Myth busted: You do not get 30% returns by investing 50,000 in NPS!

You would be surprised as to how many people believe that by investing an additional 50,000 in NPS, they “instantly” get a return equal to their tax slab! This is a case of mis-accounting or innumeracy. In this post, I discuss what exactly is the implication of “saving tax” via investing in 80C and with the National Pension Scheme (NPS).

Announcement 1 : Gamechanger paperback is still available at a 25% discount for Rs. 149 only! Grab it or gift it to a young earner

Announcement 2: Swapnil Kendhe joins the freefincal List of Fee-only Financial Planners in India and Fee-only India: a movement to serve investors and advisors. He is one of the most level-headed advisors that I know. We share similar beliefs about risk and reward. You can reach him at vivektaru.com

Tax Myth 1: Reduction in taxable income is not the same as a reduction in tax payable!

When we say, “Rs. 1.5 Lakh can be invested under 80C for saving tax”, many people interpret this as Rs. 1.5 Lakh of tax can be saved!!

What this actually means is that out of taxable income in any financial year, Rs. 1.5L can be deducted. This is, by investing Rs. 1.5 Lakh, we reduce our tax liability by 1,50,000 x tax slab(+cess).

If we ignore cesses, and if 12L is the total taxable income, then by investing 1.5L, the taxable income reduced to 10.5L and tax payable is reduced by 1.5L x30% = 45,000

Reduction in taxable income = amount invested.

Reduction in tax payable = amount invested x tax rate

They are not the same!

Tax Myth 2: No Instant returns on tax saving, just more money in hand

Update: kishanm pointed out that I had failed to used the slab configuration of taxation. So I have reworked the numbers below. The main conclusions remain unaffected.

I don’t know how this 30% return (for those in 30% slab) originates! It was so bizarre that I had a hard time arriving at that 30% figure.

Let us continue with the above example.

Taxable income = 15L

Tax to be paid: 2.625L  (12,500 in 5% slab + 1L in 20% slab + 1.5L in 30% slab; cess has been ignored uniformly)

Net income at hand: 12.375L

Hang on. I can save some tax.

I make an 80C investment  = 1.5L

Then the net taxable income = 13.5L

Tax to be paid =  2.175

Reduction in tax liability: 2.625L —-> 2.175L or 45,000 as mentioned above.

Extra cash in hand: 12.375L + 0.45L = 12.825L (this includes the 1.5L 80C investment)

Before 80C, tax removed (as a percentage of total income): 2.625L/15L = 17.50%

After 80C, tax removed(as a percentage of total income): 2.175L/15L = 14.50% = 2.175/(13.5L + 1.5L)

Notice that the effect of the 1.5L 80C “saving” is already accounted for in the numerator. The calculation ends here! The beenfits ends there!

The problem arises when I claim I got the  45,000 as a return on my investment of 1.5L, or read 45,000/1.5L = 30% “return”.

The correct equation that expresses the benefit is

(2.625L/15L) – (2.175L/15L) = (2.625-2.175)/15 = 0.45/15 = 3%

Tax saved = 3% of total income.

The mistake is using this incorrect equation is (2.625-2.175)/(15-13.5) = .45/1.5 = 30%

This is a case of “double counting”. That is investing 1.5L and saving 45,000 in tax are not independent events. I should use either the reduction in taxable income or reduction in tax for accounting. If I use both, it seems as I have got a return, “instant return” of 30%.

ice cream tax - Myth busted: You do not get 30% returns by investing 50,000 in NPS!
Remember that ice cream taxation meme? Photo by Marcin Kargol

Additional 50,000 “tax saving” with NPS

Now let us “carry on counting” (remember those movies?!) with additional 50,000 investment in NPS.

Note about NPS:

I cannot make my stand more clear than this: Do Not Invest Rs. 50,000 in NPS For Saving Tax!

Trust me, I am a 11Y old NPS investor (not my choice) and it occupies a huge, immovable, ill-liquid chunk in my portfolio. It is a trap.

Stay away from Corporate NPS, if You Wish to Retire ASAP!

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

If you still wish to invest or if you have already invested, try this:

A Guide to investing in the National Pension System (NPS)

Now let us get back to what we were discussing:

Before NPS:

Net taxable income = 13.5L

Tax = 2.175L

After NPS:

Net taxable income = 13L

Tax Paid = 2.025L.

Before NPS, tax removed (as a percentage of net taxable  income): 2.175L/13.5L = 16.11%

After NPS, tax removed(as a percentage of net taxable income): 2.025L/13.5L = 15% = 2.025L/(13L + 0.5L)

Here again it is incorrect to claim “30% instant return: because of the 50K invested.

The correct equation to express the benefit is (2.175L/13.5L) – (2.025L/13.5L) = (2.175-2.025)/13.5 = 0.15/13.5 = 1.11%

Tax saved = 1.11% of net taxable income before NPS investment.

The mistake again is double counting: using this incorrect equation

(2.175-2.025)/(13.5L-13L) = .15/0.5 = 30% and claiming an imaginary return.

Do not confuse more capital to invest (with conditions) as more returns!

1.5L in 80C + 50K in NPS

We started with 15L income and because of an investment of 2L (1.5L + 0.5L), the tax liability has come to 2.025L.

That is, from the 2.625L tax it has reduced to 2.025L. A reduction of 22.86%.

