Low charges, high returns, income tax benefits — 5 reasons to choose NPS for retirement planning Over the years, the NPS has undergone many changes and become more investor friendly. The Pension Fund Regulatory and Development Authority (PFRDA) has made the scheme more flexible and introduced new features. It has also made it easier to open an NPS account. Here are five reasons why you should invest in it
When the National Pension System (NPS) was opened to the general public 15 years ago, it managed to get less than 5,000 voluntary investors. The investment rules were not very clear, the structure was quite complicated and there was also no clarity on the tax treatment of the income.But over the years, the NPS has undergone many changes and become more investor friendly. The Pension Fund Regulatory and Development Authority (PFRDA) has made the scheme more flexible and introduced new features. It has also made it easier to open an NPS account. If you have the necessary documents, the account can be opened online within minutes. The Finance Ministry has done its bit by introducing tax benefits on contributions, including tax deductions that are exclusive to the NPS and making 60% of the maturity corpus tax free.
As a result, the NPS is slowly gathering pace. In 2023-24, some 8.73 lakh voluntary investors joined the scheme. That’s an average 2,391 investors joining per day, almost 100 every hour. But the NPS is still not the preferred investment vehicle for retirement. With only 55 lakh voluntary investors, it has tapped only 10% of the total investing population in the country.
There are many reasons for this, including low awareness about the scheme, aversion to locking up money for the long term and the compulsory annuitisation of 40% of the maturity corpus. However, investors who stay away from NPS may be missing out on a great investment opportunity. “The NPS offers everything that one looks for in a retirement savings product. It is a long-term investment with very low costs and a low risk profile,” says Rahul Bhagat, CEO of DSP Pension Fund. Here are five reasons why you should consider joining the scheme.
Also Read: NPS is a long-term investment with very low costs and a low risk profile: Rahul Bhagat, CEO, DSP Pension Fund
Use NPS tier II to earn more
NPS Tier II debt funds have done better than similar fund categories.
1.Very low charges mean higher returns for you
The fund management charges of the NPS are very low compared to what mutual funds and insurance companies charge. “The NPS is the cheapest product available in the Indian market,” says Bhagat. The investor pays just Rs.30-90 per lakh in a year. That is comparable to what ETFs floated by mutual funds charge, but is a fraction of the nearly 2-2.5% you pay for actively managed equity funds.
Though a fund management charge of 2% a year appears low, it adds up to a substantial sum in the long run due to compounding. Here’s a perspective: If you do an SIP of Rs.5,000 in a mutual fund that charges 2% per year, over 25 years you will shell out about Rs.19 lakh in fund management fees. The same amount invested in the NPS will cost you only Rs.1 lakh over 25 years, assuming the maximum 0.09% fund management charge of the NPS. We have assumed compounded annual returns of 9% in this calculation.
Low costs, high returns
Low charges helped NPS equity funds beat large-cap mutual funds.
The low charges translate into higher returns for the investor. This is why NPS equity funds have consistently beaten the large-cap mutual fund category in the past 10 years and even the flexi-cap category is ahead by a slim margin.
Also Read: NPS equity funds have consistently beaten large-cap mutual fund in last 10 years: A look at how NPS funds have performed
Don’t want to lock up your money in the NPS till the age of 60? Investors can go for the NPS Tier II option where there are no tax benefits on contributions but also no restrictions on withdrawals. You can invest today and withdraw the money the next day. There is also no exit charge.
At 0.5-1.25%, the fund management charges of debt funds are lower than those of equity funds, but they still can’t match the ultra-low costs of NPS funds. This is why NPS debt funds have done better than debt schemes of mutual funds. In the past one year, the NPS Tier II Gilt and Corporate Bond funds have delivered higher returns than the average long-duration debt fund and corporate bond fund.
You can invest in the NPS Tier II only if you have the regular Tier I account. All one has to do is activate the NPS Tier II option and start investing in the scheme. Readers should note that investing in Tier II works well for the gilt and corporate bond funds, but not so much for equity funds because there is ambiguity in the tax rules. Some tax experts point out that the capital gains arising from investments in the NPS Tier II funds may not be eligible for the favourable tax treatment that investments in stocks and equity-oriented mutual funds enjoy. Long-term capital gains of up to Rs.1 lakh are tax free in a financial year. Beyond Rs.1 lakh, the long-term gains are taxed at 10%. Short-term capital gains are taxed at 15%.
However, since there is no securities transaction tax paid on NPS transactions, the investment will not get these benefits. The capital gains will be added to the income of the individual and taxed at the marginal rate applicable to him. “This will not suit taxpayers in the 20% tax bracket and above,” says Chartered Accountant Nishant Khemani. “The higher tax on capital gains from equity investments will take away any advantage accruing from the lower costs,” he adds.
2.NPS investments get exclusive tax benefits
Though investments in the NPS Tier II don’t get any tax benefit, the Tier I option is loaded with tax incentives. There are three ways to save tax with NPS. Firstly, contributions to the scheme are eligible for deduction in the overall Rs.1.5 lakh limit under Section 80C. Then there is an additional deduction of Rs.50,000 for contributions under Section 80CCD(1b). This is over and above the Section 80C deduction and exclusive only to the NPS. Taxpayers in the 30% bracket can save up to Rs.15,600 by investing Rs.50,000 in the scheme. If one factors in the tax savings, the net outflow for the investor will be only Rs.34,400 (or Rs.2,866 per month).
