Things You Didn’t Know About NPS

“I am done with my 80C and 80D tax savings for the year. But still paying lot of tax.” Said Monisha, a 31 years old Software professional to her colleagues Akshay and Neha.

Neha: Me too !! Is there a way out ??

Monisha: Of course NPS !! I have heard from many people that it is the best tax saving option beyond 80C. It is covered under a separate limit of Rs. 50,000 u/s 80CCD. Isn’t that right Akshay ?

Akshay (smiling): Well not really. I would prefer not going for NPS. Are you aware of a few things about NPS ??

Neha (Curiously): Like??

Akshay: First of all, it is not a tax saving scheme. It is more of a tax deferment scheme.

Monisha: What’s a tax deferment scheme now? Please explain in simple terms. We are not finance experts.

Akshay: I will explain with a simple example. Suppose you make an FD of Rs. 1 Lakh with 7% interest for one year. How much income will be taxable after 1 year?

Monisha: This is easy. I will pay tax on Rs. 7000 which is the interest earned on my original 1 Lakh.

Akshay : How would you like to pay a tax on entire Rs. 1.07 Lakh ?

Why I will Not Invest in NPS _

Monisha : That would be so unfair. I should be taxed only on the income. If possible, that income should also be tax free.

Akshay: Correct. But unfortunately, in an NPS, you have to pay tax on the withdrawal amount (not on gains). Suppose you invest Rs. 50,000 in NPS for lets say 20 years, you have total Rs. 10 Lakhs accumulated as your contribution.

Lets assume, this amount grows to around Rs. 17 Lakhs (assumption as there is no fixed return defined in NPS), only 40% is tax free that too if withdrawn after the age of 60.

So in this case, only Rs. 6.80 lakhs can be withdrawn as tax free. Remaining amount needs to be used to purchase annuity. Also, the returns coming from this annuity are poor and also taxable.

So, if you wish to withdraw entire Rs. 17 Lakhs, you have only Rs. 6.8 lakhs tax free. Out of the remaining Rs. 3.20 Lakhs which was your principle, is also taxable. So you are not really “saving tax”. You are just deferring it by few years.

Neha: Oh No !! That’s really bad. I would toh want my returns also tax free. Who will pay tax on principle also!!

Monisha : But tell me something !! Isn’t “deferring tax” a good idea ? At least I am not required to pay tax today.

Akshay: That depends on your perspective. The way I would look at it, today I am earning. So I can still afford to pay tax. At my retirement, my earning would stop. So paying a big tax at that time would be a bad idea for me.

Neha: Apart from this, are there any other reasons for you not to invest in NPS ?

Akshay : Yes, few more actually. One major reason is passive fund management. NPS doesn’t have an active fund manager like an ELSS or diversified mutual fund. It replicates an index. I believe that in India, we still have lot of potential for higher returns through active fund management. I would not like to go for passive fund management.

Moreover, it has a highest equity exposure of 50% even if you go for an active choice. Now, if my time horizon is more than 15 years, why should I have such a low equity exposure?

Another reason is liquidity. If I need money in midway, I can withdraw only 25% of my contribution (not total fund value). That too is subject to following conditions:

  • The Partial withdrawal shall be allowed for specific purposes such as higher education of children, marriage of children, purchase or construction of residential house or for treatment of specified diseases.

  • Individual should have subscribed to NPS for at least 10 years.

  • Maximum of 3 withdrawals during the entire tenure are allowed.

  • Minimum gap of 5 years is required between the two withdrawals. However, this condition shall not apply in case of withdrawal for treatment of specified illness.

Neha : Indeed. These don’t really sound great.

Monisha: No No!! This is wrong!! NPS amount can be withdrawn freely.

Akshay : What you are talking about is Tier 2 Account of NPS. It has relaxations on contributions and withdrawals. But then, contribution to Tier 2 are also not eligible for “tax saving” u/s 80CCD.

Only Tier 1 Contributions qualify u/s 80CCD and there are all the above restrictions applicable on them.

Neha : What’s the use then ? Tier 2 is like any other non-tax-saving investment.

Akshay : Lastly, its not a big reason, but one of the negative factors which I dislike about NPS is compulsory contribution. I have to mandatorily contribute Rs. 6000 p.a. to NPS once I open it. That’s not a very big amount, but still that compulsion doesn’t look too comfortable to me.

Neha : Right. So if we do not invest in NPS, we have to pay tax on that income. That would be worth it?

Akshay : Lets look at the whole thing in totality. If we are in a 20% tax slab, we would “save” Rs. 10,000 as tax by putting Rs. 50,000 in NPS today.

Ultimately, we will have to pay tax on it during our retirement.

Also, this amount will have lower growth as it has lower equity allocation and passive fund management.

Plus, I have lot of restrictions on withdrawals and compulsions on contributions.

I would rather pay Rs. 10,000 as tax and invest Rs. 40,000 in an actively managed diversified equity fund, which would give me higher returns, tax free and plus no compulsions to pay every year. Also, in case I want, I can withdraw the entire fund value.

Over a 20 years period, I am expected to get at least Rs. 6-7 lakhs more by investing in a diversified mutual fund (even after paying the tax).

Over a 30 years period, this difference can increase upto the extent of Rs. 20 lakhs even if I am in the 30% tax slab (ie even after paying Rs. 15000 as tax for 30 years).

Neha : Oh My God !! I have more than 30 years to retire. For me the difference will be even more than Rs. 20 Lakhs if I go with diversified equity MF instead of NPS.

Monisha : Sounds Logical. So none of us should invest in NPS right?

