National Pension System: Should you invest in Tier II account?
BENGALURU: The National Pension System (NPS) plays a significant role in investors’ retirement planning. Investors can open a pension account under NPS right from 18 years to 70 years.
Last week, we wrote about NPS as an investment option, and this week, we will explain to you about two types of NPS accounts - Tier I and II accounts. We would also try to explain which is a better option to build your retirement corpus -- NPS or Mutual Funds.
Tier I and Tier II accounts
If you open the Tier I account, you get a Permanent Retirement Account Number (PRAN), and your investment is locked-in until you reach 60 years. You can open the account with R500 and minimum subsequent contribution is R1,000. In case if you wish to withdraw, 60% of the corpus on retirement can be withdrawn.
While Tier I is for retirement planning, Tier II account is a voluntary savings account.
Investors should allocate to Tier II accounts in a structured and methodical manner so that optimum value may be derived from NPS, says Nilanjan Dey, Director, Wishlist Capital.
“Tier II is a safe and transparent structure that can potentially deliver robust performance, subject to risks. Investors can gain from its inherent advantages -- government support, long-term potential, regulatory compliance. Purely from a practical point of view, Tier II can take ordinary investors closer to their retirement goals,” he adds.
He advises investors, especially the retirement-minded ones, to systematically invest in Tier II and complete the process they initiated with Tier I. According to him, Tier I and Tier II will supplement one another.
If investors wish to open an NPS Tier IIaccount, they must be a Tier I member and this account does not have a lock-in period and you can withdraw funds at any time.
Like in Tier I, the Tier II account also offers multiple investment portfolios – Scheme E (up to 50% exposure to Equity), Scheme G (up to 100% investment in G-secs) and Scheme C (up to 100% investment in corporate bonds). Now, you can also opt for Tier II Tax Saver account that comes with a three-year lock-in period.
“We need to remember that NPS as a product has been made specifically for retirement. So even though NPS Tier II is not necessary for retirement savings, you can still use it for debt allocation of other long-term goals. If you look at the long-term returns of schemes G and C, it does seem like a good alternative to debt funds (though returns in the last 1-2 years have moderated substantially),” says Dev Ashish, founder, Stable Investor.
Though many investors treat Tier II as an alternative to a savings account and bank FDs, that assumption is full of risks which may not seem obvious at first, says Ashish.
Tier II G & C schemes and NPS as a product are managed as a long-term instrument. “The money invested in schemes G and C of Tier II also goes into medium-long-term government and corporate bonds. There is obvious interest rate risk even if credit risk is limited. For someone looking to park the money in Tier II for the short-term, it means they are knowingly or unknowingly taking interest rate risk. This should be kept in mind and make sure you check the maturity and tenure profiles of the underlying bonds in portfolios of schemes G & C,” the financial advisor says.
If you have a short-term goal that you want to save money for then you already have simple FDs and a range of shorter tenured debt fund categories that are better suited. Investors can go for those depending on the nature and criticality of your goal and your personal risk appetite.
NPS vs Mutual funds
“As for the long-term goals, where you should ideally have a higher allocation to equity, NPS Tier II doesn’t make much of a case as here too, you have better and more options available in the equity mutual funds. Depending on your risk appetite, you can vary your investments within equity but between market caps, segments, sectors and strategies. Something that is not possible with scheme E of NPS,” Ashish explains.
There is no right or wrong product when it comes to NPS and Mutual funds, says Nitin Rao, Head of Products and Proposition, at Epsilon Money Mart. “Investors should pick an investment option based on their risk profile and investment objective. If an investor is looking for capital appreciation, then equity is the right fit. NPS is ideal for investors if he or she is looking to build a retirement corpus through asset allocation process,” he adds.
Nilanjan Dey believes that NPS may well score over other forms of investments (including MFs).
“If investors are here for the longer haul, they might well be in Tier II, and not in MF alone,” he adds. Dey is referring to equity - an asset class that may be leveraged to secure superior long-term gains.
No lock-in period
If investors wish to open an NPS Tier II account, they must be a Tier I member this account does not have a lock-in period and you can withdraw funds at any time. Investors should allocate to Tier II accounts in a structured and methodical manner so that optimum value may be derived from NPS. Tier I and II will supplement one another.
Performance of different schemes of NPS Tier II accounts
