National Pension System (NPS) is a deferred pension plan managed by the Pension Fund Regulatory and Development Authority (PFRDA) and is gaining popularity among investors primarily because of some tax modifications made in the scheme. Earlier, the introduction of Section 80 CCD (1B) gave it an edge over other tax-saving investments and later on, making the entire 60 per cent of the corpus on maturity tax-free has made several investors consider NPS as a long-term investment for their retirement needs. The Budget 2019 has proposed 100 per cent tax-free status to NPS withdrawal on maturity. But, do the features of NPS make it an investment fit-for-all kind of individual investors? What should an investor be aware of before choosing NPS as its chosen route towards retirement funding? Let’s explore some features, how NPS works and see its suitability and the watch-outs:
1. Long term association with NPS
NPS scheme is a long term investment and for someone, it could be as long as 60 years to be associated with the scheme. Imagine someone starts NPS contributions from age 30. He or she will have to keep contributing for another 30 years till age 60. With increasing life expectancy, on an average, if one continues to live till 90, it will be nearly 30 years of post-retirement association with NPS during the annuity-phase. Remember, under one option, the spouse gets pension after NPS account holder dies and later on legal heirs get the corpus. The time period may stretch very longer.
2. Corpus is only partially tax-free
What you invest in NPS along with the growth it makes, the corpus gets accumulated on maturity at age 60. While a maximum of 60 per cent is allowed to be withdrawn on maturity, on the balance compulsory pension can be had. According to the current income tax rules, the annuity or the pension is taxable in the hands of the investor in the year of receipt. The amount of pension received will get added to one’s income and taxed as per one’s income tax slab. Remember, a portion of your annuity also has a principal component which too gets taxed. If the total taxable income even after adding NPS annuity and all other income earned during the year is within the exemption limit, one may enjoy tax-free benefits on entire NPS accumulations.
3. Maximum equity allocation of 75 per cent
The maximum that NPS allows to invest in equities is 75 per cent of one’s contribution and that too till the age of 50. As one age, the allocation to equities taper off. Therefore, if you wish to allocate a higher percentage of your savings into equities for a long term goal such as retirement, act accordingly. Therefore, if you are using a NPS Calculator to calculate maturity corpus, make sure you choose the right assumed growth rate for the specific asset class.
4. NPS has a passive investment approach
Management of funds can either be active or passive and both of them have their own pros and cons. Being aware of these two modes is essential to make an informed choice. In NPS, it is more of an passive approach and the pension fund managers have to replicate the index in fund management. While active fund management has the potential to outperform the index it also carries an element of risk to under perform.
5. Pension is compulsory
Being a retirement focused scheme, NPS rules do not allow full withdrawal of the corpus on maturity. While only 60 per cent can be withdrawn, one has to invest the balance 40 per cent of the corpus in an Immediate Annuity scheme of a life insurance company. The pension will be paid by the life insurer depending on which pension option one chooses.
The pension that one gets from the Immediate Annuity scheme of the life insurer is generally around 6 percent and as it is subject to tax. Returns may change and may be revised depending on interest rate prevailing in the economy. However, pension once fixed will continue till lifetime.
Few major advantages of NPS are that it is a low-cost investment option and is a dedicated scheme for post retirement needs. Although under section 80CCD(1B) one can get an additional tax benefit up to Rs 50,000 a financial year, do not merely open NPS account for the sake of saving taxes. If you are not financially disciplined and not comfortable to manage retirement funds, NPS suits you. However, make sure how it works and its various features that we discussed above before opting to open the NPS account.