Structure of New Pension Scheme

NPS Architecture

NPS is a well structured Defined Contribution Pension system with well defined system architecture having specified roles of various entities.

Pension Fund Regulatory and Development Authority

The Pension Fund Regulatory and Development Authority (PFRDA) is entrusted the responsibility to regulate and develop the pension market in India. The roles and responsibility of PFRDA include carrying out regulatory changes, overseeing quality and provision of services of NPSCAN, CRA, PFs Trustee Banks etc.,

New Pension System (NPS) Trustee

NPS Trust has been set up for taking care of assets and funds under the NPS. Trust has been appointed by PFRDA. Trustee is responsible for taking care of Funds under NPS. The securities shall be purchased by the PF(s) on behalf of and in the name of Trustees and the Securities purchased by each PF shall be held in the Custodial Account of NPS Trust. However, Individual subscriber shall remain beneficial owner of these securities assets and funds. NPS Trust will appoint Trustee Bank, Custodian NPS Trust will hold an account with it. Trustee Bank would receive Funds from Govt. / NPSCAN and send to PFs, ASPs Trustee Bank.

Central Record Keeping Agency (CRA)

CRA would undertake Record Keeping, Administration and Customers service. National Securities Depository Ltd (NSDL) has been appointed as the CRA for the NPS. The main functions and responsibilities of CRA will include: Recordkeeping, Administration, and Customers Service function for all subscribers of the New Pension System. Issue of unique Permanent Retirement Account Number (PRAN) to each subscriber, maintaining a data base of all subscribers, and recording transaction relating to each subscriber.

Pension Fund Managers

In order to introduce competition and to provide wider choice to the subscribers, PFRDA has allowed multiple fund mangers. The subscriber will have a choice to select from multiple pension fund managers and multiple schemes. Pension Fund Managers will manage investment of Retirement Savings of NPS. There will be no implicit or explicit assurance of benefits except market based guarantee mechanism to be purchased by the subscriber. PFRDA has appointed three pension fund managers, namely LIC Pension Fund Ltd., SBI Pension Fund Ltd. and UTI Retirement Solutions Ltd. for managing funds of Central Govt. employees (who will also manage State Govt Funds. Further, PFRDA has appointed six fund managers to manage funds of all citizens (excluding Central and State Govt Fund), which was opened to st the public from 1 May 2009.

Point of Presence (POPs)

PFRDA has appointed 22 POPs who will act as Collection Centre for NPS, will collect application forms from the subscribers (under All Citizens category) and send the same to the CRA.

Trustee Bank

The Trustee Bank will maintain the account of the Trustee and will receive credits from the government department or its agencies and transmit the information to the CRA for reconciliation. The Trustee bank shall remit the funds to the Pension Fund Managers, Annuity Service Providers (ASP). NPS Trust has appointed Bank of India as the Trustee Bank

Custodian

The Custodian will provide Custodial Services to the Pension Funds, which will include among others to ensure that benefits due on the holdings are received, provide detailed reports to the PFs etc. NPS Trust has appointed Stock Holding Corporation of India Ltd as the custodian for the new pension system.

Annuity Service Providers (ASP)

The role of annuity service providers (ASPs) will be critical in the NPS, since they will offer annuity to the subscribers when members reach superannuation or withdraw pension assets. As per the provision there would be mandatory annuitization, and the members have to purchase annuity from ASPs. The ASPs will offer annuity products to the subscribers receive funds from CRA and pay regular monthly annuity.

Employer Contribution in NPS to be exempted over and above Rs. 1 lakh

To make the New Pension System more attractive Government has announced two major Income tax concessions for contributions made in New Pension Scheme in the budget 2011.

While the NPS subscribers are directly benefited from one of these Income tax concessions, the second one is beneficial to the employers who contribute for NPS each month equivalent to employees contribution in Tier I.

Income tax concession to Employees under NPS:

So far, the contribution made by a New Pension Scheme subscriber in Tier I scheme is deductible from the total income under Section 80CCD of the Income Tax Act.  Like wise, the contribution made by the employer for the employee in Tier I of New pension scheme is also deductible under Section 80CCD.  However, the aggregate deduction under Section 80C, 80CCC and 80CCD is fixed at Rs.1 lakh. 

