 digit unique number. A minimum of Rs.6,000 can be invested and there is no maximum limit. But minimum single contribution is Rs.500 for Tier 1 and for Tier 2 it is Rs.1,000.

As of now, there are 7 fund managers, who managing the overall NPS amount. They are as below.

1. HDFC Pension Management Company
2. LIC Pension Fund
3. ICICI Prudential Pension Fund
4. Kotak Mahindra Pension Fund
5. Reliance Pension Fund
6. SBI Pension Fund
7. UTI Retirement Solutions

The subscriber has been given the flexibility to choose any one out of the available Fund Managers and also the percentage in which the selected PFM will invest the funds.

The three asset classes are

• E = Equity
• C = Corporate bonds  (invest in investments in fixed income instruments other than Government securities.)
• G = Government Securities (investments in Government securities)

As of now, there are 7 insurance companies, who provides you pension products for NPS. They are as below.

1. Life Insurance Corporation of India (LIC)
2. SBI Life Insurance
3. ICICI Prudential Life Insurance
4. Bajaj Allianz Life Insurance
5. Star-Daichi Life Insurance
6. Reliance Life Insurance
7. HDFC Standard Life Insurance

There are two types of accounts in NPS. One is Tier 1 and the second one is Tier 2. I tried to explain the both the account features in below image.

Note-

-As per recent PFRDA circular dated 8th August, 2016, the minimum contribution in Tier 1 Account is now reduced to Rs.1,000 a year. There will be no minimum investment limit for Tier 2 account (Earlier, it was Rs.250). Also you no need to maintain the minimum balance in Tier 2 account (Earlier, it was Rs.2,ooo).

-From Budget 2016, the 40% withdrawal at the time of your retirement from NPS will be tax-free. Rest 60% of the corpus will be treated taxable income as per old rules. Hope this above table cleared your doubts.

Additional features of NPS Tier 2 account

• No additional CRA (Central Record Keeping) 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 a 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.
• Bank details will be mandatory for opening a Tier II account.
• No separate KYC for opening Tier II account will be required; the only requirement is a pre-existing Tier I account.

Hope you now got a clarity on what is NPS Tier 2 account.

Let us consider whether NPS Tier 2 can be considered as an alternative for Savings Account, Bank FDs or Debt Mutual Funds.

# Liquidity of NPS Tier 2-

You can withdraw the money from NPS Tier 2 account as and when you need. Hence, liquidity is not an issue. Therefore, we may say as its liquid product like Bank FDs or Debt Mutual Funds. However, we may not say as liquid as your savings account. Because redemption may take some time in NPS Tier 2 (not sure of how many days it takes).

# Returns of NPS Tier 2

As this post is meant to find out the answer of whether NPS Tier 2 can be an alternative solution to the savings account, Bank FDs or Debt Funds, I will concentrate on Asset Class C (investments in fixed income instruments other than Government securities) and G (investments in Government securities). Below is the returns from these asset classes of NPS Tier 2.

First look at the returns of Asset class C (investments in fixed income instruments other than Government securities).

You notice that the returns are much higher than what you get from a typical savings account, Bank FDs, and Debt Funds. Returns are as on 29th July, 2016.

Similarly, let us look at the returns of Asset Class G (investments in Government securities).

Here also you notice that returns are best when you compare to Savings Account, Bank FDs or Debt Mutual Funds. Returns are as on 29th July, 2016.

# Volatility of NPS Tier 2 Returns

This is the major point which many of us forget to consider. NPS is a product meant for long term goal called retirement. However, with fancy returns and liquidity as an alternative plus point, we are comparing NPS Tier 2 with Savings Account, Bank FDs or Debt Mutual Funds (Debt Mutual Funds means my assumption is only for Liquid Funds, Ultra Short Term Funds, and Short Term Funds).

NPS Asset Class C and Asset Class G holding long term maturity bonds and papers. Therefore, the interest risk is always there. Check the maturity date of the underlying bonds of Asset Class C and Asset Class G.

First, let us check the underlying bonds of Asset Class C.

Here, I concentrated only on Top 5 holdings. You notice that maturity periods of corporate bonds are of long-term in nature.

Now, let us understand the holdings of Asset Class G.

Notice the maturity periods of G-Sec bonds and the weightage in the holding.

In the bond market, higher the maturity period greater would be the interest rate risk. Hence, never try to compare the interest rate risk of savings account, Bank FDs or Debt Mutual Funds ((Debt Mutual Funds means my assumption is only for Liquid Funds, Ultra Short Term Funds, and Short Term Funds) with NPS Tier 2.

# Taxation of NPS Tier 2-

For your surprise, there is no clarity on NPS Tier 2 withdrawal taxation. We all know that if you invest in NPS Tier 2, then you will not enjoy any tax benefits. However, there is no clarity on withdrawal taxation. Because withdrawal rules under Sec.10 give you correct indications that tax benefits during withdrawals are only for NPS Tier 1.

“(12A) any payment from the National Pension System Trust to an employee on closure of his account or on his opting out of the pension scheme referred to in section 80CCD, to the extent it does not exceed forty per cent of the total amount payable to him at the time of such closure or his opting out of the scheme”.

Few argue that it will be taxed like debt and equity mutual funds. It means, if your holding period is less than 3 years then it will be taxed as per your tax slab. If your holding period is more than 3 years, then at 20% with indexation benefit. However, there is no clarity either from PFRDA or CBDT.

In such a situation, it is hard to believe the taxation part and blindly invest by comparing with Savings Account, Bank FDs or Debt Mutual Funds.

As of now, it is the purely subjective matter which different people have different views.

# Expenses NPS of Tier 2-

NPS is considered as one of the lowest charging product. But it does not mean that it is free. If you invest through POPs, then you have to bear the cost of 0.25% of the contribution (Min. Rs 20 Max. Rs 25000). However, if you invest through eNPS (which is online direct mode), the charges are 0.05% of the transaction, subject to the minimum of Rs.5 and maximum of Rs.5,000 per transaction.

Considering all these costs of the transaction, it is not worth for investing in a small amount. If your investable amount is high, then it may be worth to consider.

Wher we consider NPS Tier 2 as an alternative to Savings Account, Bank FDs or Debt Mutual Funds?

In my view NO. Considering liquidity and the returns, if one decided to invest in NPS Tier 2 account, then it is considered as a blind investment. Conclusions are as below.

1. NPS Tier 2 may be the liquid product but not as liquid as your savings bank account or liquid funds.
2. Returns may be eye-catching. But you can’t deny risks.
3. NPS is meant for the long-term financial goal of retirement. Hence, NPS holds long-term maturity debt papers in Asset C and Asset G. Hence, the risk of interest rate volatility is high. Therefore, it is not worth to consider as an alternative for Savings Account, Liquid Funds, Ultra Short Term Debt Fund, Short Term Debt Fund or short term FDs.
4. There is ambiguity regarding taxation of NPS Tier 2 withdrawal. Hence, the sword of confusion always be on your head.
5. You need to consider the transaction cost also before jumping into NPS Tier 2 to park your emergency fund or any short term goal fund.