We discuss a simple, holistic guideline or thumb rule to decide between the Unified Pension Scheme and the National Pension Scheme. We have published a calculator to compare NPS and UPS.
However, this involves too many unknowns and projections if retirement is far away. Also, the calculator only compares the two products, NPS and UPS. A better way to deal with the problem is to ask which is more suitable for me.
Let us do this exercise.
Imagine for a moment your NPS corpus becomes zero (please bear with me and imagine). Also, assume your future NPS contributions vanish. With your other investments meant for retirement (MFs, PPF, etc.) and future investments into these instruments (excluding NPS contributions!), can you still achieve a retirement corpus sufficient for a comfortable retirement? You can use a tool like the freefincal robo advisor to find out.
If you can retire comfortably without your NPS corpus, you are not too reliant on NPS. There is no great compulsion for you to switch to NPS. You can stay put in NPS and have greater control over your corpus. Even if you switch to UPS, the pension will only be a small component of your retirement portfolio. It will serve as an income floor. See: Creating the ideal retirement plan with income flooring! If this is you, then we recommend staying put in NPS.
If your NPS corpus is not significant, do the following. Imagine your current NPS corpus is zero. Also, assume all your future NPS contributions vanish. Can you invest enough in other investments, like MFs, PPF, etc., for your current salary and expense profile to achieve a comfortable retirement corpus?
If the answer is yes, you can be financially independent at retirement without NPS, so you don’t need UPS. You can stay in the NPS.
If the answer is no, I cannot save enough for retirement without NPS contributions. I will not have enough nest egg for retirement without considering the future value of my current NPS corpus. Then, you are dependent on the NPS. Your investments from other sources may not be significant at retirement. Then UPS may be suitable for you.
Many people will fall in between. Their retirement corpus health is neither entirely dependent on the NPS nor completely independent. Then, they should first resolve to invest as much in other instruments as possible and keep their expenses low.
Can we refine this thought experiment?
Determine the following:
- Current annual expenses that will continue into retirement divided by the current value of the total retirement corpus (inc NPS). We will call this current withdrawal rate.
- Project your annual expenses at retirement using an inflation rate of 6%. Project your current investments (including NPS) at the time of retirement
- Divided the projected expenses at retirement by the projected total corpus at retirement. This is the withdrawal rate at retirement.
If your current withdrawal rate is less than 4%, it is a good sign that you are not overtly dependent on NP; if it is well above 4%, then you are highly dependent on the NPS.
If the projected withdrawal rate at retirement is expected to be 3.5% or lower, you probably don’t need the UPS. The lower the rate, the less you need the UPS. If it is greater than 4.5%, your expected corpus may not be enough, and you will need UPS. The higher the rate, the higher you need the UPS.
If the projected withdrawal rate is between 3.5% and 4.5%, then you still need the support of the UPS. Perhaps future promotions and pay commissions may work in your favour. But try to increase your investment for retirement, avoid debt and keep expenses low.
This is a calculator based on the above logic (more details tomorrow)
Download the free NPS vs UPS Calculator!
Version 8: Updated 28th Aug. with withdrawal rates in a separate sheet. Please check back for version updates. For feedback and bug reports, email freefincal [AT ] gmail [DOT ]com
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
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