So you decide to begin investing in NPS for the additional tax benefits. Though the ‘tax benefits’ as the only reason for investing in any product is a wrong approach, the fact is that many people who voluntarily invest in NPS do it only for the additional tax deduction of Rs 50,000 offered under Section 80CCD (1B) for NPS contributions.
Having decided to invest in the NPS, you must understand the difference between the Active and Auto Choices.
As an NPS subscriber, you have the option to invest in following four asset classes:
– Scheme E, i.e., in Equity instruments
– Scheme G, i.e., in Government Debt securities
– Scheme C, i.e., in Corporate Bonds
– Scheme A, i.e., in Alternative Investments (such as REITs, Infrastructure Investment Trusts, AIFs Category I and II)
Now NPS allows the investments to be managed in two ways: Auto Choice and Active Choice.
Different investment choices
As the name suggests, the Active choice is meant for those who want to manage their investment asset allocation actively. The Auto choice is meant for those who do not want to manage the allocation on their own and, instead, need some advice/handholding to decide the proper allocation for their retirement savings.
Subscribers don’t have to do take any asset allocation decisions on their own. The investments are made in the chosen life cycle funds. And there are three Life Cycle Funds (LC) to choose from.
Aggressive Life Cycle Fund (LC75)
This is suitable for investors wanting high equity exposure. The schedule for the upper cap on equity is as follows: equity component is 75 per cent up to age 35. Afterwards, it tapers down to 15 per cent by the age 55.
Moderate Life Cycle Fund (LC50)
This is suitable for investors wanting medium equity exposure. The schedule for the upper cap on equity is as follows: equity component is 50 per cent up to the age of 35. It tapers down to 10 per cent by the age of 55.
Conservative Life Cycle Fund (LC25)
This is suitable for investors wanting medium equity exposure. The schedule for the upper cap on equity is as follows: equity component is 25 per cent up to the age of 35. It tapers down to 5 per cent by the age of 55.
In all the life cycle fund options available under the Auto Choice, the rebalancing happens automatically once every year on the date of birth of the NPS subscriber.
In the Active choice, the subscribers choose the ratio in which their funds are to be invested among various assets. But there are certain limits. The NPS retirement corpus can have a maximum of 75 per cent in Asset Class E (Equity). And after the age of 50, the upper limit of equity tapers by 2.5 per cent each year till it reaches 50 per cent by age 60.
Here is a combined snapshot of how the cap on NPS Portfolio’s Equity component tapers down between the age of 35 and 55.
Once in a financial year, you can change from Active to Auto or vice versa.
So how do you decide between the Active and the Auto Investment choices of NPS?
You should opt for the Active choice only if you are aware of what is the right asset allocation for retirement savings and have a decent understanding of various asset classes and their behaviour. Also, you should have the necessary time and skill to actively switch/rebalance your NPS corpus regularly and in line with your risk tolerance and goal needs. But if you are unable to do any or all of these and want to eliminate asset allocation related decision-making, then taking the Auto choice is the better option.
Being designed specifically for retirement, investing in the NPS shouldn’t be random or just to get the extra tax benefit. You should always keep NPS’ asset allocation as a part of your overall strategic allocation for retirement savings.