ROP and non-ROP Annuity

In this post, I will deviate from my usual style of writing and will make use of anecdotes to make the content more practical. I will be sharing a little bit ‘gyan’ and giving some sage advice at the risk of sounding little?preachy.?In the last 30(+) years of my?professional life in the financial sector I (& my colleagues)?had multiple opportunities to organize seminars/ town halls?in 200+ cities across the length and breadth of the country, on capital market / NPS. The audience usually have been a mix of government, corporate and self-employed professionals. My key takeaway from a behavioral finance perspective are as follows:

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·????????Most people underestimate the risk of living longer (longevity risk) and requirement of adequate saving for those golden years

·????????The impact of inflation and ‘lifestyle creep’ are not the kind of math people are comfortable engaging with

·????????A minuscule percentage of the cohort can appreciate ‘compounding’ and understand?CAGR

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A plethora of content is available in the social media as to how you should build your portfolio, manage it to create wealth and have an inflation indexed return. The principles of ‘bucketing’ and ‘laddering’ are not something which are easily understood by a layperson. This in one of the reason that most people still keep their money in fixed deposits (FDs). There is a sense of certainty, which is inherent in all of us, which is fulfilled by an FD, and which an NAV can never give. This aspect is addressed by one of the most underrated feature of NPS, which I intend to espouse in the post.

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The insight I got from being in the field is that in most parts of ‘Bharat’ a sum of INR 1-2 Cr (as a retirement corpus)?is still looked upon as princely and additionally, owning a dwelling unit by retirement age is further perceived to add on to ones stature. In this example, I have considered a person of 40 years of age (married and wife age 35), who decides to invest in NPS. The age selection is critical, as this is a mid-career point where one gets serious about post retrial scenarios. In this case, if he invest INR 9,400/- per month for the next 20 years with an annual increase in contribution by 5% (which is quite possible as ability to save enhances with age) the terminal corpus will be INR 1 Cr. This is possible with a CAGR of 10%, which a ‘moderate life cycle’ scheme has been generating consistently since inception. I assume that he would have additional saving of similar amount from his other statutory benefit.?

NPS account closure at age 60 (read superannuation) requires mandatory annuitization of 40% of the terminal corpus. This aspect of NPS is generally perceived to be one of the biggest disadvantage of NPS, whereas it is completely the opposite. Let me dwell on it a little more. Most people are attracted to bank FD interest rate, as they tend to give a higher return. In the current interest rate scenario?one gets a coupon of more than 8.5% (specially senior citizen). But then in the next interest rate cycle (2-3 years),?it can fall back to as low as 5.5%-6 %. How many of you are aware that single life Non-ROP Annuity scheme can give you a return of 9.14% for the next 25 -30 years.?

I have seen most people in NPS deferring their choice of annuity section or selecting a ROP product. I believe that if one is confident of longevity then one should exercise the choice of buying a Non-ROP product. The choice of opting for 100% annuity of the corpus depends on other personal savings and social commitment. The below exhibit is all about that:

In this image, i have tried to exhibit the difference in financial outcome for INR 1 crore used at age 60 under two alternative options. The pension is INR 59,100/- p.m. when ROP annuity scheme is selected, whereas it is INR 68,400/- p.m. on selecting non-ROP, i.e. exceeds by INR 9,300/- p.m. This excess pension amount is invested, generating a moderate return of 10% p.a. and the balance pension amount can be spent to maintain lifestyle (equivalent to ROP).

We observe that the investment grows to mature a decent amount of INR 1.23 crore in 25 years. This can even become INR 2.10 crore if kept invested till 30 years. The said maturity value under non-ROP is comparatively more (after 25-30 years) than the amount the nominee gets (INR 1 Crore) under ROP, after death of the annuitants. Even a small increase CAGR for investment can build far bigger size of corpus.

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I would like to conclude with an advice. All of you who are in the age group of 58-62 and have a reasonable corpus in NPS; should consider the option of closing the current NPS account and start your annuity. By the way are you aware that once you close an NPS account you can start another one and save till you turn 75 yrs. Let me know how you feel about my suggestion. On the occasion of the forthcoming Independence Day do read about the concept of “FIRE” (Financial Independence: Retire Early). A topic, which I will cover in my next post for the millennials?and Generation Z.?