Why you should not invest in National Pension Scheme?

Many taxpayers are attracted by the national pension scheme (NPS) investment option which offers them an additional Rs 50,000 tax benefit under Section 80CCD(1b). But does it make sense to invest Rs 50,000 in NPS and save additional tax? Let’s understand in detail.

This additional tax benefit idea of NPS makes it so attractive to investors that they simply forget many other important aspects which need to be considered before investing in NPS. Yes, NPS gives you an additional tax benefit but are you very sure that you will be fine keeping that money invested in NPS right till you turn 60 years of age and can only withdraw partially that too for specific reasons. Then thereafter at age 60, you need to compulsory opt for an annuity which is taxable too. Put all of these points together and you may need to think twice before investing in NPS.

Liquidity, Withdrawal & Taxation: To put it simply, once you turn 60 years of age, you can withdraw maximum 60% of your total NPS corpus but out of this only 40% is completely tax-free and remaining 20% will be taxable in your hand. And the remaining 40% needs to be compulsorily invested in an annuity scheme which will earn you a monthly pension. The 20% taxable part can be invested also if you don’t want to pay tax on it. Another very important point is that the monthly pension what you would get is taxable and you need to pay tax on it.

Partial Withdrawal: Partial withdrawal is allowed but that is restricted to only 25% of your own contributions and provided that you have been investing in NPS for a minimum period of three years. For example, assume that your NPS corpus is Rs 4 lakh out of which Rs 2 lakh is contributed by you including that Rs 50,000 additional investment and the rest is by your employer. Now, in this case, you can only withdraw Rs 50,000, i.e. 25% of your own contribution i.e. Rs 2 lakh, anytime before you turn 60 without paying any tax. And you cannot withdraw this 25% without having a specific reason for buying a house, or education or marriage of your children.

Restrictions on equity investment: NPS invest in equity instruments also but the percentage of investment is restricted to a maximum of 50% your total investments. So, investors who are young and are capable of taking much higher risks losing out on maximising their potential of earning higher returns on their equity investments.

What should you do?     

The most unfortunate part comes when people invest in any financial product purely from saving taxes without considering the other aspects like as explained in the article for NPS investments. What they should be doing rather is to think that money is money and returns on their investments and the goals they need to achieve form it should be the main criteria to decide before investing in any financial product. Yes, the tax benefit is good and consider it is a bonus part and not the deciding factor. So, say in this particular NPS discussion, rather than thinking that you have Rs 50,000 towards this additional NPS investment, think that you have Rs. 50,000 which is available for investment at your will and now think what best you can do with this money, to invest for tax saving under NPS or otherwise. Please remember that this article is talking specifically about whether it makes sense to invest in NPS for additional tax benefit or invest elsewhere, if it is a different scenario of tax savings, equations may change.

Let’s take an example of Gagan, who is 33 years old and probably have another 27 years until his retirement. Now one more important question to ask yourself is what do you really think that if you are like Gagan, age 33, would you be able to work till 60 years of your age or rather do you want to work till then or looking forward to an early retirement i.e. retire rich retire young? Do ask this first before proceeding further.

So, say Gagan, invests Rs. 50,000 a year in NPS and generates around 12% return (in a booming market) and accumulate around Rs 82 lakhs at the end of 27 years. The returns of 12% are based on past few years of NPS returns history and considering the 50:50 average.

On the other side, if we assume that Gagan did not invest in NPS and chose to pay a tax of Rs 15,000 which makes him left with Rs 35,000 which he can invest in any good equity mutual fund scheme (every year). This can get him a return of say 15-16% return similar to the equity part of NPS. Now, in this case, his entire Rs 35,000 will be invested in equity to get a higher return and with 15-16% rate of returns, he will have approximately Rs 1 crore at the end of 27 years. Now the important point to note is that this return will be taxable at the rate of 10% versus the NPS which is taxable on maximum slab rate applicable to Gagan and that too on the entire monthly pension, which is a mix of his own corpus and returns.

Source: DNA Money