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With a plethora of long-term retirement products available across all asset classes, employees today are spoiled for choice. However, the benefits of employer-sponsored pension plans like the Contingency Fund (PF) and the National Pension System (NPS) are often overlooked by employees.

The Provident Fund (PF) and the National Pension Scheme (NPS) are both contributory and easier to understand.

Within the framework of the statutory scheme of the Provident Fund, the employer and the employee contribute 12 per cent of the basic salary and benefits. While the FP plan becomes voluntary if the applicable salary is over Rs 15,000 per month, surveys from Aon Benefits indicate that more than 75 percent of organizations contribute to the PF on the full base salary and do not cap at legal salary.

The contributions are invested and credited with interest each year by the government body – EPFO. At retirement, the employee receives the accumulations in the form of capital.

The NPS scheme is administered by the regulator – PFRDA.

The employer can contribute up to a tax-deductible limit of 10 percent of base salary to an employee’s NPS account. Aon surveys indicate that more than 50 percent of large organizations have already implemented NPS as a flexible benefits option within the compensation structure.

Contributions are invested in all asset classes and returns are linked to the market without any guarantee. Upon retirement, the employee can recover up to 60 percent of the accumulated corpus as a lump sum and the balance is converted into a pension. Unlike the contingency fund, the employee can choose the fund manager and asset allocation based on their risk appetite.

Fiscal advantages

The government has ensured that sufficient tax benefits are available to make both regimes attractive, as outlined below:

Fiscal advantages Contingency fund National pension system (SNP)
Employer contributions 12% of base salary tax-free 10% of base salary tax-free
Employee contribution 12% of base salary tax deductible up to Rs 150,000 per year under the 80C limit INR 50,000 per year tax deductible under article 80 CCD (1B)
Interest accrued pa Tax free Tax free
Retirement withdrawal 100% tax-free flat rate 60% of the lump sum tax free but Pensions on the balance 40% taxable

However, recent tax changes have capped total employer contributions for all pension plans such as PF and NPS at INR 7.5 lakhs per year, above which contributions and accrued interest would be taxable in the hands. of the employee.

Likewise, interest income on voluntary employee contributions to the Contingency Fund exceeding Rs 2.50 lakh per year will be taxable. These measures were put in place to ensure the parity of the tax savings between all categories of employees and to ensure that senior executives with significant salary savings do not contribute excessive amounts in an unlimited way to save money. tax.

Diversification strategy

NPS offers a great diversification option for those with a risk appetite investing in stocks. The NPS offers employees the choice of investing up to 75% of contributions in stocks while this is limited to 5% to 15% only under the Contingency Fund. Therefore, a recommended diversification strategy for an employee would be to invest a larger portion of NPS contributions in corporate stocks and bonds, while provident funds continue to be invested in safer assets like government and government bonds.

Return

The contingency fund is invested by the government body – EPFO ​​primarily in bonds and has provided an average interest return of 8.50% to 8.75% in recent years. This is commendable because it has been achieved even during low interest rate cycles like the one we are currently experiencing.

On the other hand, the returns of the NPS would differ from individual to individual depending on the asset allocation and the performance of the fund manager. achieved over a longer period even surpasses the yields of the Contingency Fund by a comfortable margin.

Return history Average interest loans from the Provident Fund NPS Tier 1 average of returns obtained by fund managers assuming equal investment in all asset classes
Average return over 3 years 8.55% pa 11.56% per year
Average return over 5 years 8.57% per year 10.37% per year
Average return over 10 years 8.59% per year 11.22% per year

Yields under NPS would be even higher for some fund managers with larger equity investments since inception.

The above returns from both plans are tax free and outperform other popular products such as public provident funds, national savings plans, and fixed deposits.

Projections

High-level calculations suggest that if an employee starts early and contributes to both the Contingency Fund and the NPS throughout his or her working life, under certain assumptions he / she would be able to replace much of his / her last. salary received at retirement from pension income. from the cumulative effects of the two regimes.

For example, a young graduate who enters employment at age 23 and contributes to the PF and NPS plans at 24% and 10% of the full base salary monthly throughout his active service without withdrawals, could receive retirement income at retirement which could be as high as 40 percent of the last salary drawn. This projection assumes that the salary increases on average by 7% per year and that the PF and NPS contributions yield 7% and 8% per year during the 37-year term of service.

This indicates the power of capitalization. Therefore, employees should be discouraged from making in-service withdrawals from their pension plans.

Conclusion

While there are several long-term financial products available in the market, which can be confusing, employees might choose a simpler strategy of maximizing their investments in employer-sponsored plans such as the Contingency Fund. and the NPS, which are well diversified and also offer tax incentives.

While financial planning involves decision making at the individual level, employers can also play a role in implementing the additional NPS plan at the company level and facilitating the financial education required for employees to save for the future. of a comfortable retirement.

The author, Vishal Grover, is Practice Leader, Retirement and Investment Solutions at Aon India. Opinions expressed are personal

First publication: STI


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