NPS Vatsalya: Review: Should you invest?

If you are a young parent, which financial goals would be at the top of your mind?

Let me add a few options.

1. Emergency Fund
2. Kids’ education
3. Purchase of a house
4. Your own retirement (how can you ever ignore that?)
5. Kids’ wedding
6. Parental care
7. And many more

Personal finance is personal. Hence, your goals could be anything under the sun.

However, I am sure most young parents are the least worried about their kids’ retirement. We usually leave it to the kids to figure it out. Unfortunately, that is what NPS Vatsalya offers. A retirement and pension solution for your children. A solution that most parents don’t need.

Please note this is not a commentary on NPS. NPS can be a useful retirement product. Yes, NPS has merits and demerits, but you can use it smartly for your retirement portfolio. I have discussed all these points in this post.

In this post, let us focus on NPS Vatsalya. How does it work? Who can invest? Do you get any tax benefits? How are NPS and NPS Vatsalya related? And finally, should you invest?

How does NPS Vatsalya work?

NPS is a retirement and pension plan for kids. Sounds strange, but that’s what it is.

1. The account is opened for a minor (beneficiary)
2. Until the child is minor, the guardian manages and invests in the account.
3. Once the child turns major, the child (beneficiary) gets control of the account. Can choose to exit on turning major if he/she wants.
4. If the child does not exit at the age of 18, this account gets converted into a regular NPS account and all the rules pertaining to NPS will apply.
5. When the child (beneficiary) turns 60, can take out a portion as lumpsum and use the rest to purchase an annuity plan (which provides the pension).

NPS Vatsalya: Eligibility and Important Features

1. Can only be opened for minors.
2. Must be opened by a natural or legal guardian.
3. Can be opened for both residents and NRIs.
4. Can only be opened for Indian Citizens. Hence, the minor must be a citizen of India (resident or non-resident). Cannot open NPS Vatsalya for an OCI (Overseas Citizen of India) or a foreign citizen. Note: The guardian can be an NRI or an OCI. There is no restriction on residential/citizenship status of the guardian.
5. The minor is the sole beneficiary of the account.
6. PRAN (Permanent Retirement Account number) will be allotted to the minor.
7. The account will be managed by the guardian on behalf of the minor until the child turns 18. When the child turns 18, he/she can manage the account.
8. For a resident minor, you do not need a bank account in the name of minor (or jointly held with minor) to open NPS Vatsalya account. However, you will need to furnish bank details for partial withdrawal or exit before the age of 18 (as the withdrawal can only be to minor’s bank account). For a non-resident minor, NRO or NRE account details are mandatory.
9. Minimum contribution is Rs 1,000 per annum with no cap on maximum annual contribution.

NPS Vatsalya: Exit and Partial Withdrawal Rules

#1 Partial withdrawal

Permitted after 3 years of account opening.

Allowed in specific situations on declaration basis: Education of minor subscriber, treatment of specified illnesses of minor subscriber, and more than 75% of the minor subscriber.

You can only withdraw up to 25% of the contributions (excluding returns). That almost kills the utility of partial withdrawal.

You can make a maximum of 3 partial withdrawals until the age of 18.

#2 Exit at the age of 18

Once the minor turns 18, he/she can exit the NPS Vatsalya account.

However, in such a case, only up to 20% of the amount can be taken out lumpsum. The remaining (at least 80%) must be used to purchase an annuity plan.

Please note, after the age of 18, NPS Vatsalya is converted in a regular NPS account (if the child chooses not to exit the account). Hence, the rules for NPS will apply thereafter.

#3 Regular Exit (after the age of 18)

Happens at the age of 60. You can postpone the exit from NPS until the age of 75.

At the time, you can withdraw up to 60% of the corpus lump sum. The remaining amount (at least 40%) must be used to purchase an annuity plan.

#4 Premature exit (after the age of 18)

Can happen only after completing 10 years in NPS.

In the event of exit before the age of 60, at least 80% of the accumulated corpus must be used to purchase an annuity plan. Only 20% of the corpus can be withdrawn lumpsum.

NPS Vatsalya: Investment options

This is exactly like NPS.

4 types of funds

1. Equity (E)
2. Government Bonds (G)
3. Corporate Bonds (C)
4. Alternative Assets (A): maximum 5%

You can decide the allocation among the 4 types of funds on your own (Active choice). Or you can choose a lifecycle fund and leave this asset allocation to the pension fund manager (Auto-Choice).

Under Auto-choice, you get 3 choices of life cycle funds.

