In my sessions over the last two months, I have heard employees lament about the new rule in the Employee Provident Fund, which restricts tax-free interest to contribution of up to Rs 2.5 lakh per year. As per government data, only 0.27% of the subscribers would get affected by this rule. Of course, those contributing to Voluntary Provident Fund (VPF) are very unhappy with the rule, as it means they can no longer expect 8.5% tax-free income. But given that the small savings scheme, as the name suggests, are meant for small savings and the rate of 8.5% is not tenable, it is a move in the right direction.
It is time for Indian investors to start getting used to market-linked returns, whether it is EPF or small savings schemes like PPF, SCSS, NSC, etc. The government’s move to reduce PPF rates on April 1, 2021 was met with consternation from public on where people will invest and how will they manage with lower interest. People seem to be more upset with the thought of not having these schemes or the schemes not giving high returns. For years, I have been propagating VPF & PPF and the common pushback was the long-term lock-in in these schemes. Individuals are happy to get loans at lower rates but do not want interest rates on investment schemes dropped!
To save for retirement, the other options are NPS, PPF and pension plans from insurance companies. The PPF rates will be rationalised in the future and it may be considered by conservative investors. Of late, pension plans and capital guaranteed insurance plans are being advertised. Some of the capital guaranteed plans are promising 8% on the sum assured. What investors need to note is that the 8% is paid after a deferred period, reducing the actual returns to 3-4% p.a., thus not beating inflation. Pension is also taxable in India. All these factors make pension plans from insurance companies unattractive.
And this is why the national pension scheme (NPS) is the best substitute to VPF. You have a choice of various options like corporate bonds, government bonds or stocks and you can decide the percentage allocation to various asset classes. And if you find it difficult to do so, there is an auto choice which allocates between equity and debt based on the risk you want to take. Investors tend to look at NPS as an equity investment. But there are debt-based choices too. The conservative life cycle fund in the auto choice has a maximum 25% allocation to equity. The auto choice provides an easy way to rebalance the asset allocation as you grow older. Further, there is no tax implication on the rebalancing.
The long term returns of the corporate bond and government bond options are 10%+ p.a. for the last 7 to 10 years. Clearly, these schemes benefitted with the fall in interest rates. But with interest rates moving up, the returns would be more in line with debt mutual funds.
With debt funds, investors may not remain disciplined and hence NPS is preferred over debt funds. Furthur, up to 25% equity allocation should push up overall returns in the long term. Another point in favour of NPS is low expense ratios. The rule of commuting 40% to a pension scheme at retirement is a drawback in NPS. However, investors will have a higher amount at retirement than with any of the other options and hence this disadvantage can be overlooked.
Investors have to condition themselves to a new order of market-linked returns and use the right schemes to plan for their financial goals. NPS is one such scheme.