National Pension Scheme (NPS): Do not invest even if you get tax benefits!

Here is why I think one should not invest in the National Pension Scheme even if you get tax benefits. This is the updated version of an earlier post.

Earlier I had recommended subscribing to the NPS if you get tax benefits via the employer contributions. Tax benefits have actually increased since the govt. announced an additional 50,000 tax benefits over and above the 1.5 Lakh possible under section 80C.

Here the reasons why I think one should not invest in NPS despite the tax benefits:

  1. NPS is partially an EET instrument

That is, there is no actual tax deduction like in PPF. You are only deferring the tax benefits until withdrawal. Upon which you will need to pay tax not just on the gains but also on the investment. That is a bad deal.

Update 1: A Guide to investing in the National Pension System (NPS)

Update 2: Budget 2016: National Pension Scheme – 40% of withdrawal made tax free! Only 40% of corpus at the time of retirement is tax-free.

People argue that this will be changed and NPS will become EEE 'soon'.

I think the government cannot afford to make NPS EEE. Even if it does one should not invest because:

2. 80% will be annuitized if you retire before 60 (after Budget 2016, 40% is tax free withdrawal, 80% of remaining corpus has to be annuitized official confirmation awaited). 

This is a terrible deal. How many of you want to work in a corporate job until 60?! If you are contemplating retiring before 60, stay away. Read more: Stay away from Corporate NPS, if You Wish to Retire ASAP!

Here are more reasons against NPS. This is part of the original post.

3.      Will you stay in a half-built house? As a product, NPS is a premature baby. It was rolled out in a hurry for government subscribers with no clarity on who will manage the fund, how it will be managed, and even when it will be managed.

For the general subscribers the case was much better but not perfect. The fund manager websites are extremely user-unfriendly and are still in their infancy. Information on investment strategy, where ones money will invested, etc. is hard to find if not available!

Hardly any personnel directly involved with the customer understands the rules and regulations as these are new! They have not been trained well enough. There seems to be no incentives offered to anybody to push NPS. Any product that has little or no commission associated with it is unlikely to be popular. The best example is the low AUM of the excellent fund Quantum Long Term Equity (see analysis here) because distributors do not get commissions to sell it

In my opinion, the product (NPS) is also half-baked. It is still evolving and only the framework is complete. Would you invest in such a product?

4.      Cheap and best is an oxymoron! Much has been said about the low fund management expenses. This means the NPS fund managers are unlikely to paid as much as typical mainstream fund managers. Therefore,

  • They are unlikely stay in the same job for long
  • I do not expect the same competence as mainstream fund managers

Want something cheap? Buy yourself an index fund If you want alpha, you are barking around the wrong tree!

5.      Poor Exit options/ liquidity If you exit before 60, you will need to annuitize 80% of the corpus. If you state only so much, as many articles do, I would say this is a good thing!

After all, most people cannot afford to retire before 60 because they simply are not investing enough for retirement. How much is enough? As much as you spend! So what is the problem with this? The idea is to discourage the misuse of a corpus meant for retirement. Given the number of nut jobs with fancy ideas around, this is actually a good thing. If you are considering retirement before 60, why consider the NPS in the first place?

The real issue is with respect to performance-related switches/exit. Assuming I can track a NPS fund managers performance and find it unsatisfactory,

  • I cannot exit the scheme without practically losing my corpus to an annuity
  • I will need to switch only among the fund mangers authorised to manage NPS. As of now, there is no easy way to gauge who is better.
  • Although switching is permitted, I will be extremely surprised if this is hassle-free!
  • To sum it up, NPS is a prison cell for the serious investor who would like to actively manage ones retirement corpus.

6.      Active management is mandatory for long term goals When it comes to investing for long-term goals, volatile instruments are inevitable, Be it debt products, equity or even PPF! So the key is to contain this volatility with making some tactical calls. They could range from rebalancing to simple profit booking to tactical asset allocation. If you are serious about retirement, you simply cannot afford to keep investing in a bunch of mutual funds without paying heed to market conditions and fund performance not to mention the fund portfolios!

The size of the corpus or nest egg is key to successful retirement planning. The larger it is, the most flexible will be your retirement plan. You simply cannot afford to follow a fill it, shut it, forget it (Hero Honda! as Ashal would put it) strategy.

7.     Why bother when we do so much better without NPS?  Using a combination of equity mutual funds + PPF combined with oodles of discipline one hope to do as well as NPS and perhaps even better. So why bother?