So, if the NPS subscriber is already having other eligible deductions such as LIC premium, PPF, bank or NSC deposits, ELSS etc., under Section 80C, 80CCC and Section 80CCD., deduction allowed under Section 80CCD in respect of contribution towards New Pension Scheme may not be of much useful as the overall limit of savings eligible for deduction is pegged at Rs. 1 lakh.  

Further, contribution made by the employer in Tier I New pension scheme should also be included in the Total income of NPS subscriber as far as calculation of income tax is concerned, while full deduction of the
same from income under Section 80CCD may not be possible as other savings made by the subscriber covers the overall limit of Rs.1 lakh under Section 80CCD.  Hence, for a NPS subscriber contribution for NPS by the Government is taxable in most of the cases.

For example, if an employee receives a salary of Rs.40,000 (pay+da), 10% of the same (Rs.4000) is paid by him as contribution towards NPS.  The Government will also be paying Rs.4000 in this case in NPS fund of the said employee.  Until now, an amount of Rs.96,000 (Rs.48,000+Rs.48000) could be deductible from the total income as far as this employee is concerned under Section 80CCD. 

However, if the said employee has been paying LIC premium of Rs.20,000 per year, he will be allowed to deduct only Rs.2000 in respect of the same under Section 80CC as total ceiling of Rs.1,00,000 under Section 80CCE will apply in this case.  So, an eligible deduction of Rs.18,000 could not be availed under Section 80CCD.  In other words, employer contribution to NPS to an extent of Rs.18,000, which is already included in the income is taxable in this case.

However, budget 2011 has proposed to amend section 80CCE so as to provide that the contribution made by the Central Government or any other employer to a pension scheme under section 80CCD shall be excluded from the limit of one lakh rupees provided under section 80CCE.  It is exepected that this proposal which will be effective from the assessment year 2012-13 (financial year 2011-12) would totally exempt employer's contribution in NPS from levying income tax.

Income tax concession to Employers under NPS:

Currently, the contribution made by an employer towards a recognised provident fund, an approved superannuation fund or an approved gratuity fund is allowable as a deduction from business income under section 36, subject to certain limits. However, the contribution made by an employer to the NPS is not allowed as a deduction.

In the Budget for the financial year 2011-12, it is proposed to amend section 36 so as to provide that any sum paid by the assessee as an employer by way of contribution towards a pension scheme including New Pension Scheme (NPS) to the extent it does not exceed ten per cent of the salary of the employee, shall be allowed as deduction in computing the income under the head “Profits and gains of business or profession”.

This amendment will be effective from 1st April, 2012 and will be applicable to the assessment year 2012-13 (for the income earned in the financial year 2011-12) and subsequent years.

Meet the Trimurti

A long time ago when I was a kid...

On one sunny day that I still have fond memories of, my father came home in the evening with a toy pig. I turned it around and discovered that it had a hole in its back. My dad announced that it was my 'Piggy Bank'.

He fished out a 10 paise coin from his pocket and instructed me to put it through the hole in the pig's back. I did it eagerly, expecting the pig to start walking. Walk it didn't but my father patted me on my back and said,

"Son, this is your first saving. I will give you 10 paise everyday and when we have collected Rs50 we will go to the bank and get you a savings account."

Savings! suddenly a new activity had begun in my life that I understood nothing about.

My Dad noticed the puzzled look on my face. He scratched his head and suddenly a meaningful look came in his eyes. I think he remembered the ant menace that my mom had been complaining of for the past few days. He showed me the ants that were carrying grains in a line to their hiding place.

"The ants are carrying grains and saving it for a rainy day, he said.

He took out my World Book Encyclopedia and showed me various other animals that save food for a time when they may need it.

"You know that I go to office to earn money for all of us. But when I turn 58 years, I will have to retire and stop going to office. We will need money to buy food and clothing even after I retire from my job and stop earning. I need to save now, so that I can pay for our food and clothing later," he explained.

"Similarly, you can save the money I give you now to buy a good book or a paint box later," he impressed upon me.

That was my first lesson in 'saving'.

A few years later I learnt in my class that all of us have two choices. We can consume now or can consume later. Hence, savings is just postponing consumption.

Does it then mean that only what we consciously keep aside for a rainy days is called "saving"?

"No, what ever you do not manage to consume and stays as a surplus is also 'saving'. But that is a lucky state to be in," my teacher responded.

And that set me thinking...