Akshay: Well Neha, Monisha, I am not an expert to be giving you any opinion for you. Whatever, I have told you is what I have been discussing with my financial advisor. What is right for me, may not be exactly right for you. Monisha is 31, married and has one child. Neha is 27 and single. So the planning for all of us could differ. The best would be take professional help without any delay.

Neha, Monisha: Thanks for the useful info Akshay. Our doubts about NPS are also clear. And now we also understand that tax planning works best when we look at it in totality and it is in line with our financial planning.

We look forward to your feedback and comments on the above article.

The Author Prof. Saurabh Bajaj (BE, MBA, FRM, CFGP) is CEO with Nidhi Investments, Mumbai. His articles have a readership from 78 Countries across the Globe. He may be contacted on CEO@nidhiinvestments.com if you have any questions.

(The views mentioned in the article are personal opinion of the author. The characters used in the article are hypothetical).

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Published by professorbajaj

Prof. Saurabh Bajaj is an Author, Mentor, Motivational Speaker and Wealth Planner. He has done his MBA from Narsee Monjee Institute of Management Studies (NMIMS) Mumbai, one of the top 10 management institutes in India. He holds the prestigious FRM (Financial Risk Manager) degree awarded by Global Association of Risk Professionals (GARP), USA. Till date, there are less than 15,000 professionals in the world, who have been honored with this degree. He has also been awarded CFGP (Chartered Financial Goal Planner) Certification by AAFM (American Academy of Financial Management). After his MBA, he joined J P Morgan, the second largest Investment Bank in the world. He has worked with J P Morgan as Risk Analyst for more than two years. Prof. Bajaj also holds an Advisory certification awarded by AMFI (Association of Mutual Funds of India). During his stint at Bombay Stock Exchange, he has handled Investment Management and Treasury operations of the BSE Corpus. He has set up an entrepreneurship venture in the field of Wealth Planning and Investment Consulting under the name “Nidhi Investments” and holds the profile of CEO. Prof. Bajaj sits on the Expert Panel of CAClubindia.com and MBAClubindia.com as Investment Expert. He is actively involved in investor education through his blog www.professorbajaj.com which has a readership from 78 Countries all over the world. His articles are also regularly published in caclubindia.com , mbaclubindia.com , totalca.com , charteredclub.com, bankbazaar.com and lawyersclubindia.com . He has been awarded the title of “Best Article Writer” from caclubIndia.com in Jan 2012 and has been selected amongst “Top 5 Technical Writers” from all over India in Feb 2013. He has been invited by various TV Channels like SPIN TV, CNBC TV18, UTV Bloomberg Etc for programs like "Expert Advice" , "What Markets Want ", "Budget Analysis" etc. He has been invited by Several organisations like Lions Club, Rotary Club, Agrawal Welfare Foundation, Rajasthan Mandal, Agroha Vikas Trust, Union MF, UTI MF, Arthamitra Gurukulam, Vidyalankar Institute of Technology etc for expert lecture on "Smart Investing", "Life is A Celebration", "Financial Freedom", "The Digital IFA" etc. He was ranked 8th Merit at All India level NMAT which got him selected for MBA programme at NMIMS, Mumbai. He did his MBA with Capital Markets as his specialisation. Soft Skills has become an inevitable part of every selection process and teaching learning process these days. The students from small towns and tier II cities, in spite of being talented and well equipped with technical skills, are seen struggling in the selection process. This is because of their lack of exposure to these soft skills. Mr. Bajaj has a zeal for training candidates to develop these skills and has been imparting the same on since last two years. This zeal and passion inspired him to set up his own firm called “Knowledge Circle” which aims to train candidates for soft skills. Till date, he has trained more than 5000 participants from over 220 organizations across various fields of soft skills. He has been associated with MSBTE (Maharashtra State Board of Technical Education) to conduct Soft skills training workshop for the faculties of Polytechnic Colleges in Entire Maharashtra (Mumbai Region, Pune Region, Aurangabad Region and Nagpur Region) since last 8 years. He has also been associated with ICAI (Institute of Chartered Accountants of India) for training CA Students on various topics related to Communications skills, Group Discussions etc. He was invited by Fr. Agnel Polytechnic College, Vashi for a motivational workshop for faculties. He was also invited by Vivekanad Polytechnic College for "Communication Skills and Email Etiquette" training for non-teaching staff. Apart from these, he has conducted “Capacity Building Soft Skills workshop for Faculties” at ITI Gunj, ITI Pusad, ITI Digras and ITI Umarkhed. This was the first ever soft skills workshop for faculties in the history of ITI’s in Vidarbha. He was also invited by Shivaji Education Society to conduct similar Soft skills workshops for the faculties and office staff of Shivaji Junior College Pusad, Shivaji High School Pusad, Shivaji Vidyalaya Belora and Shivaji Vidyalaya Bhojla. He has conducted training workshop on “Effective Presentation Skills” for the relationship managers of HDFC Mutual Fund, Andheri Branch, Mumbai. He has also been invited at College of Management and Computer Science, Yavatmal, College of Dairy Technology, Warud, B N College of Engineering, Pusad, B D College of Engineering, Wardha, College of Engineering and Technology, Akola, Dr.N.P.Hirani Institute of Polytechnic, Pusad etc. for the Guest lecture on “Developing Interview Skills”.

10 thoughts on “Things You Didn’t Know About NPS

  1. Great Framing of the whole story… and I already got the benefit to know these facts from you bhaiya..!!!👍

  2. I actually liked the way you explained the whole concept in a story telling style. So easy for a layman to understand unlike other articles which are in complicated para style drafted in a legal fashion

    Good one prof saurabh 👌🏻👌🏻

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