That is quite enough NPS bashing in one post!

Now let us ask,

  • What if my employer offers it? Should I take it then?
  • What if NPS is made the only 80C eligible instrument?
  • What if the 80C limit is enhanced?

Good questions!

A couple of points before answering. If the employer offers NPS and contributes to the NPS, the employers contribution will be eligible for exemption up to Rs. 1 lakhs over and above the 80C limit. Your contributions will be part of 80C.

So this is an opportunity to deduct an extra 1 Lakh from your taxable income. For someone in the 30% slab, this is a huge bonus. Each year I save an amount approximately equal to a months expenses as taxes because of this.

Under the above circumstances when there is an actual tax saving, it makes sense to opt for NPS, provided

  • NPS is only one component of your retirement portfolio.
  • you are disciplined enough to invest the saving wisely.

If I choose NPS for tax savings, how should I invest in it?

Choose NPS as a debt instrument. That is choose 100% of asset class C. Remember this is only part  of a portfolio with enough equity contributions from your side.

Here is an extract about asset class from the NPS Hand book

Asset class C (credit risk bearing fixed income instruments) – This asset class will be invested in the following instruments:

I. Liquid Funds of AMCs regulated by SEBI with the following filters:

  •  AMCs are SEBI regulated, with Average total assets under management (AUM) for the most recent six-month period of, at least, Rs.5000 crores.
  • All assets that are permitted for investment into liquid funds by SEBI.

II. Fixed Deposits of scheduled commercial banks with following filters:

  •  Net worth of at least Rs.500 crores and a track record of profitability in the last three
  •  Capital adequacy ratio of not less than 9% in the last three years. Net NPA of under 5% as a percentage of net advances in the last year

III. Debt securities with maturity of not less than three years tenure issued by bodies corporate including scheduled commercial banks and public financial institutions [as defined in Section 4 (A) of the Companies Act] provided that at least 75% of the investment in this category is made in instruments having an investment grade rating from at least one credit rating

IV. Credit Rated Public Financial Institutions/PSU Bonds

V. Credit Rated Municipal Bonds/Infrastructure Bonds

I think Asset Class C is a good option to ward off both interest rate risk and credit risk to a reasonable extent. My own NPS subscription has suffered due to overexposure to Asset Class G (govt bonds). I have only 15% equity exposure in NPS.
What do you think? Do you agree with my views?

Update 2:  NPS: Partial Withdrawal Rules 2016 are just awful! Beware.

Disclosure: I am a mandatory NPS subscriber with a pretty significant corpus. See my posts on NPS returns.

I would like to reiterate that this list is only for who understand the importance of retirement as a goal and are serious about planning for it

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42 thoughts on “National Pension Scheme (NPS): Do not invest even if you get tax benefits!

  1. Pattabiraman Murari

    I agree with you there. NPS is a deferred annuity product. We now have some options in it to defer the annuity. The older the annuity is purchased, the better the rate. Until then the corpus can be actively managed to generate income that increases in step with inflation. Govt bonds also can be delayed as much as possible. Locking onto the bonds early in retirement is not a good thing to do.

    Reply
  2. Pattabiraman Murari

    I agree with you there. NPS is a deferred annuity product. We now have some options in it to defer the annuity. The older the annuity is purchased, the better the rate. Until then the corpus can be actively managed to generate income that increases in step with inflation. Govt bonds also can be delayed as much as possible. Locking onto the bonds early in retirement is not a good thing to do.

    Reply
  3. Vikas

    Excellent arclce

    Excellence article. My choice would be 50% Class E, 30% Class C, 20% Class G. The reason for 50% Class E is - as I read on this website diversification is important in a portfolio (i.e. equity and debt and possibly gold and cash). Further, diversification within each asset class is also important. So, in one's equity portfolio one must hold, Index funds, large cap, small & mid cap, diversifiied equity. Considering this strategy I would choose the Class E of the NPS.

    I'd be keen to know comments on my strategy above as I'm following the same currently and would like to change if I'm not on the correct path.

    Reply
    1. pattu

      Thanks Vikas. While diversification is important, there is no need to diversify within NPS. Once can safely use NPS as pure debt product and use equity mfs to diversify the folio. When there are excellent equity fund managers available why bother choosing the E option?!

