India’s retirement landscape is undergoing a gradual transformation as private sector participation in the National Pension System (NPS) rises, annuity products evolve, and pension fund managers look beyond traditional asset classes.
In an interview with ET Wealth Online, Sriram Iyer, MD & CEO of HDFC Pension, discussed the growing role of NPS in retirement planning, its performance, the need for market-linked annuity products, and how recent regulatory changes could reshape pension investing in India.
Has private sector NPS growth matched government sector growth?
To share a quick perspective, we must understand that government sector NPS will continue to dominate overall assets under management because contributions are mandatory for government employees. Out of the nearly Rs 16-lakh-crore NPS corpus, around Rs. 12.5 lakh crore comes from government subscribers, while private sector assets account for roughly Rs. 3.5 lakh crore.
The government sector incremental AUM per year is Rs. 1.1-1.2 lakh crore, while for the private sector, it is in the region of Rs. 0.9-0.95 lakh crore.
Over the years, private sector adoption is improving steadily. However, it may take considerable time before private sector assets overtake government-sector contributions.
Are government employees now moving away from default pension fund managers?
The flexibility to switch pension fund managers and schemes has encouraged many government employees to move out of default options.
Around 10 lakh government subscribers have shifted to non-default options over the last 6 years since this was enabled for government employees. This shift has benefited private pension fund managers.
What impact did the new tax regime have on retirement savings?
The increase in employer contribution deduction limits, under the new tax regime has strengthened NPS’ relevance. Some key points to note are:
EPF contributions remain mandatory at 12% of basic salary, capped at Rs. 15,000 per month, translating into a mandatory contribution of Rs. 21,600 p.a. Majority of employers, however, deduct 12% of basic even above the Rs. 15,000 per month.
NPS offers an extra option for voluntary retirement savings that comes with tax benefits. People in the industry are pushing for more flexibility for employees to choose between EPF and NPS.
NPS is one of the few products that offer a tax break under the new regime, with employer contributions being deductible up to 14% of the basic salary as an employer contribution under Section 80CCD(2).
This makes NPS one of the few retirement savings tools that offer low cost, actively managed, flexible and tax-efficient accumulation combined with a tax break even under the new tax regime.
For the self-employed segment, voluntary self-contributions of up to Rs. 50,000 is eligible for deduction u/s 80ccd 1(b) under the old income tax regime.
Does NPS generally outperform EPF?
EPF and NPS serve different objectives and should not be directly compared. EPF mainly focuses on stability, predictable returns, and conservative retirement savings, making it a preferred option for risk-averse salaried employees seeking steady long-term wealth creation.
NPS, on the other hand, offers exposure to capital markets at a relatively low cost, allows participation in equities, provides greater investor control and transparency, and gives subscribers flexibility in choosing their asset allocation based on their risk appetite and retirement goals.
This product is geared to deliver a higher return because you could go up to 100% in equity under MSF, or you could go up to 75% in equity otherwise. And over long periods of time, equity is expected to deliver a double-digit return or close to double-digit return. over long periods of time.
Over longer periods, meaningful equity exposure through NPS has historically delivered returns higher than EPF rates.
Even with a 50:50 equity-debt allocation, NPS has delivered better long-term outcomes than EPF because equity exposure can generate double-digit returns over longer holding periods.
NPS returns vary by fund manager, asset mix, and market cycle, while EPF delivers a fixed coupon that is declared at the end of each financial year.
Why is EPF mandatory while NPS remains voluntary for private sector employees?
EPF was created primarily to ensure retirement security for employees, especially those working in smaller companies, to ensure social security by mandating a fixed contribution from both the employer and employee.
The EPFO framework acts as a regulatory safeguard because:
- Employers are legally required to contribute
- EPFO has enforcement authority
- It protects employees in the informal sectors
NPS came into existence to replace the Defined Benefit Pension scheme that existed for government employees.
For the non-government sector (both salaried and self-employed), it acts as a voluntary, low cost, market-linked retirement product.
Why should one invest in NPS and not in other market-linked products for retirement planning?
NPS and other market-linked instruments operate under different regulatory structures and seek to serve different financial goals that individuals may have.
NPS investments offer a calibrated exposure to the top 250 stocks based on market capitalisation. Initially, when it was launchedm the investment options for NPS fund managers were limited to just the top 50 stocks, but this now has expanded to 250 stocks. As the industry evolves, the range of investment options will continue to grow.
Regarding corporate bonds, fund managers mainly invest in AAA-rated names with some selective exposure to AA and AA+rated issues. The recent reforms now permit PFs to invest up to 5% of AUM in Invits/Reits and AIFs.
On the flip side, other market-linked instruments mainly aim for wealth creation and provide more flexibility with a broader investment universe and the ability to operate across different market capitalisations within the same scheme. They also offer products for the short to medium term.
While these products offer greater investment flexibility and liquidity, NPS provides a balanced exposure to equity and fixed income, aiming to achieve better risk-adjusted returns over the long term, ensuring retirement security to its subscribers.
With active choice (where individual investors can create their asset allocation across E, C and G) and schemes within the MSF (Multi Scheme Framework) setup, there are plenty of options for sophisticated investors.
At the same time, NPS also offers life-stage-based options that automatically reduce equity exposure as individuals approach retirement, perfect for those who prefer a hands-off approach to their investments.
Are current annuity rates sufficient to beat inflation?
One must know that annuity rates are typically linked to long-term government bond yields because insurers invest in long-duration government securities to hedge their liability and thereby meet future payout obligations over the life of the customer.
While current annuity rates of around 6.5-7% p.a. (for Joint life option with return of purchase price) may not on its own offer protection from inflation over the consumption phase (post retirement), it should form a core building block given the guaranteed cash flows that it offers through the customers lifetime and also acts as a succession planning tool transmitting the corpus to the next of kin without any tax leakage.
It is important to have an array of products in the retirement portfolio, a combination of annuities, fixed income products and some exposure to equity through hybrid investments to generate inflation-beating returns.
Annuities should form a key component of a broader retirement strategy alongside market-linked instruments, Senior Citizen fixed income schemes, and other financial investment instruments.
Does India need more market-linked annuity products?
Definitely! There is a huge need to develop more market-linked and variable annuity products in India. Traditional annuities offer certainty but may not sufficiently protect against inflation.
Some pointers to keep in mind are:
Variable annuity products have been available in developed markets and have found a decent acceptance since they offer downside protection and offer some upside when markets are on an upward trajectory.
Some Indian insurers have already introduced products offering:
- A minimum guaranteed return
- Additional participation linked to Nifty/market performance
Such products can potentially balance guaranteed income with inflation protection.
Why did the alternate investment structure in NPS change?
The earlier structure was impractical for illiquid investments such as Alternative Investment Funds (AIFs). Since subscribers could switch freely between schemes, pension fund managers found it challenging to allocate to Alternate assets, which typically have longer holding periods without any form of liquidity in the interim.
To address this, the regulator integrated alternative investments within broader equity and debt categories instead of maintaining a separate allocation bucket.
The revised structure has opened the AIF universe for PFs, offering participation in the unlisted equity space, offering potentially higher returns, albeit at higher risk.
How will the revised alternative investment framework impact NPS investors?
Under the revised structure, pension fund managers can now invest in alternative assets more efficiently without facing immediate liquidity pressure when subscribers make a change in asset allocation or move across fund managers.
By embedding such investments within larger equity and debt pools, fund managers now have greater room to manage alternative fund exposure without liquidity constraints. This could help NPS investors benefit from broader diversification opportunities over time.
