With Children’s Day here, it might be the perfect time to consider investing in NPS Vatsalya—a National Pension System (NPS) scheme designed specifically for children to help secure their financial future through a dedicated retirement corpus. Under this scheme, the child is the sole beneficiary.
Regulated and monitored by the Pension Fund Regulatory and Development Authority of India (PFRDA), NPS Vatsalya allows parents to contribute a minimum of Rs 1,000 per year, with no maximum limit on investments. Parents manage the account until the child reaches 18 years of age, at which point it is transferred to the child’s name.
As with any financial product, it’s essential to evaluate its structure, benefits, limitations, and available alternatives to decide if it aligns with your child’s long-term goals.
How NPS Vatsalya Works
NPS Vatsalya allows parents or guardians to open an account in a child’s name and contribute towards building a corpus for the child. Contributions go into a mix of equity and debt instruments, aiming for balanced growth with minimised risk.
Similar to a regular NPS account, this is designed for long-term savings; withdrawals are permitted after the age of 18, but ideally kept until 60 for maximum benefits.
“After a lock-in period of three years, guardians can withdraw up to 25 per cent of their contributions, which can be done a maximum of three times. This feature is particularly beneficial for addressing significant life events, such as education expenses, specified illnesses, or disabilities. Upon the child reaching the age of 18, the account transitions into an NPS Tier-I account, which is part of the All Citizen framework,” says Madhupam Krishna, a Securities and Exchange Board of India-registered investment advisor (Sebi-RIA) and chief planner, WealthWisher Financial Planner and Advisors.
“At the age of 18, if the corpus exceeds Rs 2.5 lakh, the individual will be required to use 80 per cent of the corpus to purchase an annuity, while the remaining 20 per cent can be withdrawn as a lump sum. However, if the total corpus is Rs 2.5 lakh or less, the entire amount can be withdrawn in one lump sum,” adds Krishna.
In the unfortunate event of the guardian’s death, the scheme ensures that the entire corpus is returned to the guardian’s designated beneficiary, providing peace of mind and financial security for the child’s future. In case of death of both parents, a legally appointed guardian can continue without making further contributions until the subscriber attains the age of 18 years.
In case of the minor's death, the entire corpus is returned to the guardian.
There are three investment options available. The default choice is – the money is invested in a moderate life cycle fund (LC-50), which allocates 50 per cent in equity. In auto choice, guardians can opt for one of the lifecycle funds —aggressive, which invests 75 per cent in equity; moderate with 50 per cent in equity; or conservative, which allocates 25 per cent to equity.
Advantages Of NPS Vatsalya
NPS Vatsalya is equity-linked, hence it has the potential to generate substantial returns over decades. It offers tax savings, making it financially attractive to parents.
Similar to a regular NPS, one can choose a structure for asset allocation according to one’s preferences to balance risk and returns. Also, the NPS fee is very less compared to other equity investments, such as mutual funds, or direct equity trading. So this also adds to the returns. NPS corpus is managed by Pension Fund Managers (PFMs), who are appointed and vetted by PFRDA. It ensures professional and transparent management of funds.
NPS Vatsalya also develops a child’s vision for long-term investments, retirement planning and a disciplined approach to investing right from childhood.
Disadvantages Of NPS Vatsalya
NPS Vatsalya provides low liquidity. Withdrawals are restricted before maturity, though partial withdrawals are allowed, making it less ideal for immediate financial needs or expenses for, say, education or wedding before the age of 60. It also has the option of a mandatory annuity purchase when you are 60 plus. It provides regular income, but limits lump-sum access to money.
Also, while in balanced investment, NPS Vatsalya still carries market risks in its equity component, which may not appeal to very risk-averse investors.
The suitability of NPS Vatsalya depends on your specific goals, such as retirement or regular income. In India, most parents suffer from a lack of retirement planning for themselves. Hence, an option to exercise a child or children’s retirement planning would ideally be thought of after the parent has already secured his/her own retirement planning needs.
When you plan for a child’s future, the priority should be on the accumulation of funds for the child’s educational goals, or to help him/her set up a business, rather than his/her retirement planning.
In NPS Vatsalya, upon attaining the age of 18, the child can get an annuity by investing 80 per cent of the corpus. But given the rising cost of living and other expenses, it may not be a healthy choice that a child relies on a fixed income throughout his/her life when he/she is at the peak of energy to build his/her career.
What Happens If A Child Studies Or Settles Overseas
Says Krishna: “If the child decides to settle or work abroad, NPS Vatsalya contributions and benefits can continue, as non-resident Indians (NRIs) are permitted to hold NPS accounts. However, they must adhere to NPS rules, including annuity purchase upon maturity. The annuity income, if received in India, may have different tax implications depending on the residence and tax status of the child at that time.”
However, the government and PFRDA are working to make the NPS corpus repatriable upon maturity. This means you could take your corpus directly from NPS trust to an annuity provider in your country of residence. But this is still a plan in working and no clear direction exists right now. Also, this may be allowed for some countries only and may not extend to all jurisdictions.
Comparison With Other Investment Options
NPS Vatsalya is a sound option, with the potential for decent returns and tax benefits. However, if the investment focus is for educational expenses or financial goals before the age of 60, alternatives such as Sukanya Samriddhi Yojana (SSY) for the girl child, or other options such as Public Provident Fund (PPF) or flexible mutual fund options might be a better option.
Comparison With Sukanya Samriddhi Yojana (SSY)
SSY, which is specifically meant for a girl child, focuses on secure savings with a government-backed fixed rate of interest and has tax benefits under Section 80C of the Income-tax Act, 1961.
Here’s How The Two Stack Up
Returns: SSY offers a fixed rate of return decided by the government, which is safe, but potentially lower than NPS’s equity-linked returns.
Liquidity and Purpose: SSY allows partial withdrawals at age 18 for education or wedding, whereas NPS is geared towards retirement savings, with more restricted access.
Risk: SSY is almost risk-free, while NPS involves equity exposure, which can yield higher returns but with market risk.
Tax Benefits: Both offer tax savings, but SSY provides completely tax-free maturity, while NPS Vatsalya’s returns and annuity income may have some tax implications.
If the priority is a secure, fixed-income investment with lower risk and medium-term access to expenses for education or wedding, SSY may be more suitable. However, if long-term wealth creation with a retirement focus is desired, NPS Vatsalya could be better choice.
Comparison With Mutual Funds
Mutual funds offer flexibility and high returns but come with certain trade-offs. However, mutual funds, particularly equity funds, are subject to market volatility and don’t have the regulatory guardrails that PFRDA imposes on NPS.
Mutual funds can provide higher returns than NPS because they are less constrained in terms of asset allocation. They can have 100 per cent exposure in equity and can also leverage using derivatives.
Mutual funds also offer easier access to funds without penalties, making them versatile for short- or medium-term goals, unlike NPS, which is more rigid.
The current taxation aspect of NPS Vatsalya triumphs over mutual funds as long-term capital gains (LTCGs) from equity mutual funds are taxed. There is no tax on mandatory annuity purchases, giving flexibility upon maturity.
If you aim for flexibility and potentially higher returns over the short-to-medium term, mutual funds might be the way to go. For strictly retirement planning with a more structured, risk-controlled approach, NPS Vatsalya could be appropriate.
