The recent Supreme Court ruling to add non-variable allowances like special allowance to the basic to calculate EPF contribution is a big positive for employees as they would have more at retirement.
PPF, VPF, NPS, ULIP, equity mutual funds — What should one choose for retirement? Most salaried individuals stick to EPF. And why not? A risk free, tax free instrument, which is also easy to invest into as the contribution gets automatically deducted from the salary with a matching contribution by the employer.
The recent Supreme Court ruling to add non-variable allowances like special allowance to the basic to calculate EPF contribution is a big positive for employees as they would have more at retirement. However, just EPF may not be enough to meet the expenses post retirement. Which is why private sector employers are also offering NPS on a voluntary basis. Some corporates are also contemplating using NPS for their superannuation fund.
In this context, I have often been asked whether NPS is a good retirement tool. My answer is neither yes or no. One of the reasons NPS is being promoted is because of the additional Rs 50,000 per annum tax deduction benefit under Sec 80CCD. However, I believe that equity mutual fund may be a better option in some cases.
Let us take an example and assume that equity MF and NPS will give the same return till retirement. As mandated in NPS, at the time of retirement, 60% of the accumulated corpus can be withdrawn tax-free and the balance 40% has to be invested into an annuity.
Now, let us assume that the 60% corpus in case of NPS and 100% corpus in equity MF at retirement is invested into fixed income. Due to pension returns being lower than that of other fixed income instruments and further taxable, the overall return on the reinvestment of retirement corpus, which has been accumulated in NPS will be lower than the retirement corpus, which had been built using equity MF. Hence, my preference to equity mutual funds.
While one can argue that NPS has a tax saving component and due to this the overall return in NPS will be higher, the tax savings usually gets spent and not reinvested back into equity. Of course, NPS being a very low cost product could result in better returns than equity mutual funds but the limitation of having a portion of the retirement corpus to be commuted into an annuity is a big negative for NPS.
However, the fact remains that for most people to choose the right mutual funds and stick to disciplined investing in equity mutual fund is a challenge. While funds are also more liquid and flexible, this could be work negatively in the cases where investors tend to panic or withdraw the funds to fund purchases.
It is well known that people start thinking of retirement planning in their 40s, simply because they do not think it important to start early on or cannot do so because of lifestyle expenses. Actions that give instant gratification are focused on over boring financial planning. Further, people find financial instruments, especially market-linked products, complex and difficult to follow and fear losing money.
Hence, they may prefer to choose traditional investments, which will not beat inflation and certainly cannot be used for retirement planning.
In such a situation, NPS is the best tool for retirement planning. What works for NPS are the nudges it provides which can overcome these behavioral aspects that stop people from saving for retirement.
Having the employer facilitate enrollment into NPS makes it easier for the individual to set up an account. Further, an automated investment deducted every month from your salary and invested into an auto option which balances the asset allocation between debt and equity as per your age reduces the complexity of having to choose investment options.
Finally, the fact that this forced saving cannot be withdrawn until retirement, ensures that people don’t end up withdrawing the corpus for lifestyle purchases.
So if you can’t stick to disciplined investing in equity mutual fund or don’t know which fund to choose or are confused by the markets, invest in NPS. For me, equity funds work better as I have the ability to remain invested for the long term and do not want a drag on returns in retirement due to a forced annuity.
So, choose between NPS and equity mutual funds for retirement planning based on your behaviour bias!(The writer is Financial Educator, Money Mentor and Founder of Finsafe India).