NPS Vatsalya: A Double-Edged Sword for Parents Investing in Their Children’s Future
The National Pension System (NPS) Vatsalya scheme has emerged as a potential investment avenue for parents aiming to instill financial discipline and good money habits in their children from an early age. While the scheme is designed to help parents save for their children’s future, particularly for retirement, it raises several concerns when it comes to funding education and marriage. Here are the key aspects to consider before deciding if NPS Vatsalya is the right choice for your child’s financial future.
1. Lower Amount of Equity
One of the most significant drawbacks of NPS Vatsalya is its limited equity exposure. The scheme allows a maximum of 75% of contributions to be allocated to equities, whether through auto choice or active choice. Financial planners argue that this allocation is insufficient for a long-term investment with a lock-in period of up to 18 years. Colonel (retd) Sanjeev Govila, a certified financial planner and CEO of Hum Fauji Initiatives, emphasizes that parents typically save for their children’s education and marriage, which often requires a substantial corpus. He suggests that investment options with 100% equity are more suitable for long-term goals, as they tend to yield higher returns compared to a capped equity allocation.
Kavitha Menon, a SEBI-registered investment advisor and founder of Probitus Wealth, echoes this sentiment, stating that the inability to invest 100% in equities is a significant limitation of the NPS Vatsalya scheme. Given the long-term nature of these investments, a higher equity allocation could potentially lead to a more substantial corpus.
2. Pension for Kids at 18
NPS Vatsalya allows parents to make decisions regarding the pension scheme once their child turns 18. At this point, the child can either exit the scheme or convert their Vatsalya pension account into a regular NPS Tier-I account. If the child opts to exit, they will receive 20% of the accumulated corpus as a lump sum, while the remaining 80% will be used to purchase an annuity. However, if the total corpus is less than Rs 2.5 lakh, the entire amount is paid out as a lump sum.
This structure raises concerns for parents who may need significant funds at this age to cover educational expenses, especially for higher education. The provision of a pension at 18 years old may not align with the financial needs of parents, effectively undermining the purpose of long-term saving.
3. Goal Rigidity
NPS Vatsalya is fundamentally a retirement product, which can lead to rigidity in financial planning. While the scheme allows for partial withdrawals under specific circumstances—up to three times and for reasons such as education or specified illness—these withdrawals are limited. Menon points out that most parents require funds for higher education when their child turns 18, yet the scheme does not adequately address this need.
Govila criticizes the scheme’s exit rules, suggesting that they seem to be a mere adaptation of the older NPS framework without consideration for the unique needs of children and their educational journeys.
4. Lower Ceiling for Complete Withdrawal
Another notable limitation of NPS Vatsalya is its lower ceiling for complete withdrawal. In the regular NPS scheme, individuals can withdraw their total accumulated amount as a lump sum if it does not exceed Rs 5 lakh at retirement. In contrast, NPS Vatsalya allows lump-sum withdrawals only if the corpus is less than Rs 2.5 lakh at maturity. This discrepancy can be problematic; for instance, a child with a corpus of Rs 3 lakh would receive only Rs 60,000 as a lump sum, with the remainder required to be converted into an annuity. This may not be sufficient for many families, highlighting the need for a more favorable withdrawal ceiling.
5. Extended Lock-in Period
The NPS Vatsalya scheme features a long lock-in period, which can be a deterrent for parents. The funds are locked in until the child turns 18, and if they choose to transition to a Tier-I NPS account, the lock-in continues until the age of 60. This effectively means that parents are committing to a lifelong lock-in for their child’s pension, which may not be ideal for those looking for more flexible investment options.
6. Limited Liquidity
As a pension scheme, NPS Vatsalya inherently offers limited liquidity. While parents can partially withdraw up to 25% of their contributions for specific purposes, such as education or serious illness, these withdrawals can only occur after a three-year lock-in period. Furthermore, they are restricted to three instances before the child turns 18. This limited liquidity can pose challenges for parents who may need funds for significant expenses that arise after their child reaches adulthood, such as graduation, post-graduation, or marriage.
Menon highlights that the scheme’s structure may not adequately support parents during critical financial moments, making it less effective for funding their child’s education.
7. Lack of Clarity on Tax
Finally, there is a notable lack of clarity regarding the tax implications of NPS Vatsalya. Unlike the regular NPS for individuals, which follows an Exempt-Exempt-Taxed (EET) taxation model, the tax benefits associated with investments made under NPS Vatsalya remain ambiguous. Govila calls for the government to provide clear guidelines on the tax advantages available to parents investing for their children under this scheme, as this uncertainty can impact financial planning.
Final Thoughts
While NPS Vatsalya may seem like a promising investment scheme for parents looking to teach their children about financial discipline and saving for the future, it is essential to weigh its limitations carefully. The scheme’s lower equity allocation, rigid withdrawal rules, and lack of clarity on tax benefits may make it less suitable for parents aiming to save for their children’s education and marriage. As with any financial decision, thorough research and consultation with financial advisors are crucial to ensure that the chosen investment aligns with long-term goals.