Saturday, August 29, 2015

NPS: Should you Invest or Not?

What is NPS:
National Pension System (NPS) is a voluntary, retirement savings scheme through systematic savings during their working life. Opening an account with NPS provides a Permanent Retirement Account Number (PRAN), which is a unique number and it remains with the subscriber throughout his lifetime.  The scheme is structured into two tiers:
Tier-I account: This is the non-withdrawable permanent retirement account into which the accumulations are deposited and invested as per the option of the subscriber.

Tier-II account: This is a voluntary withdrawable account which is allowed only when there is an active Tier I account in the name of the subscriber.  The withdrawals are permitted from this account as per the needs of the subscriber as and when claimed.

It can be valid across all jobs and locations. This is regulated by PFRDA (pension Fund Regulatory And Development Authority).
At the time of exit subscribers may withdraw the lump sum amount or may convert the amount to an annuity fund to withdraw as monthly pension or combination of both.
Tier-II account may be converted to Tier-I account but vice versa is not possible.


Tax Benefit:
From the FY 2015-16, 10% of the salary contributed in the NPS is eligible for a tax deduction up to Rs.1.5 lakh under the section 80 CCD and above this, you get an additional deduction ofRs.50,000, taking the total deduction benefit to Rs.2 lakh.
Although you will get extra tax deduction for what you invest in NPS, the maturity is still taxable. This is the major drawback I have found.
Under the EPF, PPF you get a deduction of only up to Rs.1.5 lakh under section 80C. But the maturity amount from it is tax-free.
NPS maturity corpus is taxable. This means you have to pay income tax on the 60% that you withdraw from NPS. The annuities that you get are again considered income and are taxable. Once the rules change and NPS becomes tax-free, which we hope, it will become a very good product because of its low costs.
Returns
So now the question is, should one open a NPS account to avail the additional 50,000 tax deduction?
Suppose I invest 50,000 a year in NPS for the next 15 years and get a return of 10%. I will get Rs. 17.97 Lakhs before taxes.
The return from NPS will be taxed. Not just the gains. If I am in 30% slab, the post-tax maturity value is Rs. 12.58 Lakhs.
Suppose my taxable income is 12,00,000.  I have managed to save Rs. 1,50,000 in say PPF+EPF+ELSS.
So my net taxable income now is Rs. 10,50,000
Case A: The total tax liability is Rs. 1,35,000. So I am left with Rs. 9,15,000 to manage my investments (other than Rs 1,50,000) and other expenses.
If, I invest Rs. 50,000 in NPS, the net taxable income is, Rs. 10,00,000.
Case B: The total tax liability is Rs. 1,25,000. So now I am left with 10,00,000-1,25,000 = 8,75,000 to manage investments (other than Rs 1,50,000) and other expenses.
In Case A, I do not invest in NPS. So I am left with Rs. 40, 000 extra. I can invest this in an equity mutual fund for 15 Y at 12% return (Min). I will get Rs. 15. 86 Lakhs.
In Case B, I invest in NPS. Meaning I do not have any extra sum left. My NPS investment for 15Y at 10% return will give be the same Rs. 12.61 Lakhs.
Please do not invest in NPS for tax-saving only. It has liquidity issue and If you quit before age of 60 years, 80% of the money will be locked in an annuity. After 60, minimum 40% is the annuity requirement.
Paying the tax and investing in equity mutual funds you will be able to beat NPS return.

Hence, please do Not Invest in National Pension Scheme to save Tax only