If you prefer a forced-savings product, NPS is a good choice. It can become better with tax benefits
The surprise in Budget 2016 was partial exemption provided to the National Pension System and Employee Provident Fund, thereby bringing these on a par.
While the government had to relent on Employees' Provident Fund Organisation because of an uproar, the 40 per cent exemption on NPS on maturity has been retained.
Does this put NPS at a disadvantage?
Let’s look at NPS more closely. Your employer’s contribution to NPS to the extent of 10 per cent of your basic plus dearness allowance is allowed as a deduction without any limit.
Your own contribution up to Rs 50,000 is also allowed as an exclusive deduction.
On maturity, 40 per cent of the accumulated corpus can be withdrawn tax-free and another 20 per cent of the corpus can be withdrawn by paying tax.
You have to buy an annuity with the balance 40 per cent.
The annuity is taxable in the year of receipt.
The argument against NPS is due to the taxability on the partial withdrawal and the compulsion to buy an annuity with the balance 40 per cent.
Currently, only a few annuity products offer returns of around seven per cent annually.
The argument is that even if you let go of the exclusive tax benefit and invest the post-tax amount in a regular equity fund offering 15 per cent returns, you will be better off, since the maturity amount is completely tax-free and there are no pre-conditions on how you should use this corpus.
Let’s crunch the numbers.
If you invest Rs 50,000 annually in NPS for 26 years with 50 per cent debt (8 per cent returns) and 50 per cent in equity (15 per cent returns), the total corpus will be Rs 92 lakh or Rs 9.2 million (Rs 21 lakh from debt and Rs 71 lakh or Rs 7.1 million or Rs 7.1 million from equity) at the end of the tenure.
Since you get a tax break at the rate of 30 per cent, your actual investment every year is only Rs 35,000 (Rs 50,000 minus tax benefit of Rs 15,000).
Ignoring the maturity complications, this value of Rs 92 lakh (Rs 9.2 million) approximately is available for an investment of Rs 35,000 every year for 26 years, giving a calculated return of 14.60 per cent a year.
If you pay tax and invest the balance Rs 35,000 in an equity fund and earn 15 per cent annually, you will accumulate a corpus of about Rs 99 lakh (Rs 9.9 million).
On a standalone basis, equity funds seem to have a clear edge because of a higher corpus and because it is also devoid of any complications after maturity.
There is a contra point.
One, the corpus amount is not that different and the NPS corpus is built at a much lower risk factor than the pure equity fund option.
Hence, the 14.60 per cent return on NPS is much better than the 15 per cent return on pure equity fund.
Two, the lure of tax deduction ensures it becomes a powerful incentive for regular investment.
In other instruments, the break in investments is one of the main reasons for a lower corpus.
The tax on maturity value and compulsory annuitisation is a dampener.
But with the Finance Minister clearly backing the NPS scheme, it is likely that the tax exemption will cover the full 60 per cent withdrawal that is allowed in NPS and even the annuity may be exempted.
Though this cannot be assumed as a matter of course, the return drops to around 13.45 per cent (from 14.60 per cent) even if you take the existing tax structure into account.
That is an excellent return for a forced saving product, unlike EPF or life insurance policies which have fairly low returns. If you prefer a forced-savings product, NPS is a good choice.
It can become better with more tax benefits.
Illustration: Uttam Ghosh/Rediff.com
Harsh Roongta is a Sebi-registered investment advisor
