The Pension Fund Regulatory Development Authority (PFRDA) board has cleared a long-standing proposal to raise the maximum equity limit under the NPS Active Choice Plan from 50% to 75%. This brings Active Choice on par with the NPS – Aggressive Lifecycle Fund. The Board has also cleared proposals to permit investment in A-rated corporate bonds up to 10% of the fund’s portfolio. Previously investment in corporate bonds was restricted to AA- and above rated bonds.
In a third major change, partial withdrawals up to 25% of total contributions will be permitted for higher education or for starting/acquiring a business.
The NPS or National Pension System has two types of plans – Active Choice and Lifecycle Fund.
Under the Lifecycle Fund Plan, the equity-debt split is automatically set according to your age. There are three lifecycle funds – conservative, moderate and aggressive. These set equity allocation at 25%, 50% and 75% respectively till the age of 35. After you cross that age, the funds reduce equity in favour of bonds based on your age. You can read more about this here.
Under Active Choice, you can select the split between equity and debt. You can also change this split up to twice a year. However, the maximum equity allocation was earlier restricted to 50%. This has now been upped to 75%. This upward revision brings a much higher return potential and higher volatility to your NPS portfolio.
However, before you worry about risk do note that this allocation still remains your choice, you can keep it below 75%, all the way down to 0%. Also, NPS is a long-term product, maturing at the age of 60. This can iron out the short-term market movements that trouble mutual fund investors.
Our analysis shows that moving from a portfolio split equally between equity, government bonds and corporate bonds to a portfolio with 50:25:25 split between the three assets results in a higher CAGR. In case of the top performing fund manager for both model allocations, this difference is 12.5% CAGR (in 50:25:25) versus 11.5% CAGR (equal split) over the past five years.
The second major reform has been the permission given to NPS fund managers to invest in bonds rated A- and above, as opposed to AA- and above, earlier. This will allow NPS fund managers to earn a much higher yield on their debt investments and pass it on to you. The top-performing corporate bond fund (run ICICI Prudential Pension Fund) delivered 10.09% over the past five years. This could potentially go higher with the relaxation of investment norms.
The third major change has been the addition two new grounds to the list of permitted premature withdrawals from the NPS. They are higher education and starting a new business/acquiring a new business. This list currently includes house purchase or construction, critical illness and marriage and higher education of children.
NPS partial withdrawals can be made up to 25% of your total contributions to the NPS. This is 25% of contributions and not 25% of the corpus which means that the returns earned by the NPS funds cannot be withdrawn under this route. Also, note that you can only make three such withdrawals during the entire tenure of the NPS.
All in all, these are very welcome steps by the PFRDA board.