The National Pension System (NPS) is GOIs Defined Contribution Pension Scheme and all Indian Citizens (including service personnel) can subscribe to it. One can open NPS Tier 1 Account which carries significant tax benefits, and an additional Tier II account which has relatively no withdrawal restrictions, but does not provide any tax benefits. One needs to consider the associated risks and returns/benefits and liquidity issues before investing/subscribing to NPS.
Risks
As it is a well-regulated system with robust oversight mechanisms, the system risk is negligible. The investment risk is customizable as one gets to choose the proportion of investment in Equity, Corporate Bonds and Govt Bonds known as E,C & G respectively. The maximum allocation that you can make towards Equity is 75%. One can also choose auto mode wherein the System decides the allocation and varies it automatically as per your age. You can also change the preference once in a year. You can even change the Pension Fund Manager once in a year.
Returns/Tax Benefits
(a) Most attractive benefit is the exclusive additional deduction for investment up to Rs. 50,000 in NPS (Tier I account) under sub-section 80CCD (1B). This is over and above, repeat over and above, the deduction of Rs. 1.5 lakh available under section 80C of Income Tax Act. 1961.
(a) As the subscriber can customize the allocation, the returns will accordingly vary. One can safely assume that over a 10 yr period, any conservative allocation would give returns above risk free returns during the period. With allocation to equity between 50-75%, one can expect returns in the range of 12-15%.
(c) After 60 Yrs of age, you can withdraw up to 40 percent of the total corpus in lump sum which is exempt from tax. Amount invested in purchase of Annuity, is fully exempt from tax. Up to 25 per cent of contribution withdrawn before 60 yrs is exempt from tax.
Liquidity
Subscriber can exit from the Scheme after 10 years of account opening or on attainment of the age 60 years whichever is early. The Scheme will define the pay-out as per the exit age of the Subscriber.
(a) Exit Before age of 60. You can withdraw up to 20% of Corpus in lump sum if you exit before the age of 60. And you need to invest the balance amount in Annuity. If the Corpus is less than or equal to Rs.1 lakh, there is no need to invest into Annuity. In such case you can withdraw the entire amount in lump sum.
(b) Exit after Age of 60. You can withdraw up to 60% of Corpus in lump sum and need to invest the balance amount in Annuity. If the Corpus is less than or equal to Rs.2 lakhs, there is no need to invest into Annuity and you can withdraw the entire amount in lump sum. Subscriber exiting from NPS at the age of 60 gets additional flexibilities. These are deferring annuity/withdrawal, continuing subscription till 70 yrs and withdrawal in instalments.
(c) Partial Withdrawal from the Scheme. Subscriber can take out three partial withdrawals from Tier I account before attaining 60 yrs of age. You can withdraw 25% of the Contribution for specific purposes like Child marriage, Higher education, Treatment of Critical illnesses, buying home etc.
One apprehension while investing in NPS is that only 60% would be withdrawable at maturity. You can appreciate that you will by this time accrue a savings of 30% on tax, and receive more than about 10% as return by then. So effectively it is only the gains that you may not be able to withdraw. Moreover, you will get the locked amount back as annuity at a time when income will be less due to commuted pension, implying lower tax liability. Further the govt will keep revising the provisions favorably, and the locked corpus shall remain a very small proportion of your overall portfolio. You can also suitably integrate the locked portion in your Estate Planning.
Recommendation
Subscription to NPS is strongly recommended, esp for those who are in the higher tax brackets as it offers significant Tax relief, decent returns and flexible liquidity. Subscription can be limited to the extent one gets tax relief which is presently Rs 50,000/-; but can be reviewed as and when the ceiling is revised by the Govt.
One reply on “NPS-Additional Tax Saving With Customizable Returns”
The author has given an in-depth analysis on NPS, as a viable savings option. The scheme is beneficial as it gives you tax benefits both in short term as well as long term horizon.