Update: Krishnan Muthusubrmanian pointed out a flaw in my analysis. The case for not invested in NPS is much stronger. Apologies for the inconvenience.
After budget 2015, the following tax deductions are applicable to the National Pension Scheme.
(1) An individual can invest a maximum of Rs. 1.5 Lakhs in Tier 1 for tax decuction under Section 80CCD(1) which is part of 80C.
The employers contribution falls under 80CCD(2) and is sepearate from the 80C limit of Rs. 1.5 Lakhs. There is a misconception that there is no limit for tax deduction under this section. This is not true.
The maximum value under 80CCD(2) is computed as follows.
Let A = amount contributed by employer in a financial year.
Let B = 10% of income from salary
Let C = Gross Total Income
(2) Then the maximum value permissible under 80CCD(2) is the smallest among A,B and C.
(3) In addition one can, after April 1st 2015, invest Rs. 50,000 in Tier of the NPS for deduction under Section 80CCD(1B)
So now the question is, should one open a NPS account to avail the additional 50,000 tax deduction?
Suppose I invest 50,000 a year in NPS for the next 15 years and get a return of 10%.
I will get Rs. 15.88 Lakhs before taxes.
The trouble with NPS is that the entire sum will be taxed. Not just the gains. If I am in 20% slab, the post-tax maturity value is Rs. 12.61 Lakhs.
Update 2: NPS: Partial Withdrawal Rules 2016 are just awful! Beware.
Update 1: Budget 2016: National Pension Scheme – 40% of withdrawal made tax free! Only 40% of corpus at the time of retirement is tax-free. Therefore, 40% of 15.88L will be tax free. That is, 6.35L will be tax-free.
Out of the remaining 9.53 L, as per current rules 40% has to be annuitzed (require explicit communication for this). Therefore 3.8L has to be used to purchase an annuity. Read this to understand how Annuity Plans Work.
About 5.7L will be left. If this amount is not used to buy an annuity, one will have to pay tax as per slab.
Suppose my taxable income is 10,00,000. I have managed to save Rs. 1,50,000 in say PPF+EPF+ELSS.
So my net taxable income now is Rs. 8,50,000
Case A: The total tax liability is Rs. 97,850. So I am left with Rs. 7,52,150 to manage investments, expenses, liabilities etc.
Suppose I invest Rs. 50,000 in NPS, the net taxable income is, Rs. 8,00,000.
Case B: The total tax liability is Rs. 87,550. So now I am left with 8,00,000-87,550 = 7,12,150 to manage investments, expenses, liabilities etc.
In Case A, I do not invest in NPS. So I am left with Rs. 39, 700 extra (50,000 minus tax). I can invest this in a equity mutual fund for 15 Y at 10% return (conservatively). I will get Rs. 12.61L.
In Case B, I invest in NPS. Meaning I do not have any extra sum left. My NPS investment for 15Y at 10% return will give be the same Rs. 15.88 Lakhs. However, as mentioned above, only 6.3L will come to hand tax-free. About 5.7L will be taxed per slab and rest 3.8L will be used to buy an annuity.
Here we have assumed NPS (with 50% equity) will give the same return as equity mutual funds. Don't you think this is a bad assumption?
Don't you think you can get better returns in equity mutual funds than NPS?
As long as rate of return from NPS and equity mutual fund are same, it does not matter whether I defer my tax liability by investing in NPS or pay tax now and invest the rest in equity mutual funds.
That 40% tax-free corpus in NPS means little as one will have to buy an annuity to get a pension which will be taxed as per slab.Remaining part of the corpus will be taxed per slab.
Do not complicate your portfolio by investing in NPS for tax-saving. NPS is like a frigid ULIP. You will lose all liquidity. If you exit before 60, 80% of the money will be locked in an annuity. After 60, minimum 40% is the annuity requirement.
Changing AMCs or asset allocation is a pain.
Fund management is an unknown commodity here. Soon the AUM of NPS will beat all equity mutual funds. This might severly impact returns.
Pay the tax now and choose equity mutual funds. With luck you will be able to beat NPS hands down with full freedom to wield the corpus any which way you want.
Do not invest in a bad product to save tax.
Do Not Invest in National Pension Scheme For Saving Tax!
Need more convincing? Try this: National Pension System (NPS): Exit and Withdrawal Rules
Credits: I thank Krishnan Muthusubramanian and CA Karan Batra who runs charteredclub.com for valuable insights.
You Can Be Rich Too
My new book with PV Subramanyam, published by CNBC TV 18
The book comes with 9 online calculator modules to create your own financial plan.
Infibeam ₹ 280 with Coupon BS10
Googe Play Books App Store (₹ 244.30)
Read a Sample Chapter and Buy Now!
What Readers Say
- Simple and powerful This book empowers the reader with the concepts in easy to understand & simple form. Those who have been reading blogs of both authors would know that they are not only good with finance domain but also have a knack of simplifying the methods of investing for their readers. This book by them is a gem of financial knowledge for people who are starting to invest or want to get better at it. The presentation and the thought process with calculators is extremely powerful.The book should be read & calculators used simultaneously to understand the concepts well. The calculators when used with real inputs will show you where you are & where you need to reach for each of your goals. Don't ignore these numbers.Learnings from Chapters 7 to 11 will help you avoid going off path & saving your money from financially hazardous products. With discipline & right approach suggested here you wouldn't need a financial advisor to build wealth.
- This is perfect book on personal finance. Very nicely explained about taxation about debt mutual fund. Topics like early investing and asset allocation are very well explained. - Mahesh Deshmukh
- Highly Recommended For anyone who wishes to take control of his/her finance this book is a must read. Very simply put, even an amateur in finance will be able to understand and implement. The author genuinely attempts to inculcate the habit of investing among the people who have the ability to invest but refrain from doing it, either due to lack of time , interest or understanding!. The message from the book is " Investment done without setting a goal/ objective is like leaving for a trip without knowing the destination, not everytime the end result will be promising. Hence, it's important to invest in a planned & disciplined manner." A read is highly recommended 🖒
- A must book for everyone who wants to take control of personal finance. Nice explanation of how a debt mutual fund works. Bonds trading and indexation benefits in high inflation years were something new I learnt. After reading this book you will be able to easily choose any funds, because you will know what that fund does or how that fund works
Read all reviews here: Amazon Reviews