Should we invest in NPS (National Pension Scheme) to save Tax?

 

I received some queries about NPS from some of my friends/clients. I have been seeing ADs in newspapers that says “Invest in NPS and save Tax of Rs. 15450”. Is it good or bad to investors?

In this mail, I would like to put forward some imp. details about NPS.

NPS – National Pension Scheme. It is basically to encourage people to save towards retirement and to avail pension facility post-retirement.

You can open two types of NPS accounts:

  1. Tier-1: Has lock-in upto retirement age (60). Amount invested in Tier-1 account is eligible for Tax exemption u/s 80CCD (1B) upto Rs. 50000. Minimum investment per annum: Rs. 6000.
  2. Tier-2: Has no lock-in but having a Tier-1 account is mandatory to open Tier-2 account. Not eligible for Tax exemption u/s 80CCD.

Rate of return on NPS investment:

There are 8 Pension Fund Managers, who manage NPS money. ICICI, HDFC, SBI, UTI, LIC etc are the fund managers.
When you invest in NPS, you can select the Fund manager.

Investment option:

a) Asset Class E – Invests majorly in equity (maximum upto 50%) and balance in Fixed income instruments including Government securities
b) Asset Class C – Invests in Fixed income instruments other than Govt. Securities
c) Asset Class G – Invests in Govt. securities

Based on the investment choice and the Fund manager, returns will vary.

Only 40% of the amount accumulated at the time of retirement can be withdrawn and the balance 60% shall be converted to pension. 40% of the accumulated amount is not-taxable and the balance 60% is taxable as per Tax slab.

Illustration of returns comparison between NPS & Equity Mutual Funds. I have taken current age as 34 as I have sent this calculation to a client whose age is 34.

a) Scenario-1: Invest in NPS & save Tax.

Investment in NPS p.a Expected rate of return from NPS Current age Retirement age Amount accumulated @ 60 in NPS
50000 9% 34 60 Rs. 50,86,156.74
50000 10% 34 60 Rs. 60,04,997.10
50000 11% 34 60 Rs. 71,03,931.80
50000 12% 34 60 Rs. 84,18,700.33

The amount received @ retirement is Taxable as per Tax slab. So, tax has to be deducted from the amounts in the last column to arrive at the net-receivable amount. Rate of return from NPS till date has been ~ 9%.

b) Scenario-2: Pay Tax on 50000 as per Tax slab & invest Net amount in an equity mutual fund.

Investment amount p.a Tax Bracket Tax paid Net amount invested post-tax Rate of return Current age Retirement age Amount accumulated @ 60
50000 30% 15000 35000 15% 34 60 Rs. 98,89,906.80
50000 30% 15000 35000 18% 34 60 Rs. 1,67,37,738.26
50000 30% 15000 35000 20% 34 60 Rs. 2,38,29,846.59
50000 20% 10000 40000 15% 34 60 Rs. 1,13,02,750.62
50000 20% 10000 40000 18% 34 60 Rs. 1,91,28,843.73
50000 20% 10000 40000 20% 34 60 Rs. 2,72,34,110.39

Amount received in an equity mutual fund is not-taxable post 1 year. Hence, the entire amount stated in last column is receivable.

Equity mutual funds have given average returns of ~ 18 – 23% p.a in the last 20 years and will continue to do so.

Conclusion:

1) Just to save Tax now, it is not advisable to invest in NPS because anyway you have to pay Tax while exiting NPS at retirement and moreover NPS returns are not encouraging. Rather i would pay tax and invest balance amount in Mutual Fund SIPs since they have given far superior returns as compared to NPS. The corpus/wealth that could be created by investing similar amount in Equity mutual funds is phenomenal as compared to NPS.

2) My aim is not to write against NPS but to give you a realistic picture of how good or bad it is relative to other available products.

3) Average Inflation in India has been ~ 8.5% in the last 100 years. I don’t advise / support any product that gives 8 – 9% returns in the long-term as they don’t beat inflation, which means your real return (Inflation adjusted return) is ZERO which also means your / my money is not growing in value w.r.t inflation, if you invest in such products.

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