Do Not Shift Your EPF Corpus to NPS: It is a Trap!

In this post, I discuss why it is a terrible idea to shift your EPF corpus to the NPS (National Pension Scheme). In a circular dated 6th March 2017, the Pension Fund Regulatory and Development Authority (PDRDA) announced a road map for provident fund and superannuation plan subscribers to shift to the NPS.

The shift will be one-time, tax-free and will not be counted as income. Hence this cannot be used for tax deduction. Here is why I think you should stay away from this opportunity.

Two basic concepts in investing are necessary for appreciating my viewpoint (if you wish to!).

1: Asset Allocation:  The fact that NPS has the possibility of higher equity exposure than EPF should be of no relevance in deciding whether to switch or not. A portfolio, and in this case, a retirement portfolio should have an appropriate mix of equity and fixed income. For those whose retirement is several years away, at least 50-70% can be in equity. This can be sourced from equity mutual fund separately. EPF is a solid source of fixed income and the rest of the folio can just have this.

If you do not have an appropriate exposure to equity, you should consider it. If you already have this, then there is no need for NPS (with or without equity)!!

2: Liquidity:  The ability to pull out money asap is more important than returns or tax. NPS sucks at this. Even if you wanted to retire early or quit early to start your own business, your money in NPS will be locked until 60.

In the case of EPF, complete withdrawal is possible two months after you stop working. This alone should be enough for you to not switch to NPS.

Photo Credit: Fraser Mummery (Flickr)

The other factors are reasonably obvious.

Annuity:

It is amusing that after years of investing in a government owned mutual fund, we will have to buy an annuity from an insurer for 40% of the corpus. And this annuity, as pointed out by S R Srinivasan at AIFW, is no different than any other annuity in the market. There is no unique NPS annuity. If I have money, I can buy the same product without joining NPS.

EPF, on the other hand, is free of annuity – the employee contributions, that is. The employer contribution (a part of it) will provide a pension via the EPS, which is practically peanuts. Most EPF investors I know, treat this as zero. This condition is not as stifling as NPS.

Taxation

Any  EPF withdrawal made after 5 years of continuous service is tax-free.  NPS, on the other hand, has a crazy taxation rule. Only forty percent of the corpus (after buying 40% annuity) is tax-free. The rest of the corpus is fully taxable as per slab.

Many people argue that retirees will pay lesser tax and the above withdrawal can be deferred. I don’t buy this. The pension from that 40% annuity is fully taxable as per slab. In addition, most people will have some form of such taxable income – FDs, rent etc. So it would be prudent to assume that the tax rate will not change after retirement.

Power of the Union

The year 2016 was a terrible year for the govt. First, it had to take back the EPF taxation proposed in the budget. Then it had to take back the more stringent withdrawals rules proposed before the budget. Why? Because the EPF is backed by labour unions and protests even turned violent.

Did you see anyone complain when the NPS did not have the 40% tax-free rebated from 2004 to 2016? Why? Nobody cares about the NPS. In fact, many government employees have voiced their protests about the NPS.

The government is unlikely to play around with the EPF for the rest of its term. Also, the interest rate should be a touch higher than other fixed income products. Even if this drops below 8% in the future, I think the EPF is a solid product.

VPF!

VPF qualifies for 80C tax deduction – much better option than opening an NPS account just to save that 50K tax. Yes, yes the IT sections are different (80C for VPF and 80CC1(b) for 50K), but the flexibility of the VPF and its tax-free returns make it a better choice. There is more to investing than saving tax.

The tier 2 of the NPS (an analogue to the VPF?) has no tax benefits and no one know what the taxation is for withdrawals. It has been in existence for 13-14 years!!

The only reason many investors opened an NPS account was to avail that extra 50K tax deduction  (only 40% is actually tax-free).  If you have done this, let this be. Do not switch your EPF corpus to NPS. It is a trap.

How about Superannuation Subscribers?

You will have to buy an annuity for 2/3 rd of the superannuation fund corpus. Rest 1/3 is tax-free. Thanks to Muthu (who played a key role in organising 6 Bangalore DIY meets) for correcting this.  Superannuation plans were also supposed to be taxed like NPS (only 40% tax-free), but this has been taken back.

So in this case, 26.7% more has to be annuitised when compared to NPS and 6.7% lesser corpus will be tax-free in the Superannuation fund. But unlike NPS, there is no mandatory need to buy an annuity. Also one can close the plan before 60. So considering these factors, you may decide to switch to NPS. It is not a clear yes or no here.

A sensible government will not make NPS Tax-free

Please do not live in hope that “NPS will become tax-free in future”. If you spend some time reading about how our economy runs, how the government earns, how many pay taxes, how it spends etc. you will realise that no responsible/sensible government can afford to make NPS tax free. Remember that they want EPF to taxed.

