All about NPS
NPS is the much talked about National Pension Scheme introduced in 2004, for government employees. It is now open to all Indian citizens as a retirement saving vehicle. This blog explores the instrument and provides insight into the working of NPS.
The account details
NPS has a Tier-1 account, which is the non-withdrawable retirement savings account and a Tier-II account, a mere savings account. You can open an NPS a/c online using Aadhar or PAN card. The minimum contribution is Rs.500 pm / Rs.6k pa. Every subscriber gets a PRAN# (Permanent Retirement Account Number). NPS has 3 classes of assets:
The account details
NPS has a Tier-1 account, which is the non-withdrawable retirement savings account and a Tier-II account, a mere savings account. You can open an NPS a/c online using Aadhar or PAN card. The minimum contribution is Rs.500 pm / Rs.6k pa. Every subscriber gets a PRAN# (Permanent Retirement Account Number). NPS has 3 classes of assets:
- E: Investments in predominantly equity market instruments. Maximum investment in this class is 50% of total contribution.
- C: Investments in fixed income instruments other than Government securities.
- G: investments in Government securities.
Investment Choices
NPS offers "Active Choice" & "Auto Choice" options to its subscribers. Under the Active choice, the subscriber has an option to choose a fund manager and provide the ratio in which his / her funds are to be invested among the asset classes. The auto choice allocates 50% to equities, 30% to corporate debt and 20% to government debt. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in E and C asset class will decrease annually and the weight in G class will increase annually till it reaches 10% in E, 10% in C and 80% in G class at age 55. At present, the funds are managed by 7 fund houses at very low fund management fees of 0.01% compared to 2% when one invests directly in the mutual funds market.
Tax Benefits
This scheme is classified as EET - exempt at the time of contribution, exempt at the time of earning interest/returns & taxable at exit. Upon attaining 60 years of age, 40% withdrawal is tax free, another 40% of the corpus must be used to buy an annuity and the balance 20% is taxable at prevailing marginal rates. Various tax benefits have been offered to this scheme since inception, but the latest offer from this financial year is:
NPS offers "Active Choice" & "Auto Choice" options to its subscribers. Under the Active choice, the subscriber has an option to choose a fund manager and provide the ratio in which his / her funds are to be invested among the asset classes. The auto choice allocates 50% to equities, 30% to corporate debt and 20% to government debt. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in E and C asset class will decrease annually and the weight in G class will increase annually till it reaches 10% in E, 10% in C and 80% in G class at age 55. At present, the funds are managed by 7 fund houses at very low fund management fees of 0.01% compared to 2% when one invests directly in the mutual funds market.
Tax Benefits
This scheme is classified as EET - exempt at the time of contribution, exempt at the time of earning interest/returns & taxable at exit. Upon attaining 60 years of age, 40% withdrawal is tax free, another 40% of the corpus must be used to buy an annuity and the balance 20% is taxable at prevailing marginal rates. Various tax benefits have been offered to this scheme since inception, but the latest offer from this financial year is:
- Employee's contribution - 10% of (Basic + DA), Relief u/s 80CCD(1), subject to max Rs.1.5Lacs u/s 80C
- Employer's contribution - 10% of (Basic + DA), Relief u/s 80CCD(2), over and above Rs.1.5Lacs limit of 80C
- Self-employed - Upto 10% of gross income u/s 80CCD(1)
- An additional tax benefit of Rs.50k has been granted u/s 80CCD(1B) - over and above Rs.1.5Lacs limit of 80C
How much tax do you really save?
Practically, most tax payers would have already exhausted their Rs.1.5Lacs exemption u/s 80C. Also, it is not easy to convince employers to move from EPF to NPS. So, only the excess Rs.50k u/s 80CCD(1B) could be realistically availed by a tax payer. If the assessee is in the 30% tax bracket, then s/he gets to save Rs.15450 p.a on the Rs.50k NPS contribution. If we offset the tax applicable on the 20% corpus withdrawal at retirement, net tax saving would come to Rs.12450 p.a. If the NPS subscriber chooses an auto-choice or an asset allocation favoring equities, then his/her returns would be in the range of 12-15% p.a over a 15-25 year contribution time frame.
For example, a 40 year old, planning to retire in 15 years and availing the Rs.50k relief u/s 80CCD(1B) could accumulate a corpus of Rs.20.87 Lacs (@Present value of Rs.8.7Lacs) upon retirement. If wisely invested, that could provide a return of Rs.1.62 Lacs p.a (@Present Value of Rs.67k p.a) for the next 20 years until s/he is 75 years of age. In simple terms, a contribution of Rs.50k gives back Rs.67k p.a in one's twilight years. Similar contribution in PPF may provide only Rs.50k p.a (vs) NPS' Rs.67k p.a.
Conclusion
If an investor takes the realized tax savings of Rs.15450 and invests it in an equity-oriented mutual fund for say 15 years, it would return another Rs.6.45Lacs (@Present value Rs.2.69Lacs), boosting the overall effective return from NPS by another 30% (from Rs.20.87L to Rs.27.32Lacs). So, in both ways it proves as a valuable addition to one's retirement corpus. Even assessees who are risk averse could try this path and boost their retirement funds by limiting their asset mix to 50% in equities.
Practically, most tax payers would have already exhausted their Rs.1.5Lacs exemption u/s 80C. Also, it is not easy to convince employers to move from EPF to NPS. So, only the excess Rs.50k u/s 80CCD(1B) could be realistically availed by a tax payer. If the assessee is in the 30% tax bracket, then s/he gets to save Rs.15450 p.a on the Rs.50k NPS contribution. If we offset the tax applicable on the 20% corpus withdrawal at retirement, net tax saving would come to Rs.12450 p.a. If the NPS subscriber chooses an auto-choice or an asset allocation favoring equities, then his/her returns would be in the range of 12-15% p.a over a 15-25 year contribution time frame.
For example, a 40 year old, planning to retire in 15 years and availing the Rs.50k relief u/s 80CCD(1B) could accumulate a corpus of Rs.20.87 Lacs (@Present value of Rs.8.7Lacs) upon retirement. If wisely invested, that could provide a return of Rs.1.62 Lacs p.a (@Present Value of Rs.67k p.a) for the next 20 years until s/he is 75 years of age. In simple terms, a contribution of Rs.50k gives back Rs.67k p.a in one's twilight years. Similar contribution in PPF may provide only Rs.50k p.a (vs) NPS' Rs.67k p.a.
Conclusion
If an investor takes the realized tax savings of Rs.15450 and invests it in an equity-oriented mutual fund for say 15 years, it would return another Rs.6.45Lacs (@Present value Rs.2.69Lacs), boosting the overall effective return from NPS by another 30% (from Rs.20.87L to Rs.27.32Lacs). So, in both ways it proves as a valuable addition to one's retirement corpus. Even assessees who are risk averse could try this path and boost their retirement funds by limiting their asset mix to 50% in equities.
Very informative as usual. Would you recommend NPS over a Unit Linked Insurance policy? There are policies which have a similar risk profile with the added benefit of death cover.
ReplyDeleteRecently read a news item that govt is considering allowing the 40% corpus to be used other than annuity product. Would that make it more attractive?
NPS certainly scores over ULIP. ULIPs charge higher admin fees and a portion of your premium is used to pay for the death cover, effectively reducing the amount available for investment and thereby reduced lower returns.
ReplyDeleteIf would be a big relief to the subscribers if the mandatory purchase of annuity product is removed, as returns from annuity products are lower and the annuity so received is taxable as well!