How to improve the Indian National Pension System (NPS)

by Hansi Mehrotra

20th November 2016

As a consultant on the execution of the New Pension System (NPS) in 2009, I came to appreciate the unique challenges India had given that 85%+ of the workforce, the ‘unorganised sector’, didn’t necessarily have regular cash flow through formal banking channels. Unlike other markets, we couldn’t make it mandatory or give huge tax incentives.

The aim was to make it attractive – easy-to-use and really cheap. The NPS was launched as a three-layered structure, with the government-run administration platform (Central Recordkeeping Agency or CRA), financial services and postal network as distribution (Points of Presence or PoPs), and professional investment management (Pension Fund Managers or PFMs). Subscribers can decide their own investment mix by choosing weights amongst three simple asset class investment options, or default to an age-based ‘auto-choice’ option that gradually shifts the asset allocation from equities to bonds. The regulator would conduct investor education to ensure a consistent message delivered through mass media.

Seven years later, the NPS hasn’t exactly been a roaring success. I believe we need to address some issues on product, distribution and communication.

Product has to be transparent and address whole life

Contrary to the common complaint of preservation being an issue, I have to constantly remind people that a pension fund is meant to be preserved. It’s a way to hide our money from ourselves. But usually, preservation comes with tax incentives; the NPS has an EET (exempt at contribution, exempt within and taxed at withdrawal) structure. Hence, thelack of tax parity with the Employee Provident Fund (which has EEE structure) for the organised sector could be a valid issue. The government justifies the EET structure on the basis of higher returns due to equities exposure, but this seems odd since equity mutual funds have tax exemptions. All pension products should have the same tax treatment. Having said that, it’s unlikely to be have influenced the decision of the unorganised sector which can’t contribute to the EPF anyway.

Costs are another issue. The investment costs are apparently too low. This is puzzling, because low fees should attract investors, not keep them away. The low fees were meant for passive investment management, while the scope is now expanding to active management, marketing and distribution. Secondly, pension fund managers had hoped for bigger volumes in the long term so that even low fees could be viable. But that hasn’t happened, which puts a question mark on the need to invite more bidders this time. The set up and administration costs probably appear high as a percentage, but they should come down with digitisation.

The larger issue is the lack of investment policy. The initial mandate was for passive management of large cap equities to keep the product simple and costs low. The flip-flopping to active and back, with current proposals for small cap and private equity, is denting investor confidence. The NPS should publish its investment policy statement, like other well governed global pension funds, allowing prospective investors to make well-informed decisions.

The product design could be improved. Subscribers are reluctant to lock in their savings into a product that forces them to buy a low-yield annuity. In the absence of a social security system, why does the NPS force investors to buy annuities?

Separately, savers are more worried about their short and medium-term goals than retirement. Why not attract such savers by making the Tier II more relevant? It could have a health insurance, saving fund or even a capital protection option to cater to subscribers worried about market volatility.

Distribution needs aligned incentives

The PoPs were intended to be nodal collection points rather than distribution points i.e. they were designed to pull rather than push. If we want them to push, they need to be incentivised accordingly. This also applies to retirement advisers. The latest proposals still seem inadequate on this front.

Communication should be consistent and by experts

Another problem is the lack of communication. The success of the Jan Dhan Yojana shows that this government knows how to market a scheme when it wants to. So it doesn’t make sense for the pension regulator asking PFMs to take on the communication role given the low fees and their track record in investor education for mutual funds. It would be better to engage communication experts, and perhaps try more engaging approaches. I am sure ad agencies and production houses can come up with other clever ways to engage audiences.


An edited version of this post originally appeared in ET Wealth at

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