One of the biggest pain points that investors find in the National Pension Scheme (NPS) is the taxation part. Of the 60 per cent corpus that could be withdrawn lump sum at age 60, about 40 per cent is tax free and 20 per cent is taxable under the present rules. Now, in a recent development, the government has exempted even the 20 per cent from tax taking the tax exemption limit from 40 per cent to 60 per cent. This means that the money invested in the scheme (up to a limit) is exempt from tax, the profit earned from it while staying invested is exempt from tax and the money withdrawn is also exempt from tax. So, now one can withdraw the entire 60 per cent of the total corpus tax free and the balance 40 per cent will be annuitized, i.e., pension plan bought with the money. This changes in tax rules on NPS withdrawal will apply to all subscribers, including government employees and will come into effect in 2019.
The other changes recommended include:
The Central Government’s contribution as employer to the NPS will be increased to 14 per cent of the basic pay from the current 10 per cent. The employee contribution will remain unchanged at 10 per cent. This is likely to increase the accumulated corpus of government employees.
Contribution under Tier II of NPS has been brought under the ambit of Section 80C for deduction up to Rs.1.5 lakh for the purpose of income tax benefits. Amongst the two types of accounts that NPS offers to its subscribers, the Tier II account is a voluntary savings account and subscribers can withdraw their money from it whenever they want. The Tier I account is non-withdrawable till the subscriber reaches the age of 60. Partial withdrawal before that is allowed in specific cases. To invest in Tier II account, opening Tier I account is mandatory.
The central government employees will get more investment options (both debt & equity) and choice of pension fund managers.
These changes will come into effect from April 1, 2019.
Does the NPS now become an attractive investment option?
Now that in NPS, the main thorn in the flesh is gone – the taxation part, investors have started doing the obvious – a comparison between NPS returns with those of EPF and PPF. And they are finding NPS returns attractive. But we feel that the comparison is myopic and unfair. NPS, EPF and PPF are retirement products. The similarity ends there. They are structured differently, i.e., the features vary right from the investment options where your money is parked to withdrawal restrictions. For instance, in EPF, the entire accumulated corpus is returned to you at the time of retirement. In the case of PPF, after the initial maturity of 15 years, you have the option to either withdraw your entire money and close the account or you can extend it till your lifetime for a fixed block of five years, each.
In NPS, the entire corpus is not available on hand to an investor at the time of retirement. While 60 per cent of the accumulated fund can be withdrawn (totally tax free), the retiree has to mandatorily buy annuity, i.e. pension plan from the balance 40 per cent. The annuity income will be taxable at the applicable tax slab.
The Annuity feature is a boon: Many investors are averse to this lock-in feature of NPS and are not willing to park a sizeable portion of their retirement fund in an annuity. They want complete control over their corpus.
But the main worry of any person after retirement is not earning high returns. It is how to invest a huge corpus running into lakhs or crores and get a regular income out of it. So, contrary to the above perception of money getting locked-in, annuity actually is a suitable option for retirees to get a fixed flow of monthly income. The retiree has a peace of mind about this fixed pension crediting into his bank account every month irrespective of the state of stock markets, the economy, political environment, interest rates, etc.
Secondly, this 40 per cent locked in an annuity which will not be returned to a retiree in his lifetime actually works in his interest. Retirees dipping into their retirement fund to fulfil their children’s goals is very common. Now when the money is locked in an annuity, not only is it available only for parents for sustenance but they will also think diligently and long term as to how to utilise the balance 60 per cent corpus. Further, a Do-it-Yourself (DIY) investor may want to call the shots and prefer managing retirement money on his own. It may appear easy earlier but with passing age, the mental faculties are not very sharp and supportive enough to enable a retiree to take informed financial decisions. In such context, it is a relief for a DIYer that 40 per cent of the corpus is locked in and he is getting a fixed income out of it.
Who should invest in NPS?
Investors in the highest tax bracket can consider to invest in NPS. Besides the corpus withdrawal made tax free, investors in the 30 per cent bracket can take advantage of the Rs.50,000 deduction offered under 80 CCD.
Investors who have at least 15 working years left to retire and have time on their side to accumulate a huge corpus can consider to invest in NPS.
NPS not only induces the habit of compulsory saving and investing regularly but there are stringent restrictions in withdrawing the corpus. So, individuals who are not disciplined and tempted to withdraw from their investment kitty every now and then can invest in NPS. They can forget about the money till they retire.
NPS actively manages the investor’s money by placing it in equity and debt (fixed income like deposits, bonds, etc) with an auto switch option to shift between the asset classes. Investors who need help in deciding their asset allocation can adopt a life-cycle based approach in NPS under which the allocation to different asset classes changes gradually as the person’s age increases. This can also be helpful to investors who do not have the time to review and rebalance their portfolio.
We at VSK believe that there is no bad or a good financial product. It is suitable or unsuitable depending upon the unique financial situation of an individual. Not just returns, investors need to evaluate all the aspects of NPS and then decide whether it is a suitable investment for them.