1. Conservative Life Cycle fund (LC25)
2. Moderate Life Cycle fund (LC50): This is also the default choice
3. Aggressive Life Cycle fund (LC75)

Under Active choice, you can choose allocation according to your preference.

1. Equity (E): Maximum 75%
2. Government Bonds (G): can go up to 100%
3. Corporate Bonds (C): can go up to 100%
4. Alternative Assets (A): maximum 5%

NPS Vatsalya: Tax Benefits

NPS tax benefits/concessions come in two ways.

First at the time of investment.

Then at the time of withdrawal/exit, NPS faces a favourable tax regime.

There is no notification from the Government until now that extends the NPS tax benefits under Section 80CCD to NPS Vatsalya too. Hence, as a parent, there is no clarity yet whether you will get tax benefit for contributing to your child’s NPS Vatsalya account. However, you only need a simple notification, and I would expect that to happen soon.

However, please note, once the child attains the age of 18 and becomes a major, the NPS Vatsalya account gets converted into a regular NPS Tier-1 account. Hence, all the rules (and tax benefits) of NPS Tier-1 will apply. The child (on turning major) will get tax benefit on investment in NPS.

At the time of maturity/exit after the age of 18, since the account is a regular NPS Tier-1 account, all the tax concessions that apply to NPS Tier-1 account will apply.

I have covered the NPS tax benefits in detail at the end of this post.

Should you consider NPS Vatsalya for your child?

NPS Vatsalya solves a problem that does not really bother most parents.

For most parents, the topmost priority is to provide good education and upbringing to their child. NPS Vatsalya does not help with funding kids’ education.

Yes, there is a possibility that kids may struggle financially as they grow up and you may want to support them. However, NPS Vatsalya wouldn’t help there either. The money is virtually locked in until your child turns 60.

No one has an infinite capital. Hence, if I must create a corpus for my kid’s education and wedding, I will allocate capital to products such as PPF, SSY, mutual funds etc. These products can provide growth/liquidity for the aforementioned goals.

I see little merit in locking the money until the kid turns 60. Most parents wouldn’t even be alive to see their kids retire at 60. If your daughter is 5 years old, the account will mature in 55 years. We don’t know how the product would have evolved by then OR what would be the tax treatment.

Again, there is nothing wrong with product design. NPS (or NPS Vatsalya) is a useful retirement product. You can consider investing in NPS for your retirement. Let your kids plan for their retirement. You do not have to meddle there.

Worry about your own retirement before you worry about your kids’ retirement.

Yes, you can open NPS Vatsalya account for your child to tick a checkbox. However, I do not see much merit in allocating heavily there.

A quick review of tax benefits on investment and exit from NPS

While this post is about NPS Vatsalya, I will quicky cover the tax benefit on investment in NPS and tax treatment of proceeds at the time of exit from NPS.

#1 Section 80 CCD (1)

1. Applicable if you file ITR under the old tax regime. Not available under the new tax regime.
2. Available for own contribution to NPS
3. Subsumed under the benefit of Rs 1.5 lacs under Section 80C
4. Capped at 10% of salary for employees and 20% of gross total income for self-employed. Salary means Basic Salary + Dearness Allowance

#2 Section 80CCD(1B)

1. Applicable if you file ITR under the old tax regime. Not available under the new tax regime.
2. Available for own contribution to NPS
3. Up to Rs 50,000 per annum. Exclusive tax benefit. Over and above 1.5 lacs under Section 80C.

#3 Section 80CCD (2)

1. Available for both the old and new tax regime.
2. Available when your employer contributes to NPS account.
3. Benefit capped at 14% of salary for Government employees. For private employees, capped at 10% if you file tax returns under the old tax regime and 14% if you file tax returns under the new tax regime.
4. There is an additional cap on this benefit. Total tax benefit for employer contribution to your EPF, NPS, and superannuation account is capped at Rs 7.5 lacs per annum.

Tax Treatment at the time of exit

#1 For regular exit

1. Lumpsum withdrawal up to 60% is exempt from tax.
2. The remaining amount must be used to buy an annuity plan and the income from such an annuity plan is taxed in the year of receipt.

#2 For premature exit

1. Can only withdraw up to 20% lumpsum. That amount is exempt from tax.
2. The remaining amount must be used to buy an annuity plan and the income from such an annuity plan is taxed in the year of receipt.

#3 Partial Withdrawal

1. Partial withdrawals from NPS are exempt from tax under Section 10(12B) of the Income Tax Act.

Additional Read

NPS Vatsalya: FAQs

Disclaimer: Registration granted by SEBI, membership of BASL, and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investment in securities market is subject to market risks. Read all the related documents carefully before investing.

This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.