      Reply
  4. Vikas

    Excellent arclce

    Excellence article. My choice would be 50% Class E, 30% Class C, 20% Class G. The reason for 50% Class E is - as I read on this website diversification is important in a portfolio (i.e. equity and debt and possibly gold and cash). Further, diversification within each asset class is also important. So, in one's equity portfolio one must hold, Index funds, large cap, small & mid cap, diversifiied equity. Considering this strategy I would choose the Class E of the NPS.

    I'd be keen to know comments on my strategy above as I'm following the same currently and would like to change if I'm not on the correct path.

    Reply
    1. pattu

      Thanks Vikas. While diversification is important, there is no need to diversify within NPS. Once can safely use NPS as pure debt product and use equity mfs to diversify the folio. When there are excellent equity fund managers available why bother choosing the E option?!

      Reply
  5. Anand

    We can invest according to how rules are as of now!
    I know that anything can change tomorrow.
    As of now, PPF is tax-free. But tomorrow it might become taxable.
    This does not mean that I should not invest in PPF.
    There is strong chance of PPF remaining tax-free.

    If the taxation of NPS is not clear, how do you expect people
    to invest in it? You say that it should be taxable like a debt fund.
    But this is just a wish! Not the fact!

    Mandatory annuity is a turn-off. We all know that annuity products
    give poor returns. Read subra's post: http://www.subramoney.com/2013/11/do-not-buy-an-annuity/
    Annuity is an extremely inflexible product.

    Personally I am ok with tax but not okay with mandatory annuity.
    As of now, my employer does not offer NPS benefit.

    Reply
    1. pattu

      I am well aware of the limitation of annuity. Subra in his book is okay with 40% of it. I am against all annuities. My point is having a constant source of income in retirement to cover part of the expenses is not a terrible thing at all.
      I can twist around your argument and say, "There is a strong chance of (NPS) remaining tax-free" if DTC comes through. No product greater than a 10 years with monthly contributions is taxed on maturity as per slab. Hence my expectation is that NPS will be taxed as a debt fund. Do remember that even if it is taxed as per slab, you can redeem it in the next FY after you retire to lower your tax burden significantly. So this tax is a non-issue to me.

      Reply
      1. Rohan

        pattu - you mentioned "Do remember that even if it is taxed as per slab, you can redeem it in the next FY after you retire to lower your tax burden significantly. So this tax is a non-issue to me." Can you please explain in more detail about how is it possible to redeem this? Thanks.

        Reply
  6. kuttan

    For the first time I see an article in favor of NPS with clear cut points to justify. Excellent Mr Pattu!

    I am also an NPS subcriber, through Kerala govt. Kerala was a late entrant to this scheme and had actually started deduction from this month salary onwards. Any info regarding NPS with respect to kerala govt employees? Why I ask is because not even the authority who deducts monthly subscription from our salary has any idea when and where these contributions get credited and whether or not the govt actually contributes and equivalent amount----to be precise,no transaparency. I mean shouldn't they atleast provide govt employees with a USER/pass to access our accounts?!!
    One vital aspect of NPS that is not much discussed is,lets say a scenario, where, a person retires at the age of 60 in the year 2050. How can we get a decent monthly income out of the 40% annuity,given the fact the interest rates are falling ever since the 1990's. for instance we cannot expect a FD return of 10% for all the coming years,as the economy progress( I believe FD rates for 1 year are less than 1% currently in USA). An annuity of,lets say LIC, giving 7 or 8% today might not be the same in 2050.
    And that age of 60 one can't afford to take risk in equity markets. Future is unpredictable. So is NPS, a double edged sword?

    Reply
      1. kuttan

        Hi, Thanks for the reply. Yes, I have a PRAN number assigned,but shouldn't we have an I-pin or password too?

        Reply
        1. pattu

          Please go to the CRA website, download the application form for I-pin and password and submit to your admin (finance). They will have to submit it to your nodal office (locate it in CRA)

          Reply
  7. Hema

    Sir, my company is giving a flexible benefit package component in the salary and i am allowed to define amount against NPS upto 10 percentage of my basic. Will this be considered as my contribution or my employers contribution? Company website says i will save taxes and i feel this is beyond 80C.

    There is another option of a Superannuation fund contribution (LIC) also from the same flexible benefit package which is upto 15% of my basic which also says i will save taxes This is also annuity option i believe.

    Question 1: Will it get benefit beyond 80C for the above?
    Question 2: considering i take debt option of NPS, Which one of the above (SA or NPS) is better? What if i quit my job and stop paying them altogether after a few months?

