3.1 – Types of accounts

Once you have decided to invest in NPS, it is time to understand the details of the product. 

Before that, a quick note on the two routes you can choose to invest in NPS –

1. You can directly invest through the All Citizens Model.
2. Or, if your company is registered under the Corporate NPS Model, you can contribute to NPS as a deduction from your salary.

Under Corporate NPS, employers contribute to NPS on top of the Employee Provident Fund (EPF) contribution. The employer may either keep it a mandatory or a voluntary retirement benefit plan. If NPS is offered on a voluntary basis, you will have a choice whether or not to join NPS. 

Moving on, under NPS, there are two types of accounts—Tier I and Tier II. Tier I is your primary retirement account, with restricted withdrawals and minimum construction rules until you turn 70 or retire.  So, all the minimum contribution requirements and withdrawal restrictions we mentioned earlier apply specifically to this Tier I account.

To keep your Tier I account active, you need to invest at least ₹1,000 per year (₹500 minimum per contribution). Tier II, on the other hand, is more of a savings account. You can only open it after getting a Tier I account, and there are no minimum contributions and withdrawal restrictions with Tier II. There’s no limit on how much you can invest in either account. In this chapter, let us focus on the Tier I option.

There are two important decisions you need to make at this stage – asset allocation and the fund manager.

3.2 – How it works

If you’ve ever been to a fancy five-star hotel, you’ve probably seen a variety of restaurants—Asian, Italian, Indian, Mediterranean, French, and more—all under one roof. Each restaurant offers you a starter, main course, and dessert.

Now, imagine you can pick and choose: maybe you have an appetizer in one, a main course in another, and dessert somewhere else, or if you’re feeling lazy (like me), you settle for everything in just one spot.

Think of the NPS (National Pension System) like this hotel. The restaurants are your fund managers, and the dishes are your assets. Each fund manager can offer you a mix of equity, debt, corporate bonds, and alternatives. You get to choose whether one fund manager manages all your assets or different managers handle each type, giving you full control over how you build your retirement portfolio.

3.3 – Investment options

You’ve got four fund options—Scheme E (equities), Scheme G (government securities), Scheme C (corporate debentures), and Scheme A (alternative investments) under the All Citizen Model.

• Scheme E primarily invests in listed shares and has higher risk than others. However, this is the only component that contributes significantly to returns. NPS fund managers typically focus on large-cap stocks and keep the exposure to mid and small-cap stocks lower to reduce the risk.
• Scheme G focuses on central government securities and state development loans. While there is virtually no default risk here, the portfolio is still exposed to interest rate movements.
• Scheme C is riskier than Scheme G. It invests in corporate securities and infrastructure-related debt instruments.
• Scheme A is a relatively newer option (introduced in 2016) and invests in unconventional assets through Alternative Investment Funds (AIF Category I and II), Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), Basel III Tier 1 bonds, and securitized papers. These investments carry higher risk compared to other schemes. 

Now, you can invest up to 75% in Scheme E if you’re under 50, and up to 100% in Schemes C and G. But for Scheme A, you’re limited to just 5%. This is under what’s called the “active choice” model. After 50 years, the equity allocation limits gradually comes down as shown in the figure below-

If you don’t want to pick and choose, there’s also an auto choice- lifecycle fund option. In this, your investments are automatically balanced based on your age. The older you get, the less risky your investments become, meaning your exposure to equity and corporate debt decreases over time. Here too, depending on your risk appetite, you can choose from three different options available – LC75 – Aggressive Life Cycle Fund, b) LC50 – Moderate Life Cycle Fund and c) LC25 – Conservative Life Cycle Fund.

For those upto 35 years, the maximum equity allocation under the aggressive plan is the highest at 75%, while for the moderate and the conservative funds, the equity allocation is capped at 50% and 25%, respectively.

Recently, in October 2024, a new investment option called ‘Balanced Life Cycle Fund’ has been introduced in which the maximum equity allocation of 50% tapers down after the age of 45 years as compared to 35 years under existing life cycle funds. 

If you don’t choose any of the options in the auto-choice too,the  Moderate Life Cycle Fund (LC50) will continue to be the default choice

If you’re just starting out in your career, don’t be put off by the relatively lower returns from Scheme E in the short term. Equity has the potential to give inflation-beating returns over the long haul.

Scheme A, however, carries more risk and doesn’t have much of a track record yet, so you might want to avoid it for now. You can switch between active and auto choices up to four times a year. You can also change your asset allocation between Schemes E, C, G, and A four times a year. If you want a set-it-and-forget-it strategy where the risk automatically lowers as you age, auto choice could be your best bet.

3.4 – Selecting fund managers

Ten pension funds are currently available for the All Citizens Model: Axis, Aditya Birla Sun Life, HDFC, ICICI, Kotak, LIC, Max Life, SBI, TATA, and UTI. You can check their performance online to compare their performance across different schemes and time frames.

You are also allowed to select multiple Pension Fund Managers (PFMs) under the Active Choice option.

This means that you can choose up to three different PFMs to manage your investments across different asset classes. For instance, you can have one manager handling your equity investments (Scheme E), another managing corporate debt (Scheme C), and a third for government securities (Scheme G). However, to invest in the Alternate Investment Fund (Scheme A), you must pick one of the PFMs you’ve already selected for your other schemes.

You should review your fund manager’s performance regularly and consider factors like long-term consistency. If you’re not happy, you have the option to switch fund managers once a year.

You can check the returns of the schemes here and portfolio details here.

The good part is that switching from one asset class to another or changing your pension fund manager will not have any tax implications on you. This is unlike mutual funds, where switching from one fund to another is treated as a sale, and profits are taxed as capital gains. 

Key takeaways:

1. There are two important decisions you need to make in NPS — asset allocation and the fund manager.
2. You have four fund options: Scheme E (equities), Scheme G (government securities), Scheme C (corporate debentures), and Scheme A (alternative investments).
3. You can decide the allocation under an active choice, or the auto choice will decide the allocation based on your age.
4. You can change asset allocation four times a year and the fund manager once a year.
5. Unlike mutual funds, changing the fund manager will not have any tax implications for you.