The third way to save tax through the NPS has a potentially bigger impact on the tax outgo of the individual. Under Section 80CCD(2), up to 10% of the basic salary put in NPS is tax free. For example, if a person has a basic salary of Rs.50,000, his company can reduce some other taxable emolument by Rs.5,000 and put that amount in the NPS on his behalf every month. The Rs.60,000 thus contributed to the NPS will reduce the annual tax of the employee by Rs.18,720. However, this NPS contribution should be a part of the emoluments of the individual and can be done only through the company. Incidentally, this deduction under Section 80CCD(2) is available under the new tax regime as well.
At the same time, experts say one should not look at retirement planning through the prism of tax savings. “The PFRDA is encouraging NPS as a complete retirement planning tool. We have to move away from projecting NPS as just a tax-saving instrument,” says PFRDA Chairman Deepak Mohanty. “The fresh branding attempts with the tagline NPS#ZaruriHai is an attempt in this direction,” he adds.
Put your NPS on auto mode
Investors not sure about the asset mix can go for Lifecycle funds of the NPS
3.Choices have increased for investors
With DSP Pension Fund starting operations last year, investors in NPS can now choose from 11 pension fund managers. They are also allowed to change their pension fund manager once a year. Till last year, an NPS investor could invest in schemes of only one pension fund manager. The performance of pension fund managers varies across the four categories. If you look at 10-year returns, the equity funds of Kotak Pension Fund and HDFC Pension Fund are the top performers. But LIC Pension Fund scores in the gilt category while UTI Retirement Solutions and HDFC Pension Fund are best performers in corporate bond fund category. In November 2024, the PFRDA changed the rules and allowed investors to invest across three pension funds. They can now cherry pick the best performing pension funds across different asset classes and invest accordingly.
4.Flexibility has also increased significantly
The NPS has also become more flexible. Investors can alter their asset mix up to four times in a year. The best part is that switching from one asset class to another or changing your pension fund manager will have no tax implications. In mutual funds, switching from one fund to another is treated as a sale and any gain is taxable. The apart, NPS equity funds used to invest in only index based stocks. But in 2021, the PFRDA allowed investments in the top 200 stocks. This gives pension funds a bigger universe and allows them to take exposure in stocks with long-term potential.
Also, there is greater freedom in deciding your asset mix. The 50% cap on equity investments, which was a sore point for many investors, has been raised to 75%. This will suit younger investors as well as those with a higher appetite for risk. Subscribers who are not very investment savvy can go for any of the three Lifecycle funds that continuously change the asset mix as the person ages (see graphic). These funds are the only true asset allocation product that automatically changes the allocation with age. “Lifecycle funds suit investors who don’t have the time or the knowledge to decide their asset allocation,” says Bhagat.
Investors are also allowed to continue contributing to the NPS up to the age of 70. They can also defer the withdrawal of the 60% tax-free portion up to the age of 75. This means an investor can continue to benefit from the low-cost structure of the NPS well into his retirement even as he keeps withdrawing from the corpus.
5.There is greater liquidity with changes in rules
Investing in the NPS does not always mean the money is locked up till retirement. Like in case of the Provident Fund, withdrawals are allowed for specific reasons, including medical emergencies, marriage or education of children, and purchase or construction of a house. But withdrawals are allowed only if you have been an NPS subscriber for at least three years and only three times during the entire tenure of the NPS account. One can withdraw up to 25% of the contribution in NPS at any time, excluding those made by one’s employer.
Can variable annuities be game changers?
Some portion of the annuity will be invested in equity to earn more than fixed income avenues
When they retire, NPS investors have to put 40% of the maturity corpus in an annuity that gives them pension for life. For many investors, this is the deal breaker that keeps them away from the NPS. That’s because annuity rates are not very high and most people feel they can earn better returns by investing the money in other avenues.
Investors are also psychologically uncomfortable with the idea of giving away control of a big chunk of their retirement savings. Even those who agree to buy annuities, go for the return of purchase price option which gives back the principal to their legal heirs after the investor’s death.
The introduction of variable annuities could change that. The insurance regulator has given the go-ahead to variable annuity plans. These variable annuity plans follow complex investment strategies that use derivatives to provide enhanced returns while controlling the risk of investing in equities.
According to news reports, the first variable annuity products could be launched within the next 2-3 months. To start with, variable annuity products are likely to focus on plain vanilla options with equity-linked returns. The benchmark for these returns can vary, ranging from the benchmark indices such as Nifty or Sensex to specific equity funds offered by insurers.
Under these variable annuity plans, 60-80% of the purchase price would be invested in fixed income instruments and offer a guaranteed minimum pension. The remaining 20-40% of the corpus would be invested in equities and equity-linked instruments to earn higher returns. Customers can choose how much they want to allocate to equity investments.
The regulator has asked insurers to explicitly state the variation of annuity payouts in relation to the benchmark in their filing documents. They are also required to provide illustrations of annuity rate variability along with associated risks, which would help customers in making an informed choice.
However, variable annuities that invest in equity instruments is a doubleedged sword. If equity markets don’t perform well, the expected high return may not happen. Then the pension of the retiree will be even lower than what a fixed annuity pays right now.
This story originally appeared on: India Times - Author:Faqs of Insurances
