- 5 reasons why investors stay away from NPS. But should you?
- Tax treatment of the corpus is the basic reason why many investors shy away. Only 40% of the corpus is tax free, compared to 100% in other products.
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5 reasons why investors stay away from NPS. But should you?
Tax treatment of the corpus is the basic reason why many investors shy away. Only 40% of the corpus is tax free, compared to 100% in other products.
Updated: Dec 27, 2018, 01.18 PM IST
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“The NPS will lock up my money for 30 years,” says the Bengaluru-based software professional. In Delhi, senior manager Prabhakar Rai is concerned about the tax on the pension. “If the annuity income will eventually get taxed, what is the point of the tax deduction offered now,” he says.
In Kolkata, bank manager Akash Ghosh wonders whether the market-linked pension scheme is a better alternative to the assured returns offered by the PPF.
Despite the many benefits offered by the NPS, many investors are keeping away. An online survey conducted by ET Wealth last month identified five major pain points that act as barriers. However, some of these may not even be pain points. For instance, Chowdhury does not realise is that the long lock-in of the NPS can actually be a blessing in disguise. The longer he will remain invested, the more time his money will get to grow.
If he starts investing Rs 10,000 a month in the NPS and increases the amount by 10% every year, even a modest 9% return will grow his retirement kitty to a gargantuan Rs 5.5 crore in 30 years.
Tax benefits are biggest attraction for investors
An online survey conducted by ET Wealth shows that most investors in NPS were attracted by the tax breaks.
The survey had 1,253 respondents.
This is why we invited experts from different spheres to give us their assessment of the five main features that act as pain points. Read on to know what they have to say and ET Wealth’s views on the subject.
Pain point 1: NPS corpus is not tax free on maturity
NPS corpus is not tax free on maturity.
Taxation of corpus discourages investors
Why should the NPS corpus be taxed when other instruments like PPF, ELSS and life insurance are tax free, asks Manoj Nagpal.
The tax treatment of the corpus is the basic reason why many investors are not joining the NPS.
Only 40% of the corpus is tax free, compared to 100% in other retirement products such as EPF and PPF. NPS rules require that 40% corpus is put into an annuity. This eventually gets taxed because the pension is fully taxable. Since the pension from the annuity is a mix of the principal and the gain, the investor effectively pays tax not only on the gains but also on the invested capital.
Most people find this unacceptable.
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The unfairness doesn’t stop here. Though it is a long-term investment, NPS investors are not eligible for the tax benefits that other investors enjoy. Investors in stocks and equity funds don’t have to pay any tax on long-term capital gains. But investments in the equity funds of the NPS get taxed.
5 reasons why investors stay away from NPS. But should you?
Investors in debt schemes are taxed at a lower rate after three years and also enjoy indexation benefit. But NPS investments are not eligible for inflation indexation.
In its current form, the NPS is a confusing mix of EET and EEE. A portion of the corpus is tax free on retirement. Another portion is put into an annuity but eventually gets taxed. A smaller portion is taxable if withdrawn on maturity.
This portion can escape tax only if it is handled well. For the average investor, this is quite complicated to say the least. The rules need to be simplified to make the scheme more acceptable to investors.
It is interesting to note that investors who opt for the NPS usually limit their contribution to Rs 50,000 in a year to avail of the additional tax deduction under Section 80CCD(1b). Placing a limit creates an artificial ceiling and the investment becomes the default level of saving for the individual irrespective of what his actual requirement may be.
Given that a pensioned society is the stated goal of the government, these tax wrinkles in the NPS need to be ironed out.
The author is CEO, Outlook Asia Capital, a wealth management firm.
Taxation not fair, but can be managed
The NPS corpus is taxed, but a well structured withdrawal strategy can effectively reduce tax liability to zero, says Hemant G.
The NPS is a major step in making India a pensioned society. It suffers in comparison with other schemes, but there are also a lot of misconceptions about its taxability. Two years ago, the Budget gave an additional deduction of Rs 50,000 under Sec 80CCD(1b). Then last year, 40% of the maturity corpus was made tax free. Another 40% of the corpus escapes tax when put in an annuity to earn a monthly pension.
However 20% of the corpus is still subject to tax at maturity, though there are tax-saving options available to the investor.
If that 20% is also put in the annuity (besides the mandatory 40%), it will not be taxed. The investor can also withdraw in instalments spread over 10 years.