"If I can 'save' to consume at a later date, I can also spend more now if I know that I can earn enough surplus to pay for it later..."

Just then my teacher's booming voice interrupted my train of thoughts...

"Borrowing is the opposite of saving," she announced.

Now that was easy to visualize.

I had a classmate who was fairly irregular to class, spent a lot of time in the school canteen and supposedly even bunked classes to watch the 'matinee'.

How did he manage to pay for all his nefarious activities?

Well, he used to borrow money from a few friends of mine who saved their pocket money.

During the break, I manage to accost one of those friends who had lent money to my classmate.

"I can understand why Ramesh (by the way, that was my classmate's name) borrows from you. But why do you lend him money? Can he pay back?"

"Look, I don't really intend to spend all my pocket money. I am saving up for a new cycle. Money always burns a hole in my pocket. Hence, I lend it to him," he answered.

"Ramesh has a rich father, who is a family friend," he explained. "I know that I can get my money back. Ramesh also knows that when he turns 18 he will look after his family business and earn well. And then he will have no time to have the fun he is having now. Hence, he borrows to spend," he added.

Learning for me again

'Saving' is not consuming everything today and leaving something for tomorrow whereas 'Borrowing' is consuming more than what one has today, expecting to save more later to pay up for the excess consumption now.

While 'saving' is being conservative and wise, 'borrowing' is being risky and foolish unless for a basic need. Hence, it makes sense to borrow only when one is sure that in the future he will be able to save enough not only to pay up for his borrowings but also to see him through the days when he cannot earn.

What is 'investing' then?

This question bothered me till I had my first mug of beer from some bottles that we had smuggled in from my friend's place (it belonged to his father who owned a liquor shop).

Oh boy! I loved it so much, the beer I mean. But soon an idea suggested itself to me. If everybody starts liking it, the demand for beer is definitely going to rise. The growing population will ensure that the demand sustains. Wouldn't then it make a lot of sense to set up a company to manufacture beer? If demand drops then my friends and I can very well step in!

I had grown up finally from the days of aspring to be a bus conductor to wanting to own a beer factory now!

The next day, I started discussing my ambition with my friend's father. During the course of our conversation I learnt of the money needed to buy the fermenting equipment that can produce beer for years to come.

By selling all the beer that can be manufactured, I can recover the initial money spent on the business by the end of three years. Beyond that, the money that I'll make will be surplus. That would be an awful lot of money.

Of course, I remembered that as 'Investment' from my economics textbook.

In other words, 'Investing' means building up to meet future consumption demand with the intention of making surpluses or profits, as they are popularly known.

Investments are risky

True, what if tomorrow everybody decides that 'beer' is yuck. Maybe the government will ban beer consumption. Or your plant might develop a big problem for all you know. Hence, there has to be a reasonable profit expectation to motivate an investment.

Also, when you or I 'invest', we forego our present consumption or do it out of our surplus. In other words, 'savings' again supports 'investment'.

Interesting isn't it?

We started with three things that looked as different as chalk, brick and wood, but discovered that the three ('saving', 'borrowing' and 'investing') are related.

But then, I have a few questions in my mind already. I am sure you would have some too.

What if I save Rs1000 over 10 months to buy a cycle and the price of the cycle shoots up by 20% by then? I am losing the 'purchasing power' of my Rs1000. Is there some way I can make up for the risk of losing my purchasing power?

Getting a little complicated for now. Let us unravel it later.

Should we invest in Highest NAV ULIPs?

Risk involved in ULIP:

Highest Nav ULIPs

ULIP (unit linked insurance plans) is a life insurance policy mixed up with an investment in the stock market. A portion of the premium paid by you is utilised towards taking a pure endowment life insurance policy and the remaining amount is invested in the stock market by buying shares of companies chosen by the fund manager.

Needless to say the portion of amount invested in the stock market would be exposed to stock market fluctuation.  Just see the price of a stock in December-2007 when the market was peaking at 20K to 21K.  When the market crashed afterwords shares of almost all the companies in the market fell around 60% to 100%.  Again the see the recovery phase from March-2009.  Most of the stocks gained a decent recovery.  Some stocks were even surpassed their earliet highest price.  So, the price of the units, as measured in net asset value (NAV), which is an average value of stock held in a particular scheme of the Insurance company can fluctuate a lot.