NPS Annuity will not go away!

If it does, then it is just a plain old mutual fund. Why on Earth would the government do this?!!

Well, like Aadhar a EPF to NPS shift may be thrust upon you  (I already hold mandatory NPS) gradaully. Why not cross that bridge when you get to it. Such a move is unlikely to accepted by the unions.

NPS has risks!

If you hold NPS or want to, please recognise that NPS has significant risks. My NPS account is filled with Gilts (only 15% equity- mandatory) and this is how volatile it can be:

And the C or the corporate bond portion is subject to credit risks. Sure, my current returns (7Y+) is about 10%, but that comes at a price of liquidity and taxation. Please tread with caution.

Do Not Shift Your EPF Corpus to NPS: It is a Trap!

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11 thoughts on “Do Not Shift Your EPF Corpus to NPS: It is a Trap!

  1. Very interesting article and useful too. I wanted to look at the NPS option to save the tax but now I realized that it’s not a good option. Thanks for sharing this useful info (at least for me)..

  2. This is one of your best articles if I must say so because all of the reasons laid out here are solid and convincing. There’s not much room for argument. The government is trying it’s best to make NPS look good and encourage employees to move away from EPF because that would benefit the government more than it benefits us. I’m glad I am still on EPF and after reading this, I’m not moving anywhere.

    I still have one lingering doubt on the liquidity of EPF. Isn’t there like a rule that after 10 years of service, one cannot withdraw the funds and will have to wait till 58 for the pension to commence. Is that only restricted to the EPS part or the entire corpus? The EPS corpus is waste of money though. People who serve more years get a raw deal and the pension is peanuts.

    1. Thank you. Yes, the EPS is of little use. My understanding is the rule is, complete withdrawal is possible after two months of unemployment.

  3. Thanks for the article. I too had exactly this in my mind but not with such solid and complex logic as I am not great at understanding ‘economics’ yet..learning 🙂
    The simple reasons what came in my mind were:-
    1>This same govt earlier wanted to put tax on EPS and later retreat back.
    2>This same govt had reduced the interest rate on senior citizens who doesn’t have any other source of income other than interest earned from their meager corpus( only non pensioners will know the pain!)
    3>This same govt had removed all the 865 money from the market in the name of fighting black money..later started calling it digital india move…cashless economy ..all bull shits!!
    4>The same govt ‘wanted’ to impose tax on earning from stock market/equity MF..they didn’t not ultimately.
    6> The same govt is imposing a number of new rule to disallow you(the owner of the fund) to have cash withdrawal from your own bank account.
    7>..8>.. so on..
    In that situation, if ‘The same govt’ moves like this: You can move your EPS fund to NPS!! Hurray!! there must be some ‘issue’..you need to be cautious my dear friends. so awesome article this is.

    By the way, I have one question if anyone can answer — couple of years back my wife had opted to take out all money from EPS during the separation/resignation from her last employer in india(as planned to move to abroad for some years). We used that money to repay house loan(that’s a good work done). later I realized we should not have taken any money from EPS unless it’s really really needed. Now after few years I could earn more money, could save well, and thinking of if there is any option to refill the amount what we pulled back!! 🙂 IS THERE REALLY ANY CLAUSE which we can use to refill withdrawal amount into EPS account??
    (i understand it’s a silly question..but still, we have lots of GYANI folks in this forum!)

  4. Yes, already I am making FULL use of 2 PPF accounts and making a good amount of investment in MF too since past 3-4 years. I was trying to have another avenue of ‘safe’/compounding over years/tax free(EPF) just like PPF. Because MF is somehow volatile, I don’t want to invest lumpsum in even Debt Fund over a period of 20-30 years( Don’t know what market will be). So was asking if there is any way to REFILL EPF.
    [I found another way out – that SCSS through parents where max limit is 15L and use the interest earns in Equity SIP. Lets see!]

  5. Dear Pattu Sir,

    I am already investing in NPS since 2 yrs with a monthly contribution of 5K (2500 each in Tier-1 & 2) along with some equity MFs for achieving the retirement goal. After reading post, I have realized that NPS is not good if you want to take early retirement (liquidity) and corpus would be reduced substantially because of taxes.

    I would need your advice for NPS Tier-2. Can I withdraw this amount into the bank account now? Will there be any deductions? I would gradually, shift that amount to equity MF in the form of SIPs. I know it is not possible for Tier-1 and I would need to continue investing 6k p.a. to it. (I have online access to NPS account).

    Please advice.

    Thanks,
    Abhay

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