Elders in your family would always have thumb rules to share. “Of the rupee you earn, keep at least 25 paise for a rainy day” or “Save first and then spend” and so on.
As you grow old, your needs change. There is a cycle that you follow in your lifetime: when young, you borrow; in your working years later, you save; when old, you need money to spend after retirement. As economies grow old, household savings tend to decline.
In India, you can structure your retirement ideas in many ways. There is a ‘defined benefit’ way and a ‘defined contribution’ way. The ‘defined benefit’ schemes are plans like Public Provident Fund or Employees’ Provident Fund, where the government guarantees a return on investment. If you are salaried, a percentage of your basic salary is deducted for Provident Fund and your employer contributes a similar sum.
In the United States, households use pension plans extensively under the ‘defined contribution’ scheme. Over the years, their contribution to these plans has enhanced the value of their wealth. Commonly called as 401 (k) plans, these investments are in a combination of equity and debt assets. About 55 million Americans have saved a staggering $5.2 trillion in 401 (k) plans over the years, according to the Investment Company Institute, an American association. That is twice the size of India’s Gross Domestic Product.
The ‘defined contribution’ scheme in India is the National Pension Scheme or NPS. It was launched in 2004 for government employees. In 2009, the government allowed private sector companies and ordinary people to open NPS accounts. The scheme will enable you to choose how you invest. You can determine your contribution. Tax benefits under Section 80C and many other subsections make it an attractive idea.
As of February 2019, NPS has 24 million subscribers (1.25 crore) with assets under management of close to Rs 3,00,000 crore.
Currently, just about 10 per cent of the money in the NPS is invested in equity assets. However, Morgan Stanley, a global bank, expects this to go up to 25 per cent in a decade. It attributes this to recent regulatory changes aimed at allowing more allocation to equities than before. Private sector company employees can allocate a maximum of 75 per cent of their pension into equities, while for public sector enterprises, it is 50 per cent. The global bank expects India’s young workforce to contribute more towards retirement savings over the next decade.
Why NPS matters
The defined contribution pension works well because returns are market-linked. India is a fast-growing economy. It is likely to stay that way due to the rising, young, consuming middle-class. Companies that ride on India’s economic growth are all set to grow business and profits. Indian planning his or her retirement must allocate more resources to equity assets. The NPS is a perfect way to go about it. It offers you a choice to use the active allocation option or auto allocation option. Most non-finance people struggle to determine factors like risk-appetite or future equity market trend. It is best to pick the auto option as funds are automatically allocated in aggressive (75 per cent equity and 25 per cent debt), moderate (50 per cent equity and debt) and conservative (25 per cent equity and 75 per cent debt) plans.
The NPS scheme could be that nudge you need to secure your finances. It will be a game-changer not only for you but also for Indian financial markets. More long-term pension money allows India to generate savings to fuel growth. At the same time, the defined contribution nature of the scheme means that it does not burden government finances. Other small savings schemes like Public Provident Fund, National Savings Certificate or Employee Provident Fund schemes have a guaranteed return. They put a burden on government finances.
Retirement is the last thing to think about when young. For a small contribution, individuals can nudge themselves to prosperity. It has happened in the US and European countries before. There is no reason why it cannot happen in India, considering the long-term growth potential of the economy.