Amit Kukreja
The Union budget has proposed an additional deduction of Rs.50,000 under section 80CC(D) if you invest in the National Pension System (NPS). NPS that was made available to public investors almost six years ago could not attract investors. However given the tax deduction NPS now offers, it will attract investors. In India tax deductions drive a lot of investment decisions. Though the budget has not proposed any changes in the features of NPS, the additional deduction will drive huge investments into NPS in the coming years. So, where does NPS fit into your retirement portfolio?
Let’s first understand the advantages that NPS creates for investors:
• The additional tax deduction of Rs.50,000/= for investments done in NPS;
• It would now be offered as an alternative benefit to the employees besides EPF;
• It is one of the lowest cost pension schemes in the world. The total recurring expenses including the fund management fee varies between 0.05% and 0.25% per annum;
• It is portable i.e. can be managed and operated from any part of the country;
• It offers flexibility of choice of pension fund manager;
• It offers flexibility of asset allocation to equity, corporate bonds and government bonds;
• For those investors who are not confident of choosing the right asset mix for themselves, they can avail of the inbuilt ‘Life Cycle Fund’;
• It falls under EET (Exempt-Exempt-Taxable) status of taxation; and when you withdraw the funds on maturity, any portion that is used to buying an annuity will not be taxed. Only lump sum withdrawn amount will be taxable.
The key feature that differentiates NPS from EPF is its exposure to equity (Nifty stocks). The equity exposure is capped at 50%. This protects investors from the market lows. If one takes a long term view of the market, 50% allocation to equities in the portfolio will create a decent return in one’s portfolio. Since NPS is meant for retirement phase, with lock-in feature it creates the investment horizon that can be a very long term. It is not liquid; that is its strength. Compare it with EPF that has the liquidity option, investors often use life-stage scenarios to withdraw money from EPF corpus that adversely impacts the corpus ear-marked for retirement. Not to forget, EPF is a debt-scheme with returns not being as high as in an equity-based scheme. NPS is likely to take off slowly but as the market completes a business cycle or two the differential in returns of NPS and EPF will speak for itself. Leave alone the convenience of tracking portfolio and portability in NPS.
The purpose of NPS is to provide regular income during the retirement phase. The purpose would not be achieved if the corpus is not given the horizon and exposure to equity to grow. And before the corpus is turned into annuity scheme generating monthly income, the corpus needs to be insulated from any withdrawals and continued for its exposure to equity for compounding magic. NPS offers a market linked investment opportunity for your retirement corpus in the given economic environment when macro economic factors are pro-growth. It is very likely to create better returns that a provident fund can offer.
Importantly, remember that the taxation on withdrawals in NPS is on the entire lump sum amount including the principal component. This lump sum cannot exceed 60% of the total corpus built via NPS. Let us take a simple calculation. A 30 year old employee is investing Rs5000 per month for next 30 years. For his total invested amount of Rs 18 Lacs over 30 years, his total corpus accumulated via EPF (@8.75% p.a.) is approximately 87.50 Lacs. And his total corpus accumulated via NPS (@13% p.a.) is approximately 2.21 Crores. If he uses 40% to buy annuity i.e. Rs.88 Lacs and withdraws a lump sum of 1.33 Crores, he is still better off. The annuity will create his regular monthly income and the lump sum withdrawal (after capital gains taxes using indexed cost of acquisition) would still leave him with a decent amount in hand for further investments. Please note that even conservative returns for equity over a long period are not only creating a lifelong pension-bearing annuity, but also a lump sum amount, post tax, that is much higher than EPF.
So, NPS does make a strong case for your retirement portfolio. How do you choose one? Well, while choosing a pension fund manager one should evaluate consistency of returns, profile of the debt portfolio, pension fund manager’s performance record and risk adjusted returns. To build your retirement corpus earmark your assets for growth. This list could be a list of assets like EPF, PPF, NPS, Equity Mutual Funds, and Real Estate. I believe NPS will turn out to be the core element of retirement planning strategy.
Amit is a member of The Financial Planners’ Guild , India (FPGI). FPGI is an association of Practicing Certified Financial Planners to create awareness about Financial Planning among the public, promote professional excellence and ensure high quality practice standards.
