Lately, a lot of friends have been calling to ask whether they should invest in the National Pension System (NPS). With tax savings driving our investment decisions, people considering the NPS are merely looking for tax benefits. They are drawn to the additional `50,000 de duction under Section 80CCD(1b). But wouldn’t be investing in the NPS.
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Very long lock-in period
All tax saving investments have lock-in periods, but none as long as that of the NPS. The lock-in period of the PPF is only seven years, after which you can make partial withdrawals, and a full withdrawal can be made after 15 years.
An individual’s own contribution to the EPF can be withdrawn two months after leaving the job. There is a five-year lockin for bank fixed deposits, and NSCs, while ELSS funds lock in your money for only three years. The NPS can only be withdrawn at the age of 60. If you start at the age of 25-30, the lock-in period is 30-35 years. Even then, only 60% of the corpus can be withdrawn, and 40% will have to be put into an annuity .
It’s inflexible, tax-unfriendly and the annuity rates offered are too low
Taxation on maturity
Everyone tries to sell you the tax benefit on NPS, but no one mentions the taxes that will apply at maturity . Out of the 60%, this year’s Budget has proposed to make 40% tax-free on withdrawal, but 20% will be taxed as income. You can avoid taxation by putting this amount in an annuity, but that will only defer the tax. Pension received from an annuity is a mix of the principal and the interest it earns, and is fully taxable.
Low annuity returns
The annuity market in India is nothing to write home about. The yields offered range from 5% to 7%, less than what a bank deposit offers. In fact, banks offer senior citizens a higher rate of interest.The highest annuity rate can be earned if you give money to the insurance company and get a pension for life, without return of principal. That is, if you put in `50 lakh, you will receive `37,500 per month for life, but your heirs will not get anything. If you opt for the annuity that returns the principal on death of the investor, the payouts would be `28,250 per month. Even if your investment earns high returns during the accumulation phase, the poor returns on the annuity will undo much of the gains.
What about tax savings?
Fans of the NPS argue that the tax saved at the beginning more than makes up for the other drawbacks of the scheme.For instance, if you invest `50,000 in NPS, you save `15,000 in tax (assuming you are in the 30% tax bracket). To test this claim, I have compared the NPS returns with those of a mutual fund.The NPS corpus is assumed to earn annualised returns of 10% (don’t expect more because equity exposure is capped at 50%), while the equity mutual fund is assumed to have earned 12% annualised returns. The NPS investor invests `50,000 each year for 30 years, while the mutual fund investor pays 30% tax (`15,000) and invests the remaining `35,000. After 30 years, there is a marked difference in the corpus accumulated by the two investors. While the NPS investor amasses `94.97 lakh, and stands to be taxable for 20% of it, the mutual fund investment yields `1.02 crore, tax free.
There are other arguments in favour of the NPS, including low charges, compulsory savings and long-term benefits.Hopefully , with better taxation and superior annuity products, the dream of a pensioned society will come true. However, till that happens, I prefer to have flexibility and liquidity in my investments, and will, therefore, not invest in NPS. What about you?
The writer is a financial adviser. The views expressed are personal