I compare investing in NPS to putting your money behind bars. If this headline sounds like a clickbait to you, wait to hear about your favourite investment, NPS or National Pension Scheme and the bigger bait you are falling for.
Are you investing in NPS?
I have seen all kinds of investors – young and older, investing amateurs and experts, fall for the NPS trap. The tax saving bit is so attractive that they are willing to forgive and ignore every other aspect of the National Pension Scheme.
First, a quick touchdown on the origins.
NPS was introduced in 2004 by the Govt. of India for its own employees. Saddled with rising pension burdens, the Govt took upon it to reduce its liabilities by making the employees contribute for their own retirement.
Before that, the pension used to be ‘defined’ or assured. Now, it became contribution based, that is, you make your own retirement pension pot.
And then gradually, NPS was rolled out to the private sector too. Along with the favourite bait of “save taxes.”
The bait has worked and investors are lapping it up specially the Section 80CCD(1) benefit for Rs. 50,000 investment in NPS.
Unaware of the details or the implication of them, most investors who are investing in NPS are sending their money to life imprisonment.
Investing in NPS is equal to sending your money to life imprisonment.
Here’s how:
#1 Behind bars
Once you contribute to NPS, you cannot withdraw your money before age 60.
Not just that, once you get started with your NPS account, you have to keep contributing every year (minimum amount). Else, the account will lapse.
The money is locked in. There are some provisions to help you get some part of your own contribution in case of emergencies. That’s it.
This may be fine if you are a government employee and even fine, if you just want to slug it out in jobs till 60.
But then not everyone, at least several of the investors I work with, plan to work till age 60.
In comparison, your EPF can be withdrawn in entirety (at least for now), if you are unemployed for more than 2 months. Read that again!
You yourself could be one who has done that. Try doing it with NPS.
While, you are happy that something is being invested for ‘retirement’ and you are saving 30% tax too, please remember you are saving tax now, but you have to pay your dues later. More follows.
#2 Tax and withdrawal of NPS
So, you turned 60 with happy dreams about retirement.
But let me wake you up. You cannot withdraw all your money. If you need a lump sum, only 40% of your total NPS corpus can be withdrawn tax free. You can withdraw another 20% of your money, by paying tax at the marginal tax rate.
The remaining 40% has to cumpulsorily be converted into an annuity. So, a part of your money gets bail but the rest stays behind bars.
Imagine a person being let free but only the lower part of the body is released. The fingers of the hands, arms, ears, eyes, head will be released over time, one by one.
All of this annuity is counted as your taxable income. Yes, all the money that has grown over the years will now be taxed at your marginal tax rate.
Annuity products come with their own issues. In fact, annuity, as an investment product today, does not inspire a lot of confidence. You sign up for a product with a constant rate of interest, devoid of what inflation will be. You have no control of your investment portfolio.
With NPS, you also have no choice but to opt for an annuity with one of its enrolled service providers.
Welcome to NPS land!
By the way, if you had any doubt about returns and risk with NPS and if you are making the mistake of double counting your tax benefit, you must read the following notes.
Note 1 – Double counting NPS tax benefit. Too many investors fall for this.
Note 2 – NPS withdrawal, a detail of what we mentioned above.
Note 3 – NPS returns are not assured and there is risk too, in case you thought otherwise.
Final words
If you have to pay tax and still take risk to ultimately get market-linked returns, why not do it at your own convenience, flexibility and with choice?
I, for one, am not investing in NPS.
What about you?
It may be better to forego the initial tax benefit and invest the money in other options. Perhaps a combination of a multi cap fund & PPF or even a balanced fund. It has benefits such as asset allocation, tax efficiency, ability to switch from non performing fund and better liquidity.. Not to mention, one can decide how to use the final corpus.
That’s right, Sujay. Thanks for the comment.
Foe past 4-5 years NPS has started gaining momentum and as it is gaining momentum the scheme is getting better and better.
Returns are good and are market oriented during the stage of investment.
As per the article in business today ( link given below), EPF and NPS are not alternative to each other but are complimentary.
http://www.businesstoday.in/money/news/nps-vs-epf-which-one-should-you-go-for/story/248470.html
Soon, one may not have a choice 😉
NPS is a pension system. A pension, as defined by Oxford Dictionary is – “A regular payment made during a person’s retirement from an investment fund to which that person or their employer has contributed during their working life”.
NPS is exactly what it is supposed to be unlike EPF or PPF which are Provident Funds – where lump sum payments at retirement is the norm.
As for the tax treatment part, yes, these products should have tax parity. EEE or EET for all. But then again, if you see the logic of taxation on lump sum, it is a nudge to annuitize your corpus.
Now debating about whether to buy an annuity or if annuities are good products is a completely different thing. NPS essentially is meant for purchasing an annuity at retirement.
Hi, A very nice article. But perhaps if you could have explained the same with an actual scenario(numbers) if would have made more sense. For Example:
Case 1: where a person pays 50,000 and claims a tax exemption say 30% and after say 30 years what would be be corpus.
Case 2: where a person does not invest in NPS and instead some else what would be the corpus after 30 yrs.
Thanks Alok.
Well, there is one such article. Read here: http://www.vipinkhandelwal.com/why-am-i-not-investing-in-nps/
A person I know works for a PSU bank. They are made to contribute to the NPS. I don’t think they even have an alternate choice; the employer is mandating NPS. I am appalled at the mandatory 40-20-40 withdrawal and annuity ratios too. The whole thing is ridiculous.
I personally feel, all that contribution, if made to a good mutual fund will earn far better returns. Those who are not confident of making such decisions can stay with NPS. But, those who want to, should be allowed to invest elsewhere.
That’s right. You can do better without NPS.
All instruments have advantages and disadvantages , the point is that diversify it. I do not agree with this article . If somebody’s age is 40 Years, he is contributing only Rs.50000 per year in NPS for tax rebate , he is saving 16000 per year. The purpose is to get regular pension which is required for social security for sure. If somebody commute 40% of the accumulated amount and 60% to be used for Annuity, there is not tax on accumulation. For the pension amount there will be tax as per tax slab as it is an income . However if somebody else is putting more than 50000 in NPS per year, they may not get maximum benefit in comparison with other investments…
I agree with you vipin on NPS. Apt title you kept for the product i.e.life imprisonment for your money,You will not enjoy your corpus to the last penny forever.The taxation part of NPS is the worse thing , above that you cannot withdraw your full corpus with out paying any tax.I guess this rule will never change probably :).if it changes the annuity products industry will loose heavily.With this product your money will be used by the insurance companies and other govt agencies.saving tax is a big trap for the investors.personally i have not invested my money in this and I wont do also. In my opinion any investment product should be very simple,flexible,tax efficient for any investor .NPS fails in all these things and it will remain most probably like that only for a long time.A good managed equity MF or even a index fund can earn you the same returns over that long period which are simple,flexible and tax efficient compared to NPS.
Good pointers Sai. Thanks for the comment.