Saturday, 18 March 2017

NPS a different perspective

The contributory pension system was notified by the Government of India on 22 December 2003, now named the National Pension System (NPS) with effect from 1 January 2004. The NPS was subsequently extended to all citizens of the country with effect from 1 May 2009, including self-employed professionals and others in the unorganised sector on a voluntary basis.

  • Tier I :The primary account, which is a pension account which has restrictions on withdrawals and utilisation of accumulated corpus. All the tax breaks that NPS offers are applicable only to Tier I accounts.
  • Tier II: In order to introduce some liquidity to the scheme, the PFRDA allows for a Tier II account where subscribers with pre-existing Tier I accounts can deposit and withdrawn monies as and when they want. NPS Tier II is an investment account, similar to a mutual fund in characteristics.

  • The subscribers can choose between 8 Fund Managers namely-
    1. ICICI Prudential Pension Fund Management Co. Ltd.
    2. HDFC Pension Management Co. Ltd.
    3. Kotak Mahindra Pension Fund Ltd.
    4. LIC Pension Fund Ltd.
    5. Reliance Capital Pension Fund Ltd.
    6. SBI Pension Funds Pvt. Ltd
    7. UTI Retirement Solutions Ltd
    8. Pension Fund (PF) to be incorporated by Birla Sunlife Insurance Co. Ltd One Fund Manager must compulsorily be selected.
  • A subscriber must choose between active choice and auto choice for distribution of his contribution. If active choice is selected, the subscriber must indicate the percentage distribution between corporate, gilt and equity. The maximum investment allowed in equity is 50%.
To make the NPS more attractive for subscribers, PFRDA has introduced several new features, including an Aggressive Life Cycle Fund (LC-75) which allows subscribers equity exposure of up to 75% till 35 years of age. It will be brought down by 4% per annum till 45 years, 3% from 45 to 50, and by 1% from 50 to 55 years. A major complaint against the NPS is the fact that while you get tax benefits during accumulation, the final corpus is taxed. In response, the government made 40% of the accumulate .. 

The existing provision of section 10(12A)of the Income Tax Act, 1961 provides that payment from National Pension System (NPS) to a subscriber on closure of his account or opting out shall be exempt up to 40% of total corpus at the time of withdrawal. The amount utilised for purchase of annuity is also tax exempt. However annuity received as pension is taxed.At the time of normal exit, 40% of the total corpus is mandatorily required to be purchased for annuity. The subscriber has the option to use higher amount for purchase of annuity.

Above are salient features of NPS in brief. Now the main question that I am confronted with as a financial advisor. Should i go for NPS.

I shall present few facts and leave on your wisdom to decide if to go for same.

Now since I shall only discuss on TIER 1 which has tax exemption I shall give you real time example.

Table 1 considers that investment made in NPS of 50,000 and saved Rs 15000 every year for next twenty years

Table 2 considers that tax payer opted out of NPS and paid Rs 15000 tax left with Rs 35000 for next 20 years

Table 1 gives you return of NPS for past five years
Table 2 gives you return of mutual funds for same period

* returns of NPS taken as highest as per value research by UTI for past five years as average
* returns of mutual funds taken on lower side as few have given higher returns as well
* Age at time of opting for NPS is taken as 40 years

Now below Table gives you clear taxation and withdrawal post maturity at age of sixty

* For the purpose age of investor has been taken as 40 years and period of investment 20 years
* The same does not consider any other IT relief the person shall enjoy under 80C for simplicity

Check the corpus accumulated in both the options.

Clearly if someone opts for scheme I which has equity and compare same to equity mutual funds the difference is large. Also Equity mutual fund shall be completely tax free and liquid. 

Even if someone opts for Government securities and corporate bonds the fund may be lower as per MF returns but the entire corpus shall be taxed as long term capital gain hence tax free after indexation

NPS is a beautiful scheme where the cost of management is very low and is discipline approach to investments. However the same has failed to pick up as it should have. Honestly I who knows about finance has never thought of this scheme.

My rationale for not opting for same:

  • Just to save Rs 15,000 every year why should I block my money till I am 60 years old?

  • When I have similar option in Equity mutual funds where I can register SIP till time I am 60 years why this?

  • At maturity I might want to spend my entire corpus on buying a Property, Holiday and may not like to get struck with 6% p.a annuity on 60% of my fund

  • On annuity received I again pay taxes and hence left with further lower returns

  • Why not I start a systematic withdrawal plan of my corpus in equity which shall be completely tax free

Few of my investors wanted to know if they should transfer their current PPF to NPS. My analysis says PPF currently has lock in of 15 years with guaranteed return of 8% tax free. If you check NPS returns of non equity funds it is close to 10% which is part taxable. 8% tax free is almost similar to 11% taxable. Then why block your funds till age of 60

How can NPS lure more investors

  • Give option of 100% equity fund which shall attract younger investors and a choice to get good returns by staying in Equity for long
  • Make entire corpus at the end of NPS maturity completely tax free
  • The tax payer be given option to buy annuity or withdraw complete amount as he feels fine
  • Although the new finance Act has given staggered withdrawal option of 20% over few years the same is also taxable
  • Money back option at regular intervals be made optional post few years which should be tax free.
  •  Cheap or interest free loans be granted against NPS as NPS is safest collateral government can ever have

Respected Arun Jaitley Sir I have no intention to put NPS in bad light but as my duty as financial advisor it is my duty to present facts to citizens.

I hope you shall consider above recommendation to bring benefits of NPS to larger section of society as it is a great scheme but with few drawbacks. A scheme just to save tax but not flexible at end of tenure may not go well with country from majority of population working is young

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