On Monday, finance minister Arun Jaitley announced changes to the National Pension System (NPS), increasing the total tax-exempt cover to 100% of the NPS maturity value from 80% earlier.
Prior to this change, 40% of the total was annuitized without paying tax, 40% could be withdrawn tax-free and only the balance 20% was taxable. By the way, it is not clear why even the taxable portion was treated as income and taxed at the slab rate and not as long-term capital gains.
Even though the taxable component was only 20% of the NPS corpus at retirement, the quantum was high enough to push the taxable amount in the highest tax slab. This is one reason why the finance minister decided to allow exemption on the balance 20% portion as well.
How much more attractive has NPS become after this 20% has been made tax-free? According to our
previous analysis, we did not find NPS good enough, even after considering the various additional tax-deductions offered on the salary contribution.
There are two problems with NPS. One, the return of NPS could be lower than actively-managed mutual fund schemes. Over a very long time, even a 2% difference in return amounts to a very substantial amount of money.
Two, the saver is forced to put 40% of the NPS corpus at maturity in an annuity. This is a substantial amount which will earn low returns. And it is mandatory. Suppose your NPS corpus is Rs1 crore at retirement, Rs40 lakh would directly go toward purchasing an annuity product.
Currently, returns on annuities fetch pre-tax 6%, whereas, returns on government-sponsored products like Senior Citizen Savings Scheme and LIC’s Pradhan Mantri Vaya Vandana Yojana offer 8%+ returns to their investors.
We decided to quantify the effect of the recent changes in NPS vis-à-vis the older NPS rules for those in the 30% income-tax slab and, simultaneously, even compare it with the performance of investing in equity-linked saving schemes (ELSS) of MFs. This is what we found.
The above example shows that allowing total exemption on the NPS corpus will increase the post-tax retirement amount marginally. Importantly, it will do away with the hassles of calculating and paying tax on the withdrawn sum. However, equity MF schemes are more competitive in terms of performance, flexibility and taxation than NPS.
Also, the withdrawal process of NPS is a nightmare. After enquiring with a couple call centre executives of CRA-NSDL, the record-keeping agency of NPS, about the (now) tax-free status of withdrawals, we were dumbfounded with the responses received. One of the call centre executives herself was unaware that NPS was now tax-free; another executive told us that 60% of the maturity value was taxable (correct answer is 20%).
Other than being up-to-date with the latest changes, we found that our main query – whether the 20% taxable portion of withdrawal is taxed at the slab-rate or as capital gains–also took the executives by surprise. We were told to consult a chartered accountant for the taxation aspect. On the other hand, the same executives are fluent in the various tax-benefits and the Sections of the Income-tax Act under which the tax-exemptions can be availed.
Senior journalist R Jagannathan has described his own journey of withdrawing from NPS in this
article. He described the whole withdrawal process as “unnecessarily complicated and tiresome to the subscriber.”At retirement, when you want to spend a peaceful life, if you have to go through hassles of getting back your own money after savings for decades, it is not worth it.
If some one enters around 48-50,it is only 10 years and with Tax benefit we get both for employers contribution-excluded from salary and hence tax free and 50 k from employee contribution,we can divide 33 % and get around 3 % saving per year till 60 years.Even if NPs with large cap and 50 % max return gives 10-11 % return, totally we get 14 % and it is worth it.since we cannot withdraw in between long term compounding also is taken care.Also at 50 + less exposure to equity and in large cap maybe a good strategy and it is designed in NPS.
The main problem is 40% annuity with only 6% return.we have to hope annuity return may increase in future or rules will change and trade off on returns for safety and secure returns post retirement.if someone has to enter NPS in their 30s and invest for 30 years,the tax benefit angle maybe negligible and tenure also is long and they can take a call.
NPS has an exclusive tax benefit (apart from the 1.5 Lakhs 80CCD 1B for 50,000.
If I don't save 50,000 in NPS, I will get only 35000 post tax.
So if I save this 50000, I get immediate 42.85 % returns (15000) from the taxable 35000 amount (after paying 30% tax on 50000) I would be effectively able to invest in any other product for future returns.
Apart from this exclusive 50000 (80CCD(1B) ), I also get upto10% basic pay contributed by employer as tax free component into NPS since it is not included in the taxable salary at all.
Whenever these exclusive tax benefits for NPS is stopped by the Govt, I will stop saving in NPS.
I am 34 now. I don't know and can't guess what will be the taxation when I turn 60 in 2044.
So I am not bothered about the 40% annuity / 20% tax free component at all since there is going to be a lot of changes in the country in next 26 years.
Also - I don't expect the 'journey of withdrawing NPS' will be that much bad in 2044 as in today.
Calculate this with 50000 of nps vs 35000 good equity contribution over next 25-35 years. Even if we assume better returns with equity by 2 percent as above, good equity investing will surpass nps, even after considering tax benefit .
The argument that it makes nps makes you save 42 percent at start is not logical, as we are looking what will happen even we invest that additional money into nps. Now suppose you smartly invest 50000 into nps and say that you will invest 15000 so saved in good equity. Even then returns will be less after 20-30 years of this combination, if you compare it with investing everything in well managed equity (even after taking out amount if tax saved).
Now all if this is assuming that well managed equity will give at least 1-2 percent better returns than nps equity options. This has been persistently seen though.