NPS has encouraged individuals to embrace market-linked investment instruments: Rahul Bhagat

The National Pension System (NPS) completed 15 years for the general public. The National Pension System has changed significantly over time and is now more investor-friendly. The Pension Fund Regulatory and Development Authority (PFRDA) has added additional features and increased the scheme's flexibility. Additionally, it has made creating an NPS account simpler. Republic Business spoke to Rahul Bhagat, CEO, DSP Pension Fund on the success of NPS and more. Edited excerpts:

How is the National Pension System compared to the Old Pension System and how has the transition from old to the new has impacted government finances?

The NPS, established by the Government of India in 2004, represents a significant departure from the OPS model. Unlike the OPS, which operates as a defined benefit pension scheme, wherein retired employees receive a fixed pension amount based on their last drawn salary and years of service, the NPS functions as a contributory scheme tied to market performance. This means that NPS subscribers contribute towards their retirement income, with contributions coming from both employers and employees. Subscribers have the flexibility to select investment schemes and pension fund managers, ensuring greater autonomy over their pension savings. Moreover, NPS offers portability, allowing subscribers to transfer their accounts between employers and locations, and flexibility regarding investment choices and withdrawal options at retirement.

The shift from the OPS to the NPS has had a notable impact on government finances. Defined benefit schemes like the OPS place a significant strain on government resources due to the ever-increasing pension liability. Factors such as the expansion of the government workforce, extension of pension benefits to non-government offices, pay revisions, wage indexation, and increased life expectancy contribute to this escalating liability.

In contrast, defined contributory schemes like the NPS mitigate the government's pension liability. Contributions to the NPS are capped at a certain percentage of salary, providing more predictability and control over pension expenditures.

The transition from the OPS to the NPS has thus positively impacted government finances by curbing pension liabilities. To provide context, the pension expenditure of the Central Government has surged over the decades, growing at a staggering rate. By transitioning to the NPS, the government has been able to mitigate this exponential growth in pension costs.

For instance, data reveals that the Centre's pension bill skyrocketed over three decades, from Rs 2,138 crores in 1990-91 to Rs 190,886 crore in 2020-21. This exponential growth underscores the unsustainable trajectory of pension costs under the OPS model.

Furthermore, a study by the Reserve Bank of India in 2003 highlighted the precarious financial situation faced by some states, where committed expenditures on salaries, pensions, and interest payments exceeded total revenue receipts. The transition to the NPS helps alleviate these fiscal pressures by introducing greater fiscal discipline and sustainability to pension obligations.

What specific trends or changes have you observed in individual savings behaviour since the introduction of the NPS?

Since the inception of the National Pension System (NPS), there has been a noticeable shift in individual savings behaviour, particularly in the realm of retirement planning. One of the most prominent trends is the heightened focus on long-term financial security, spurred by the structured approach offered by NPS towards retirement savings.

The introduction of NPS has encouraged individuals to embrace market-linked investment instruments, marking a departure from traditional savings avenues. This shift reflects a growing awareness among savers about the potential benefits of investing in vehicles that offer higher returns over the long run. Moreover, the voluntary nature of NPS participation has empowered individuals to take greater control over their retirement savings journey. This flexibility has resonated well with savers seeking personalized approaches to financial planning.

Another significant trend is the leveraging of tax benefits associated with NPS contributions. The tax deductions provided under Sections 80CCD (2) and 80CCD(1B) of the Income Tax Act have incentivized individuals to channel their savings into NPS, thereby optimizing their tax liabilities while securing their financial futures.

Furthermore, the introduction of NPS has contributed to a broader dialogue around retirement planning and financial literacy. Individuals are now more inclined to educate themselves about various investment options and strategies, fostering a culture of informed decision-making.

Overall, the introduction of NPS has catalysed a shift towards proactive retirement planning, diversified investment portfolios, and increased financial literacy among individuals. These trends underscore the evolving landscape of savings behaviour in response to changing economic dynamics and the imperative of securing one's financial future.

How has the NPS contributed to fostering a culture of retirement planning and financial preparedness among individuals?

The National Pension System (NPS) has played a pivotal role in cultivating a culture of retirement planning and financial preparedness among individuals. By offering a structured platform for long-term savings, NPS has raised awareness about the importance of planning for retirement early in one's career. The customizable nature of NPS allows individuals to tailor their contributions and investment preferences according to their financial goals and risk tolerance, thereby empowering them to take proactive steps towards securing their financial future. Furthermore, the tax benefits associated with NPS contributions serve as a significant incentive for individuals to participate in the scheme, encouraging them to prioritize retirement savings as part of their overall financial strategy. Overall, NPS has not only provided individuals with a viable avenue for retirement planning but has also fostered a broader conversation around financial literacy and the need for prudent financial management.

Can you highlight any key demographic groups or segments that have shown significant uptake or engagement with the NPS? What factors do you attribute to this?

Several demographic groups have demonstrated significant uptake and engagement with the National Pension System (NPS). One notable segment comprises young professionals and millennials, who are increasingly recognizing the importance of early retirement planning and are leveraging NPS's flexibility to tailor their savings strategies. Additionally, self-employed individuals and those in the informal sector have shown interest in NPS due to its accessibility and potential for long-term wealth accumulation. Factors contributing to this uptake include the tax benefits offered by NPS, which appeal to individuals seeking to optimize their tax liabilities, as well as the growing awareness about retirement planning fostered by initiatives promoting financial literacy and awareness campaigns.

Have you noticed any notable shifts in investment preferences or risk appetites among NPS participants? If so, what do you attribute these changes to?

Yes, there have been noticeable shifts in investment preferences and risk appetites among NPS participants. Initially, there was a tendency towards conservative investment choices, with a preference for safer assets such as government securities. However, there has been a gradual evolution towards a more balanced approach, with participants increasingly allocating a portion of their NPS contributions to equity and corporate bonds to potentially enhance returns over the long term. This shift can be attributed to a growing understanding of the importance of diversification in investment portfolios and a willingness to accept moderate levels of risk in pursuit of higher yields. Additionally, the availability of various investment options within NPS and efforts to enhance financial literacy have contributed to participants' willingness to explore different asset classes and risk profiles.

How much equity exposure can an individual take in NPS and is there any cap to its?

In the National Pension System (NPS), the maximum equity exposure an individual can have depends on the choice of investment option. Under the "Auto Choice" option, which is the default option for NPS subscribers, equity exposure starts at a maximum of 75 per cent of the portfolio at a younger age and gradually decreases as the subscriber approaches retirement age, reaching a minimum of 15 per cent by the age of 50. Subscribers can also choose the "Active Choice" option, where they have full control over asset allocation, including equity exposure. However, there is a cap on equity exposure in the "Active Choice" option, which is currently set at 75 per cent of the contribution amount. This cap ensures that subscribers maintain a diversified portfolio and manage risk effectively, considering their individual risk tolerance and investment objectives.