Take the case of a person buying a ULIP.  He always has the risk that his capital invested in the units can be eroded, if the markets is weak. Thus at maturity of the policy, one might not get a high return that one expected at the time of buying the ULIP.

Capitalising the risk involved:

Risk involved in the investment in the ULIP is actually a drawback.  But insurance companies are now trying captialise this drawback itself for mobilising new funds in the form of providing the scheme known as “Guaranteed NAV ULIPs”

Highest NAV ULIP-  The real name is Constant Proportion Portfolio Insurance:

The investment process followed in these “highest NAV guaranteed” Ulips is called Constant Proportion Portfolio Insurance — a trading strategy designed to ensure that a fixed minimum return is achieved at a set date in the future. This strategy involves a continuous re-balancing of the portfolio of investment between equity and debt.

Consider a Ulip promise to pay highest NAV in the next seven years that starts today at a NAV of Rs 10. Let us assume that 100 per cent of the allocated premium is invested in equities.

Now, the market goes up and at the end of the first year the NAV increases to Rs 15. This is the highest NAV of the Ulip till now and the insurer has to make sure that the policyholder can be repaid at the end of the remaining six years on the basis of the Rs 15 NAV.

Shuffling is the key:

The company would now transfer a part of investment made in the equity market to debt instruments such as govenment or private bonds that ensure a return of Rs 15 after six years.

In the second year, the markets do down and the NAV declines to Rs 11 from Rs 15. However, the insurer doesn’t need to do anything as the return of highest NAV has been ensured by the investment bebt market.

Now comes the prudency of the fund manager of the scheme.  Since is market is low as we assumed that NAV has declined from Rs.15 to Rs.11, the fund manager has the liverage now to re-invest part of the amount withdrawn from the equity  debt when the NAV was Rs.15, in the equity market again at a lower price.  This action may lead to appreciation of NAV further.  But this element of risk is not to be taken in the case of Highest NAV schemes as there no such declaration by the company to the extent that the appreciation gained which is available in the debt fund will be re-invested in the equity market.  Obviously, the NAV of this scheme would tend to appreciate at a slow phase compared to non-guaranteed ULIPs or pure mutual fund schemes.

As per the fine print of these “Highest NAV” schemes, in the subsequent years also , if the stock market goes again a portion of the investment available in the equity fund will be transferred to debt instruments.

This sort of shift of funds from equities to debt instruments would be continued and when the policy matures, all the investment made by the policy holder would go to debt instruments.

Highest NAV guaranteed Ulips thus turn out to be primarily debt-oriented rather than equity-oriented plans — you can expect a gross return of between 8 per cent and 10 per cent on investment. But since there are various charges associated with a Ulip, your net return could be still lower at 5 to 7 per cent.  Besides, guarantees come at a cost. The total cost of these guaranteed Ulips are higher than that in a non-guaranteed product.

This guaranteed NAV scheme is not offered by Mutual funds as they are not allowed by the market regulator Sebi to provide any kind of guarantee to investors either on capital or on investment returns.

But insurance regulator IRDA allows life insurance companies to offer guarantees on their products, even when these are market-linked.

Even the life cover and the tenure of such highest NAV guaranteed Ulips are not as beneficial to customers as in non-guaranteed insurance plans. The sum assured offered is generally five times the annual premium and the policy term is 10 years. So, these plans are not only giving you a smaller life insurance, they are covering a shorter span of your life.

Who should Invest in These Products ?

If you are looking for modest returns, like 8-10%, you can invest in these policies. The return of these policies may be high in the beginning, if market does well; but when market starts performing badly, the returns can take a hit and then be in a tight range. Your NAV will be protected for sure.

The bottom line is if you are more concerned about the worst side of market investment, which may lead to capital erosion some times, Highest NAV/Guaranteed NAV Scheme may suit you.  But you got be contend with low or medium capital appreciation.