The NPS allows the investor to remain invested even after retirement and stagger the withdrawals till 70. In many cases, a well structured withdrawal strategy, coupled with prudent tax planning, can effectively reduce the tax to zero. In the normal course, however, as stated above, 20% of the corpus is subject to tax.
NPS allows premature withdrawals. Up to 25% of the contribution made by the investor can be withdrawn in case of emergencies and for specific purposes. These premature withdrawals are tax free. It’s important to note that these premature withdrawals do not affect the taxability of the corpus.
Another tax friendly feature of the NPS is that GST is waived on annuities purchased with the NPS corpus. Normally, there is 1.8% GST payable on the value of the annuity. But NPS investors are exempt. The Pension Fund Regulatory and Development Authority has written to the Finance Ministry that NPS Tier II savings should get the same tax benefit as mutual funds.
Equity investments should get exemption from long-term capital gains and debt investments should get indexation benefit. If these proposals are accepted, this will make NPS saving even more tax friendly, and making NPS a fully tax exempt scheme will be a real boon for pension subscribers.
The author is Chairman, Pension Fund Regulatory and Development Authority.
ET Wealth View: There should be tax parity for all retirement products.
Tax benefits are a major driver of investment decisions in India.
As our survey shows, 70% of the respondents who invested in NPS were attracted by the tax benefits offered. After the additional tax deduction was announced, the number of investors shot up. More investors jumped in when 40% of the corpus was made tax free. The tax treatment of the NPS corpus is a valid concern and should be addressed if the government wants to make the pension scheme more popular.
There is a move to allow EPF subscribers to shift to the NPS. There is no doubt that the NPS can deliver better returns than the EPF in the long term. The ultra low-cost structure of the scheme makes it an ideal vehicle for long-term savings. But nobody will opt to switch out of the EPF unless the NPS offers the same tax benefits as the EPF. It is heartening that the PFRDA has stood up for investors on this issue and has taken it up with the government.
Pain point 2: Compulsory annuity takes away flexibility
Investor is forced to put 40% of the corpus a low-yield and tax inefficient option.
Low annuity rates won’t beat inflation
If annuity can’t be avoided, PFRDA must offer NPS subscribers a special rate, says M.
Although NPS returns are likely to beat those from the EPF, the rigid withdrawal rules are a big drawback. Forcing the subscriber to buy an annuity with 40% of the corpus can restrict his ability to fight inflation after retirement.
At a nominal 6% year-on-year inflation in expenses, a monthly pension of Rs 10,000 (after tax) received at age 60 will lose 25% of its purchasing power by the time he is 65 and 50% of its purchasing power by the age of 72. Subscribers annuitising 60% of their corpus just to avoid tax will suffer more.
The annuity purchase can only be deferred for three years, meaning one cannot take advantage of favourable annuity rates at higher ages.
Also, if a subscriber dies during the period of deferment, the spouse will be forced to buy the annuity.
It is perhaps ironic that subscribers of a pension scheme must get pension by buying standard annuity products offered by life insurance companies.
If the mandatory annuity requirement cannot be removed, the PFRDA must at least consider offering a special annuity rate for NPS subscribers to compensate them for the mandatory annuitisation upon exit and the lack of liquidity and market risk during the tenure of the scheme.
When more and more Indians are considering retirement before 60, an age-based exit rule is impractical.
But exiting at an earlier age would mean 80% annuitisation, which is too harsh on those who wish to opt for voluntary retirement. At the very least, the age of the NPS account could be considered instead of the subscriber’s age and 40% annuitisation should apply to NPS accounts that have been operations for 15 years or more.
When there are other options with full liquidity and better taxation (EPF, PPF, mutual funds), the mandatory annuity requirements, lock-in, and unfavourable taxation offer a prudent investor no motive to consider the NPS.
They would recognise that the additional Rs 50,000 deduction in taxable income offered by NPS comes with a huge cost.
The author is a financial blogger and teaches at IIT Madras.
Annuity ensures lifelong pension for investor
Annuity ensures pension for life and offer options for every situation, says Sandeep Shrikhande.
The NPS is the only retirement savings scheme that stresses on a regular payment to the investor after he stops working.
Most financial instruments, such as fixed deposits, mutual funds and insurance plans, provide for regular accumulations and a lump sum payout at maturity.
The major disadvantage of a lump sum receipt in the hands of an individual is the tendency to expend the same immediately. In a nuclear family system like in our country, retirement funds often get utilised for other financial goals, such as children’s education or marriage or housing.
The retiree is left with a smaller corpus for his post retirement life, which is not a fixed tenure.
