Though
National Pension System (NPS) offers good tax differing options, it is not
suited to investors whose debt portion is already met through contribution to
PF, PPF etc. and want to route the additional investment to equities. This is
because as per existing regulations, NPS does not allow equity exposure beyond
50%. Though a new life cycle fund introduced recently, allows up to 75% equity exposure,
it is only up to the age of 35 and after that equity exposure comes down by 2%
every year. That means the equity exposure will be down to 55%, by the time one
turns 45 and will drop further to 35% by the age of 55.
Does
it mean that you can forgo the tax deferment option in such situations? Since
historically equity has generated better returns in long term, it makes sense
to pay tax now and then invest the remaining money in equity MFs.
We
have tested this by assuming 12% return for equities 8% for debt and 10% for
NPS (i.e. on the assumption that asset allocation here is 50% equity and 50%
debt).In the first option tax payer routes Rs. 50,000 p.a. to NPS, the exclusive
window allowed under section 80CCD(1B). In other options, he decides to pay tax
and invest the remaining money into an equity MF. These annual investments will
vary depending on the tax slabs. So the second, third, and fourth options are
based on 30.9% tax slab (remaining investment Rs. 34,550) 20.6% tax slab
(remaining investment 39,700 and 10.3% tax slab (remaining investment 44,850)
Total
value of Rs. 34,550 p.a. investments into equity fund has overtaken the value
of Rs. 50,000 p.a on investments into NPS in the year of 29.Similarly, break even year will be earlier for people in lower tax slabs—that is 19th
year for people in 20.6%tax slab and 10th year for people in 10.3%
tax slab. Please note that the above mentioned analysis is without considering
the tax implication of NPS at maturity. If that is also considered, this break even will be much earlier.
Reasons
why NPS may not be suitable for a new employee and neither for an existing one
may be listed as under:-
- Very long lock in period:-
NPS
has the longest lock-in period amongst the tax saving instruments. One can only
withdraw at the age of 60. Even then, one can withdraw only 60% of the accumulated
balance, while the rest (40%) has to be compulsorily utilized to buy an
annuity. Hence, if one
opts to create retirement corpus through NPS his lock in period can be as long
as 30-35 years, if he starts investing from the age of 25-30.
- Taxation on maturity
NPS
is a tax deferment product and not a tax saving one. Out of the 60% that is
allowed to be withdrawn, 40% is tax free while the rest 20% will be taxed as
income. Furthermore, the pension received is taxed under the current Income Tax
provisions. The Indian annuity market is still not conducive for annuity
seekers. The current annuity yield is between 5-7%--much less than fixed
deposit. So, even if the savings earn a higher return during the accumulation
phase, low pension rate will undo most of the gains.
In
light of the above it is possible to create a retirement corpus through the MF
route in a tax friendly manner, by commencing a monthly SIP solely for retirement
purpose.
Calculations
show that a monthly SIP of Rs. 5000 religiously continued for 30 years will
yield a corpus of roughly Rs. 1.20 crores. This will in all likely hood yield a
monthly cash flow of Rs. 80,000 at a conservative rate of return of 8% (called
SWP or systematic Withdrawal Plan).
With
some planning (preferably done by your financial advisor) you can live your
twilight years with “sar utha ke jiyo”.
Happy
retirement to you
Click on the link to read-- Why PPF may not be suitable for your retirement
