How the national pension scheme can be utilized for early retirement

An argument that is often heard against the National Pension Scheme(NPS) is the long lock-in till age of 60 years. Another concern is the accessibility of the corpus in case of early retirement.

Subscribers have for long been used to defined benefit scheme like the employee provident fund which gives a fixed return and find it difficult to estimate the corpus in NPS. They worry about how markets could be in the long run and the uncertainty associated with not getting a fixed return. One of the reasons annuity plans from insurance companies have so much acceptance is because they are sold with the promise of a certain amount and pension based on that.

However, these options may not provide a sufficient retirement corpus, given the limited returns in these plans. Based on current expenses of 75,000-1 lakh, the retirement corpus required at age 50, on an inflation adjusted basis, would be 6-8 crore for a 35-year old. For this, the individual will need to invest 1.5- 2 lakh per month assuming return on investment of 10% per annum (p.a,). The amount to be invested if the individual wants to play safe and invest at 8% p.a. will be 2.5 lakh per month. Clearly, one needs to go beyond traditional investments to be able to reach the target. In order to retire at 50, individuals need to assess their ability to invest such an amount and the options that can generate a 10% p.a. return.

Equity mutual funds, NPS (active equity) and annuity schemes from insurance companies are the options which can be considered for an expected (but not guaranteed) 10% p.a. return. Annuity schemes as explained earlier are an easy choice since investors look at them as defined benefit plans. However, this is not so. The returns in insurance promoted annuity plans are not fixed and the returns during the accumulation phase(i.e. the period till retirement) could be low due to the high costs associated.

The NPS, while locked in till age 60, does have a premature withdrawal option which allows subscribers to prematurely exit the scheme, subject to their being invested in it for at least five years. So, persons wanting to retire at 50 can withdraw 20% of the accumulated corpus, tax free, and an annuity needs to be purchased with the balance 80%. Subscribers also have the option to continue with the NPS by paying the minimum subscription amount every year and start the annuity at the age of 60. The advantage there is that, at this point of time, 60% of the corpus can be withdrawn tax free and 40% goes into an annuity. A new feature in NPS also allows for withdrawal of the lump sum amount periodically under a systematic withdrawal plan (SLW).

The advantage that NPS has over equity mutual funds is lower cost and the pension. Retirees find it very difficult to plan for regular income from their corpus, whether they are 50 or 60 years old. This is something they do not need to worry about with NPS, since it provides periodic returns through pension and SLW. Equity funds have better liquidity and the investor can choose the risk allocation, but the ability to remain invested is the biggest hindrance in building a good retirement corpus.

The question that begets is whether early retirement is even possible, given the investment of 2-2.5 lakh per month. Remember this is only for retirement. Add to this other financial goals and the investment amount rises by another 75,000 to 1 lakh at least. This sort of an outlay is not easy. One can either take more risk or delay retirement. Delaying retirement means the investment amount reduces by more than 50%. This is much more doable than banking on higher risk investments.

Early retirement is possible by investing the requisite amount in an instrument which can grow well in the accumulation phase and takes care of regular income in the distribution phase like the NPS. Inflation is a silent killer—ensure all investment choices are evaluated on a post-tax, post-inflation basis. Time is the greatest asset. Invest early and take the benefit of time to compound your investment in the accumulation phase. In the distribution phase, use it to continue generating an income to be mentally engaged and reduce the pressure on the corpus to deal with any deviations from the plan.

Mrin Agarwal is founder-director, Finsafe India.