The compulsory annuitisation of minimum 40% of accumulated corpus in NPS is actually a blessing in disguise for a retiree.
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It will ensure that he gets a lifelong pension. With the increase in number of subscribers, annuity options available are quite attractive. The choices range from lifetime annuity to annuity with return of capital or annuity to both husband and wife and even return of capital to the legal heirs of the individual. Most insurers offer guaranteed annuity rates. In a volatile interest rate environment, it is good to have an assured stream of income for life.
There are concerns over taxation of annuity income. However, post retirement, many individuals may not attract high tax slabs. Besides, returns from other investment options, like FDs and post office schemes, are also taxable.
About 8.6% of the population in India is above 60. This is estimated to grow to 20% by the year 2050. With virtually no social security and limited retirement savings options in our country, it is important to provide a lifelong income to the ageing population.
In that context a compulsory annuity is an imperative solution.
The author is CEO, Kotak Mahindra Pension Fund. The views are personal.
ET Wealth View: Tax benefits for annuity income will make NPS popular.
There are several problems with annuities.
Firstly, annuity rates are not very attractive.
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An investment of Rs 50 lakh will yield a monthly pension of about Rs 30,000-32,000. If the person lives for 20 years in retirement, the return works out to barely 6.2%. The other problem is that the pension from the annuity is fully taxable as income at the normal rates.
The pension from an annuity is a mix of the principal and the gain. If taxed, the investor effectively pays tax not only on the gains but also on the invested capital. Though it may not be possible to make annuity income completely tax free, the introduction of some tax benefits for pension from annuities will make the NPS more popular. Also, investors should not be forced to buy annuities but allowed to invest their NPS corpus in other pension options such as the Senior Citizen’s Saving Scheme and the newly launched Pradhan Mantri Vaya Vandana Yojana.
Pain point 3: No withdrawals till retirement at 60
Investors may want to use the money to meet other financial goals as well.
Let investor access money
Investors may have other needs, says Prableen Bajpai.
The rigid rules for withdrawals reduce the attractiveness of the NPS.
During the productive years of a person, there are multiple occasions where she might need money.
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At this stage, inaccessibility to one’s own funds curbs a person’s financial freedom.
Of course, NPS does give an investor the option to exit before 60. But 80% of the accumulated corpus will have to be put in an annuity and only 20% will be available. The investor can also choose to make partial withdrawals of up to 25% of the contributed amount. But there are restrictions here as well. Partial withdrawals can be made only thrice and only for specified reasons.
There should also be a gap of at least five years between two partial withdrawals.
This is very restrictive. A person will not be able to withdraw money for her daughter’s marriage if she had made a withdrawal less than five years ago for her education.
The withdrawal rules should be aligned with real-life situations to make them more meaningful.
The author is Director, FinFix.
Early exit hurts retirement
Necessary to discourage early exits, says Kulin Patel.
A penny saved is a penny earned. But compounding ensures that more than a penny is earned. Keeping investments in long-term products enables interest to earn interest.
Keeping your money untouched for 10 years at 8% per annum will more than double it.
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This should be kept in mind when withdrawing from retirement savings. It is not just the money one withdraws now, but the opportunity cost of the compounding of that money too.
To instil discipline among investors, the NPS has inbuilt features that discourage subscribers from withdrawing too soon.
For instance, the higher minimum annuitisation in case you withdraw before 60. When the purpose of the product is to help subscribers accumulate funds for old age, then the measures that restrict early withdrawals are necessary.
The NPS, however, has some flexibility in certain cases for withdrawals.
Whichever way you look at it, patience does pay when investing in long-term products.
The author is Head of Retirement, South Asia, Willis Towers Watson.
ET Wealth View: Enough scope for emergency withdrawals.
A lot of people feel that locking up the money in NPS till retirement is not a good idea.
We don’t agree. If the investment is for retirement, there should be hurdles to prevent early withdrawals. The average investor does not have the necessary discipline to remain invested for the long term. The NPS discourages premature exits, though it also offers enough scope for partial withdrawals in case of genuine medical emergencies or for certain other critical financial goals.
Pain point 4: 50% cap on equity restricts potential
Younger and aggressive investors may want to invest more in equities.
Let investor fix allocation
Cap on equities is restrictive, says Hansi Mehrotra.
The 50% cap on equities was placed to make investors get used to the idea of investing in equities.
If investors know what they were doing, they should be free to select their asset allocation. Those who don’t know, can invest in the lifecycle fund.
