The Pension Fund Regulatory and Development Authority (PFRDA) has proposed to raise the limit for equity allocation in National Pension System (NPS) Active Choice plan to 75%, which is similar to the equity allocation in the NPS Aggressive Lifecycle Fund. A discussion paper for the same was released on February 16 by PFRDA, and comments are invited till March 18.
Subscribers in the NPS can either go for ‘Active Choice’ in which they decide the allocation among the NPS asset classes themselves or put their money in a lifecycle fund which will do this automatically based on their age.
The NPS asset classes are equities, corporate bonds, government bonds and alternative assets.
Under the current rules, the upper limit for equity allocation in the NPS Active Choice is 50%. As an alternative, subscribers can go for one of the three lifecycle funds – Conservative, Moderate and Aggressive. These funds have upper limits of 25%, 50% and 75% on equity which apply from 18 to the age of 35. After this age, the funds automatically reduce the equity proportion in your NPS corpus as you get older. In other words, they use age as the sole factor in deciding asset allocation. You can read more about how the NPS works as a system, here.
Major reasons for the change
Using age as the sole criterion to decide asset allocation as the current lifecycle funds may not always be appropriate. Factors such as risk appetite and financial profile also matter. Hence this flexibility should be given to subscribers in the Active Choice plan as well.
Various studies including one conducted by CRISIL have shown that under various interest rate and equity scenarios, the Aggressive Lifecycle Fund (75% equity limit) has beaten its Moderate and Conservative counterparts. Five times as many subscribers have opted for the ‘Aggressive Lifecycle Fund’ (52,454) compared to the ‘Conservative Lifecycle Fund’ (10,574 subscribers).
100% equity allocation is allowed in the pension systems of many OECD countries including the UK, USA and Australia.
As individuals near retirement, it becomes difficult for them to stomach volatility. Hence the paper proposes that the equity limit will be tapered from the age of 50 to the age of 60. It will thus be reduced to 50% at the age of 60 as a result of the taper.
This is a welcome move and can greatly boost the returns on the NPS corpus in the long run. Unfortunately, this does not apply to Central and State Government subscribers whose returns have already suffered due to restrictions on their asset allocation. It should be extended to them as well.
Things to note
The new enhanced equity limit, once implemented, will apply to Tier 1 and Tier 2 of the NPS
You can switch between Active Choice and a lifecycle fund/change your asset allocation, up to twice a year.