Know your credit card

Credit Card is no more a white elephant in India.  Just like having an account with a bank credit card  has become a common financial instrument among middle class. But,  do we know the mechanism of Credit Card finance as we do about banking ?  Obviously the answer will be “No”.   A wise usage of credit card would surely benefit us.  The advantage is you get a financial leverage without incurring any additional cost towards the same if you are able to settle the amount within the stipulated time.
According to the Bureau of Labor Statistics, for instance, last year Americans paid a record $16.3 billion in credit card late fees alone — little surprise , especially in view of the fact that the average American household is now juggling 14 credit cards. This is not to suggest that we Indians are better placed. One Mumbai family, which recently committed suicide, reportedly had 73 credit cards! RBI data suggests that there are now over 88 million cards in circulation in India compared to just 60 million in 2006-07, with the total outstanding balances till May this year having gone up by a whopping 87% to Rs 12,375 crore.
A small awareness about the card could save you lot of money.
What’s in a Credit Card?
1. Name. The full name of the account holder — the person who is responsible for paying the credit bill each month.
2. Issuer. The name of the company that is granting the credit and their logo. Issuers are usually banks and other financial institutions.
3. Type of Card. VISA, MasterCard, etc.
4. Account Number.
* First Six – Identify the issuer.
* Next four – Region/branch of issuer.
* Next five – Your account number.
* Final number – Digit for security.
5. Customer Service Number. This number is available if you should have any questions about your account or past transactions. There is also a number for lost or stolen cards. Write it down.
6. Magnetic Strip. This strip stores important information about your account such as name, account number, PIN, expiration date, and credit limit.
7. Expiration Date. Merchants require this information if you’re making a purchase by phone or the internet. It lists the date your card will expire in Month/Year. Most cards are valid for 1-3 years before they expire.
How does a Credit Card Work?
1. Purchase. When you purchase something with a credit card (MasterCard in this example), the merchant first checks to see if the amount you’ve charged will be approved — to make sure you haven’t exceeded your credit limit. They do this by sliding your card through an electronic device that is connected to an approval network. Once accepted, you’re given a printed receipt to sign. Both you and the merchant each keep a copy of the receipt.
2. Merchant and bank. The merchant deposits the credit card receipt with their bank, which credits their account in the amount charged. The bank then sends this transaction electronically to MasterCard.
3. MasterCard. MasterCard continues the transaction by crediting the bank and then charging the issuer of the card.
4. Card Issuer. The issuer of the card completes the transaction cycle by sending a bill to the card holder for the purchase amount. Hopefully, the card holder pays the bill in full thus avoiding any interest or finance charges.

credit card flow chart

Step 1: The merchant submits a credit card transaction to the Authorize.Net Payment Gateway on behalf of a customer via secure connection from a Web site, at retail, from a MOTO center or a wireless device.
Step 2: Authorize.Net receives the secure transaction information and passes it via a secure connection to the Merchant Bank’s Processor.
Step 3: The Merchant Bank’s Processor submits the transaction to the Credit Card Interchange (a network of financial entities that communicate to manage the processing, clearing, and settlement of credit card transactions).
Step 4: The Credit Card Interchange routes the transaction to the customer’s Credit Card Issuer.
Step 5: The Credit Card Issuer approves or declines the transaction based on the customer’s available funds and passes the transaction results, and if approved, the appropriate funds, back through the Credit Card Interchange.
Step 6: The Credit Card Interchange relays the transaction results to the Merchant Bank’s Processor.
Step 7: The Merchant Bank’s Processor relays the transaction results to Authorize.Net.
Step 8: Authorize.Net stores the transaction results and sends them to the customer and/or the merchant. This communication process averages three seconds or less!
Step 9: The Credit Card Interchange passes the appropriate funds for the transaction to the Merchant’s Bank, which then deposits funds into the merchant’s bank account. The funds are typically deposited into your primary bank account within two to four business days.
How are finance charges calculated?
If you expect to pay your balance over a extended period of time, you should understand how your creditor computes finance charges. New purchases accrue interest immediately and finance charges are actually added to your balance each month — you’re essentially paying interest on interest. This alone is a good reason to pay your balance in full each month. Let’s take a look at a few balance computation methods:
Average Daily Balance. This is the most common method used by creditors. You are charged interest on the average amount you owed each day during the billing period (minus any credits made on a particular day during the cycle). Depending on your credit agreement, new purchases may or may not be added to the balance — cash advances are usually included.
Previous Balance. The creditor uses the outstanding balance from the previous billing cycle. Payments, credits, or new purchases are not included. This is the most expensive method.
Adjusted Balance. This method is similar to “previous balance” except that payments or credits received during the current billing cycle are subtracted from the previous outstanding balance. New purchases during the current cycle are not included. Adjusted Balance costs you the least.