There’s even a lifecycle fund option where the equity allocation starts at 75%. If a higher allocation to equities is desirable, why place a cap on it?
More importantly, investments in the NPS are only part of one’s overall assets. Besides the NPS, an investor might have invested in other instruments.
Which investment option is better in nps
It’s also likely that these investments are loosely matched to the tenures of her other goals. Since retirement is the furthest away, she needs an investment that offers maximum returns with lowest fees, doesn’t allow her to switch too often in response to market movements and is locked away till retirement.
The NPS currently meets the second and third conditions, but not the first.
By removing the 50% cap and allowing 100% allocation to equities, NPS could become the ideal way to save for retirement.
The author is Founder, The Money Hans.
Balanced approach is best
Cap on equities protects downside, says Mukesh Shah.
Everybody wants to earn maximum returns from his investments and equities can certainly provide an edge.
However, NPS investments are meant for retirement, just like the Provident Fund, and should be handled with caution. The 50% cap on equity exposure in the NPS balances the risk-reward equation to the benefit of the investor. It protects the corpus against the vagaries of the equity markets but has the potential to earn a higher yield compared to a fixed income instrument.
Removing or even raising the 50% cap on equities will render the NPS vulnerable to negative returns in the short to medium term. In a down cycle, it can seriously dent the savings of those about to retire.
In any case, the introduction of a new Aggressive Life Cycle Fund, which allows young investors to allocate up to 75% to equities, and the relaxation of rules allowing fund managers to invest in non-index stocks and midcaps, fulfills the requirement of all types of investors. A balanced approach works best for investors in the long run.
The author is Vice-President, Sushil Finance.
ET Wealth View: The average investor does not reach the 50% limit.
Not many people see the cap on equity exposure as a deal breaker.
This is because the average Indian investor has less than 20% allocated to equities and only a few people will feel restricted by the 50% limit on equity funds in the NPS. Even so, there is a case for removing this cap because individuals should be allowed to choose their asset mix. Investors who are not able to decide themselves can opt for any of the four Lifecycle Funds where the asset mix is determined by the person’s age.
Pain point 5: No assurance on returns
Some investors seek certainty and are wary of market-linked returns.
Certainty of returns is key
Investor should know his pension, says A.D.
Trade unions have opposed the NPS because it does not offer assured returns. In fact, it should not be called a pension scheme because pension is not defined. NPS may be looking good right now because markets have done well.
But this could change dramatically if there is a downturn.
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Some funds of the NPS have given barely 2% returns in the past one year. If equity markets crash, the returns could be in the negative. What happened in 2008 could get repeated.
If an investor retires in a black swan year, he will have a corpus much smaller than he planned for. What if the bearish phase extends for 5-10 years? Will he be able to survive without his pension just because markets are down?
A 25-year-old may be able to wait it out for the markets to bounce back, but a retiree does not have the luxury of time. This is why investors want some kind of assurance in the income during retirement. Unless the NPS offers an assurance of positive returns, investors should steer clear of it.
The author is Secretary of Hind Mazdoor Sabha.
Markets deliver in long run
Debt-based options will not sustain, says Archit Gupta.
Interest rates have come down significantly in recent years, so the rates offered on the EPF have become increasingly unsustainable.
Paying a higher rate of interest than what the corpus earns is a recipe for disaster.
On the other hand, the NPS funds have given very good returns to investors in the past 3-5 years.
Some of the equity funds have generated annualised returns of nearly 15% in the past five years. Such high returns can do wonders to your retirement planning. In case of an inflationary situation, returns from government securities can dwindle but investing in equity can dodge inflation in the long term, as equity is the only asset class capable of beating inflation.
A conservative investor may argue that investing the retirement kitty in stocks is risky. But NPS is not only equity. It also offers debt funds and allows the investor to choose his asset allocation. An investor can switch to debt if the equity markets are looking jittery. The high returns from NPS will also lower the tax impact at the time of retirement.
The author is Founder and CEO, Cleartax.in.
ET Wealth View: Most other options are also market linked now.
Almost all investment options are now market-linked, including mutual funds, Ulips and even small savings schemes such as the PPF, NSCs and the Senior Citizens’ Saving Scheme.
So it is not surprising that only a small minority of respondents even thinks of this as a pain point.
Even so, we believe that the NPS should also have a liquid fund option where risk-averse investors can stash their gains without fear of loss. As A.D. Nagpal points out, gilt funds of the NPS have given less than 2% returns in the past one year.
A liquid fund might have done better.