Here is why you should not invest Rs. 50,000 to get additional tax saving in NPS under section 80CCD(1B) 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 deduction under Section 80CCD(1) which is part of 80C. The employer’s contribution falls under 80CCD(2) and is separate 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 the 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 an 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.
After Budget 2016: National Pension Scheme – 40% of withdrawal made tax free! Only 40% of the 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 annuitized (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 an 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 me 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?
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 severely 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 Rs. 50,000 in NPS for additional tax saving benefit under section 80CCD(1B)
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.
Update 2: NPS: Partial Withdrawal Rules 2016 are just awful! Beware.