EPF vs NPS: Should you shift to NPS because the govt wants you to?

The govt is keen on offering an option to shift from EPS to NPS. While this is a good move from their viewpoint, does it make sense for existing EPF investors to shift to NPS in search of higher returns? We look at the key differences between EPF and NPS to find out

Published: October 25, 2019 at 9:57 am

The government has proposed amendments to the EPFO act allowing a switch from EPF to NPS. It also wants new employees (non-govt) to directly join the NPS instead of the EPF. While this is a good move from the viewpoint of the govt as it wants to move from a fixed income regime to a market-linked one to reduce its dependence on borrowings, does it make sense for a current EPF subscriber to shift to NPS?

Naturally, such amendments will be met with opposition as many perceive the NPS as risky with an unknown return compared to the NPS while not recognising the fact that unless we move to a market-linked regime, our fiscal deficit will never come down and we can never “progress”.

The government owes the EPFO Rs. 9,115 Crores most of it is the EPS contribution. The supreme court ruling on higher EPS pension did not help! The EPF was already under financial strain as discussed earlier: Higher EPS Pension: Can EPFO pay Higher Pensions or will it go bust?

This video explains why the finances of the government are in a precarious state, why it is keen on NPS for all employees and why it forced NPS on government employees since April 2004.

Since its introduction, the govt NPS has impressively outperformed the EPF and with dropping interest rates, it is likely to continue in future as well. See for example:

EPF vs NPS: Key Differences

  1. EPF is a defined benefit scheme where the interest rate (though variable) is known beforehand for the financial year. NPS is essentially a mutual fund with returns completely determined by the market.
  2. EPF has 15% equity exposure. In NPS one can have a fixed 50% equity exposure or a decreasing exposure from 75%.
  3. The EPF has an (insignificant) pension component built into the contributions. If your basic pay is more than 15K, Rs. 1,250 goes towards a pension annuity fund. For a basic lower than 15K, it is 8.33% of the employer’s contribution. This is not applicable to the NPS.
  4. The NPS contribution is 10% of basic + da with a matching contribution from non-govt employers and 12% for govt employers (from 1st April 2019). NPS has no ceiling on the contributions. In the case of EPF, it is 12% of basic + da but the employer contribution has a ceiling of Rs. 15,000. Due to a supreme court judgement, allowances will also be included for computing the EPF contribution (but the ceiling of Rs. 15,000 stays). You can use this EPF Calculator with withdrawal rules to understand how the rules work.
  5. Both the EPF and NPS have partial withdrawal rules due to emergency situations or other family needs. See for example NPS Partial Withdrawal Rules 2019. So this is not much of a reason to decide between EPF and NPS.
  6. NPS has an additional Rs. 50,000 tax benefit on employee contributions and the employer contribution are also exempt from taxable income. This, however, should sway your decision to move to NPS as explained here: Do Not Invest Rs. 50,000 in NPS for additional tax saving benefit!
  7. The main difference between NPS and EPS is at the withdrawal stage. This is explained below.

EPF: Upon retirement, an EPF subscriber can get the full amount in his EPF account plus a pension from EPS.  Anyone over 57 can withdraw 90% of the EPF balance. If you quit your job, the entire EPF balance can be removed after 60 days of non -employment. The EPS balance can also be withdrawn if the service is less than 10 years. Else a pension will be a paid.  All amounts are tax-free.

NPS:  Upon retirement (60 or above), 40% of the corpus must be used to buy a pension plan. The rest can be withdrawn free of tax. If you wish to exit the NPS before 60, you must buy a pension plan with 80% of the corpus!

Should you switch from NPS to EPF?

For a corporate employee in a stressful environment, the retirement age is not going to be 60 as defined by the NPS. It is not 58 as (currently) defined by the EPF (they want to push it to 60 too! See this for instance). If you can work until 50 it would be a blessing.

More and more people are quitting their regular jobs in favour of freelancing. This possibility should be kept in mind when planning for retirement. The EPF clearly favours this because the person can get the full EPF amount in hand (excluding EPS) whereas most of it would be locked in an annuity in the case of NPS.

Annuities or pension plans are not necessarily bad and income flooring with them will give you peace of mind. However, there must be enough liquid corpus available to combat inflation. This is crucial regardless of NPS or EPF. An 80% corpus lock-in can prevent early retirement or at the very least tax-inefficient if your freelancing work puts you in the 30% slab.

Two arguments can be made in favour of the NPS. 1 For a person investing heavily elsewhere for retirement (eg stocks or mutual funds), the 80% NPS annuity clause may not matter and in fact help to ensure some a good amount of expenses is guaranteed for life. Therefore NPS with its potential higher return possibility is an attractive fixed income option.

2 One can argue that the government will change the 80% lock-in clause or at least impose it only for the lower-income group in future and take a chance with NPS, risky as it is. In any case, only those in the 20s and early 30s should consider this option. However, if you change your mind later, NPS will become a trap. For older individuals, it would be better to stick with EPF.

Therefore if you are thinking about moving to NPS from EPF, ignore the possibility of higher contribution, higher returns and higher tax benefits. That is the government baiting you to reduce its pension debt. Instead, focus on your future. How long will you work for a salary? If this is ten years of less then stick with EPF.  If you are not sure, stick with EPF until you are.

If you have just started working, focus on increasing your investments in equity and ensure your EPF is only about 30-40% of your retirement portfolio. Wait for the govt to change NPS premature withdrawals rules. Shift to NPS only if this is significantly favourable than what it is now.

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