Now, before any tax saving investment, tax/income = 2.625L/15L = 17.5%

After tax saving investment, tax/income = 2.025L/15L = 13.5%.

A change of 4%

 

Summary

You do not get any “returns” for reducing your tax outgo. All you get is more money at hand (including the tax saving investment made).

Extra capital to invest should not be confused with extra returns!!

Where you invest that extra money is more important!!

Here is another innumeracy: Can you really save tax with a home loan?!

Announcement 1 : Gamechanger paperback is still available at a 25% discount for Rs. 149 only! Grab it or gift it to a young earner


Use this form to ask general Questions or about the robo template ONLY (For comments/opinions, use the form at the bottom)

And I will respond to them in the next few days. I welcome tough questions. Please do not ask for investment advice. Before asking, please search the site if the issue has already been discussed. Thank you.  PLEASE DO NOT POST COMMENTS/OPINIONS WITH THIS FORM it is for questions only.

[contact-form][contact-field label=”Name” type=”name” required=”1″][contact-field label=”Email” type=”email” required=”1″][contact-field label=”Ask your question (Got an opinion or comment, use comment box at the bottom of the page. DO NOT post them here)” type=”textarea” required=”1″][/contact-form]

GameChanger– Forget Startups, Join Corporate & Live The Rich Life You want

My second book, Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantco-authored with Pranav Surya is now available at Amazon as paperback (₹ 199) and Kindle (free in unlimited or ₹ 99 – you could read with their free app on PC/tablet/mobile, no Kindle necessary).

It is a book that tells you how to travel anywhere on a budget (eg. to Europe at 50% lower costs) and specific investment advice for young earners.

GameChanger review 4 650x477 - Myth busted: You do not get 30% returns by investing 50,000 in NPS!both covers 650x467 - Myth busted: You do not get 30% returns by investing 50,000 in NPS!

The ultimate guide to travel by Pranav Surya is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

You can Be Rich Too with Goal-Based Investing 

My first book with PV Subramanyam helps you ask the risk questions about money, seek simple solutions and find your own personalised answers with nine online calculator modules.

mini Final cover - Myth busted: You do not get 30% returns by investing 50,000 in NPS!

You can be rich too Review1 650x254 - Myth busted: You do not get 30% returns by investing 50,000 in NPS!

The book is available at:

Amazon Hardcover Rs. 271. 32% OFF

Infibeam Now just Rs. 270  32% OFF. If you use a mobikwik wallet, and purchase via infibeam, you can get up to 100% cashback!!

Flipkart Rs. 279. 30% off

Kindle at Amazon.in (Rs.271) Read with free app

Google PlayRs. 271 Read on your PC/Tablet/Mobile

Now in Hindi!

Hindi You can be rich too - Myth busted: You do not get 30% returns by investing 50,000 in NPS!

Order the Hindi version via this link

Want to conduct a sales-free "basics of money management" session in your office?
I conduct free seminars to employees or societies. Only the very basics and getting-started steps are discussed (no scary math):For example: How to define financial goals, how to save tax with a clear goal in mind; How to use a credit card for maximum benefit; When to buy a house; How to start investing; where to invest; how to invest for and after retirement etc. depending on the audience. If you are interested, you can contact me: freefincal [at] Gmail [dot] com. I can do the talk via conferencing software, so there is no cost for your company. If you want me to travel, you need to cover my airfare (I live in Chennai)

Connect with us on social media


Do check out my books


You Can Be Rich Too with Goal-Based Investing

My first book is now available at a 35% discount for Rs. 258. It comes with nine online calculators. Get it now.  The Kindle edition is only Rs. 199.

Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want

My second book is now only Rs 199 (Kindle Rs. 99) Get it or gift it to a youngearner

The ultimate guide to travel by Pranav Surya

Travel-Training-Kit-Cover This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step.  Get the pdf for ₹199 (instant download)

Create a "from start to finish" financial plan with this free robo advisory software template


Free Apps for your Android Phone

All calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

About Freefincal

Freefincal has open-source, comprehensive Excel spreadsheets, tools, analysis and unbiased, conflict of interest-free commentary on different aspects of personal finance and investing. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. We do not accept sponsored posts, links or guest posts request from content writers and agencies.

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.

4 thoughts on “Myth busted: You do not get 30% returns by investing 50,000 in NPS!

  1. Pattu SIr,

    I feel the calculation is slightly wrong. If the Taxable Inc is 12 L then (assuming AY 17-18 and age less than 60 yrs) the tax payable is 1.85 lac and not 3.6 lac as you observed. After 80C deduction the tax payable would be 1.4 lac and after NPS also it would be 1.25 lac. Similarly the percentages and money remaining with candidate after paying tax etc. would also change.

    Hope I didn’t offend you

    Kishan

    1. No offence. You are right. I forgot about the slab taxation. I have reworked the nos and updated the post. The conclusions are unaffected. Thank you.

  2. Do people think they save 30% of the total income? I thought the pitch is to save 30% of the invested amount. 45K for 1.5L invested and 60K for 2 L invested.
    Ofcourse – the assumption of 30% of invested income also is not true for many as they forget that they already have PF, Housing loan, insurance etc so actual outstanding 80c benefit is less than 1.5L investment. Have colleagues who invest 1.5L in ELSS every year as that is the 80C limit.

    1. It is a fact that we “save tax”, but to treat the tax saving investment as offering instant returns is silly. MOney saved is not money earned. Money saved = money saved.

Comments are closed.