Tuesday, 21 February 2017

Should You Invest into NPS or Not?

We usually try to utilize all the avenues of saving tax on section 80CCD1B is one such avenue under which tax exemption for rupees 50,000 of investment in NPS is available. This section cannot be utilized for any investment other than NPS. Investments in NPS can be claimed for tax reductions under the overall limit of the section 80C. But under 80C there are a lot of other investments for which you can claim tax exemption. But section 80CCD1B is specifically for NPS. Now tax exemption should not be a reason for any sort of investments. Different investments suit different needs. Read Some NPS tips to know more about it.


Why Government Introduced NPS?

The Government introduced NPS to offload its pension expenditure and to put a self sustaining mechanism in place and that is the precise reason why investment in NPS is compulsory for central government employees and for some state government employees who have joined after January 2004 and since the investment gives exposure to equity, corporate debt and government securities. The risk and thus the returns are balanced and so NPS was extended to all the citizens from 2009 as the best framework was in place.


Does NPS suit you?

If you have not thought of investing for retirement or you thought about it, but your thoughts were not converted into actions or if you wanted to, you wanted to start investing for retirement but did not know where to invest, then NPS suits you. NPS would enable you to invest specifically for retirement. It would also serve as an alternative to mutual funds for some subscribers. But if you are an informed investor are saving regularly for retirement know how much money you would need in retirement and know where to invest to support yourself in your retirement days then do not go for NPS. 

Example for informed investor to take a better decision: Let us assume that Mr. Alex and Mr. John, both are 35 years old and they both fall in the tax bracket of 30% . Mr. Alex from his current age of 35 years, invests 50,000 rupees each year into NPS till the time he turns 60 years old. Mr. John invests 35,000 rupees each year in equity mutual fund from his current age of 35 years, till the time he turns 60 years of age. Now why 35,000 rupees in case of Mr. John is, if he doesn't invest these 50,000 rupees into NPS, he would have to pay taxes according to his tax slab. So after paying taxes of around 15,000 rupees, Mr. John invests 35,000 rupees into equity mutual funds each year. 

Let us assume Mr. Alex had gone for an active choice when he signed up for NPS and he kept his equity allocations to 50% till the time he retired. He never changed it and so let us assume the returns for 25 years was around 10% per year. As 50% of the allocations were to equity and 50% to be debt. Let us assume Mr.John's equity mutual fund give an returns about 14% on an annual basis for 25 years. On maturity, that is why Mr. Alex  and John, both turn 60 years old, Mr. Alex would get a corpus of 54.09 lakh rupees. Whereas Mr.John would get a corpus of 72.40 lakh rupees. The difference is around 18.31 lakhs. For Mr. Alex on maturity, 40% of this corpus completely tax free. If you want to withdraw 60% of the corpus, he would have to pay taxes according to his tax slab about 20% of the corpus and the remaining 40% would have to be invested into annuities and if he does not wish to pay any taxes, he would have to invest 60% of the amount into annuities. 

Annuities give very low returns which may or may not match inflation and income from annuities are taxed according to your tax slab. On the other hand the maturity amount from Mr.John would be completely tax free as it was invested into equity mutual funds. And now, Mr. John would be free to invest his entire corpus into a combination of investments that would give him a continues flow of income.