Last year’s general budget offered an exclusive advantage for investments in New Pension Scheme (NPS), wherein the investments up to Rs. 50,000 qualified for an additional tax incentive over and above Rs. 1,50,000 allowed under Section 80C for various types of spends including payment for life insurance premiums, 5 year fixed deposits, Public Provident Fund, Equity Linked Savings Schemes etc. This had brought a little cheer, especially in view of the fact that the investment linked deductions and the basic exemption limit had not been increased. Since the last day to make an investment and thus avail the additional deduction for the financial year 2015-16, i.e. 31st March is approaching, let’s analyse the option and whether to really go for the additional tax incentive:
What is New Pension Scheme (NPS)?
NPS is a Govt. initiative to move towards a pensioned society that requires the enrolled person (subscriber) to contribute towards his/ her pension corpus till the age of 60 years. The minimum annual contribution to the eligible account (Tier-1) is Rs. 6,000. The subscriber is given an option to choose an investment manager of own choice out of the empaneled managers. The subscriber can take this decision on the basis of the historical returns achieved by the fund manager which are easily accessible on the website of PFRDA. Further, one can choose to invest in any of three investment options – equity, corporate debt and Govt. securities, but given that it’s a pension scheme, not more than 50% of the money is allowed to be invested in the equity option. At the age of 60 years, 60% of the accumulated corpus money can be withdrawn in a lump sum, and an annuity product has to be purchased with the balance 40% of the corpus. Barring the illiquidity, which otherwise helps in investing discipline too, NPS is one of the lowest cost investment products. Further, if one has his/ her mobile number linked with PAN/ Aadhaar, NPS account can be opened in 10 minute.
Taxation of the Corpus and Annuity Payments
Finance Minister, in his speech presenting Union Budget 2016-17, proposed to exempt payment from National Pension System Trust to an employee on account of closure or his opting out of the pension scheme, to the extent of 40% of the total amount payable to him at the time of closure or his opting out of the scheme. Monthly annuity payments received by the subscriber shall also be subject to tax. However, the whole amount received by the nominee, on death of the subscriber shall be exempt from tax.
Should one Invest in NPS?
While I was doing my own research on the product and deciding whether one should invest in NPS for the sake of additional tax savings, I came across many criticisms for the scheme and was highly discouraged to open an account in it. However, doing more research and some calculations, I finally concluded to open an account.
Here is how I resolved my confusions on the following criticisms of the scheme:
1. NPS is Taxable on Withdrawal – Majority of the investments incentivized through tax savings are based on Exempt-Exempt-Exempt (EEE) Model while NPS was in the category of Exempt-Exempt-Taxable (EET). This ultimately meant only the deferral of the taxes until withdrawal and not exactly saving the tax. However, this aspect has been partially taken care off in Union Budget 2016-17 by making the withdrawals from NPS Corpus exempt to the extent of 40%.
2. Invest in Other Investment Instruments instead of Not-so-liquid NPS – The pension corpus cannot be generally withdrawn till the age of 60 years. This needs to be in fact looked upon as an advantage since such a restriction allows accumulation of a sizeable corpus at the time of retirement. Further, an additional deduction of Rs. 50,000, available only for contribution in NPS puts it into further advantageous position.
With Rs. 50,000 contribution per year under NPS and assumed return of 10% per annum over the invested amount, subscriber who is currently 30 years of age will have a corpus of Rs. 82.25 lakhs at the age of 60 years against total investment of Rs. 15 lakhs. On the other hand, if the same person, instead of investing in NPS, invests the same amount (Rs. 34,550 i.e. Rs. 50,000 minus tax savings foregone Rs. 15,450) in mutual funds over the same period and with same assumed rate of return, the investment grows to Rs. 56.83 lakhs. It calculates to a sizeable difference of Rs. 25.42 lakhs or say 45% which by no means should be ignored. Tax impact on the maturity amount has not been considered in the above calculations, but even the raw post-tax calculations result in 18% higher corpus, given the current tax provisions.
3. Why to Invest in NPS when Annuities are Available Otherwise too – A retiree gets a periodical and guaranteed cash flow after purchasing an annuity and accordingly, may be able to plan his/ her retired life better. One school of thought has an opinion that one can purchase an annuity from the retirement corpus of other investments even without an NPS account. Annuities are not exclusively available to NPS subscribers. However, the calculations carried in the above example were looked for its impact on annuity corpus as well. It was noticed that after withdrawing 60% of the corpus and considering its tax impact, Rs. 32.90 lakhs was available for annuity purchase out of NPS corpus, just about its half Rs. 16.63 lakhs was available for annuity purchase out of the MF corpus.
As discussed above, NPS gives you an option to diversify your retirement portfolio by giving tax advantage at the time of investments and a partial relief at the time of maturity. One may choose to invest in NPS but only till the tax-deductible amount i.e. Rs. 50,000 since without the tax advantage, NPS certainly loses its charm.
Happy Tax Saving and Investing.