    Reply
    1. pattu

      Hi Hema, I am not sure about the NPS contribution. You will need to confirm this with their accounts. Typically it should be their contribution with an option for you to contribute from your salary. I am not familiar with company pay slip terminology CTC etc. So best to confirm this.

      If you quit your job and move to another you should be able to transfer the NPS account. If you quit altogether, the money will be locked and you cannot withdraw unless you opt for an annuity. So that is not a good idea.

      As for the LIC option, I think NPS is better that that. Please plan for retirement with the tools here and invest in other instruments suitably.

      Reply
    2. pattu

      The following reply is from financial planner Mr. Narendra Kondajji to your query:
      In case NPS, if it is employer's contribution it is usually given as perquisite. It may or may not appear in payslip but definitely in form 16 as exempt perquisite. If NPS is a voluntary contribution (in addition to employer's contribution as perquisite), it will appear as a deduction in pay slip and will appear in form 16 U/s 80C

      Reply
      1. Hema

        thank you sir. I checked with my company and they clarified that if i define my basket of allowance to go towards NPS or Superannuation, it is over and above 80C.

        regards
        Hema

        Reply
  8. RRJ

    Hi,

    I am currently in UK with pension contribution from company. Now when I come back to india I have an option to transfer this to india (through uk govt's legal option called QROPS) into one of the uk govt's recognized pension funds. NPS is one of the approved option in india apart from several insurance providers' pension offers

    At an outset I am not a big fan of NPS primarily because of the annuity clause. However considering the other options available are all pure annuity, i am thinking of moving my pension corpus to NPS.

    I have couple questions on NPS

    1. Can I keep the NPS account active after the one time transfer without any additional contribution since my company only contributes to EPF and not NPS

    2. Is there clarity on whether the lump sum portion of NPS withdrawal is taxable. I am getting different inputs on this with some saying EEE is applicable and others stating EET.

    RRJ

    Reply
    1. pattu

      To keep the NPS active you will have to contribute a trivially small sum each year. This can be done online via SBI.
      The taxation angle is not clear. At the worst case I would expect it to be taxed with indexation.

      Reply
  9. Sankaranarayanan Hariharan

    Any tips on how to choose a good fund manager out of 6 we have currently now. Please advice.

    Reply
  10. prasad

    Hi
    I too have same case of Hema explained above. Which is best out NPS and SA ( Super Annuation) to allocate my allowances.. It is so, how much can we plan per month. i am 35 years old.

    Reply
    1. manish

      There is NPS calculator/future income calculator available @ http://www.hdfcpension.com/nps-calculator.html#

      Investing in NPS is extra beneficial especially when there is employers contribution as well. With additional 50000 deduction in 80ccD(1) and employers contribution covered through 80ccd(2), this is quite lucrative now. This is especially true for incomes falling in 30% tax bracket.

      Reply
  11. Sandeep kumar

    I want to tell you all guys this is just maximize your tier 2 investment which as same as saving account with more than 6%(atleast expected). i know this would not giving you tax benifit at all but you will get more interest than normal saving S/B bank account. and unlike tier one, you could withdraw amount from tier 2 at anytime. Those who are planning to have regular income after 40 years of age could invest blindly.

    Reply
  12. J. R. Pinto

    26-May-2015

    Dear Sir,

    Read your article dated 21-Apr.-2014 on NPS on http://www.freefincial.com titled "ational Pension Scheme (NPS): Do not invest unless you get tax benefits!"..

    The uncertainty on withdrawals beyond the amount used for the annuity purchase is certainly a dampener.

    As pointed out by someone, it would not come as a surprise if the entire withdrawal from the NPS corpus in a particular year be treated as income for that year.

    Since the earliest, fresh-out-of-school members of the NPS in the government sector would not retire before around 2062, it's a long way off before first-hand treatment on withdrawals is known.

    Ofcourse, unorganized-sector NPS contributors who joined the scheme post-2009 at midlife or so will get to know of the the tax treatment earlier but may be so few in number that their cries for justice and clarity may barely be heard, let alone heeded.

    In ending, may I request you for your view on admissibility of tax, if the entire retirement corpus is used to purchase the annuity?

    Secondly, for FY 2015-16, if ₹1,50,000 is invested in 80C-exempt instruments like EPF, PPF, etc., and ₹50,000 is invested in NPS-Tier I (directly without the involvement of the employer), would the taxable income be reduced by ₹2,00,000?

    Your views, please?

    Reply
    1. freefincal

      Yes to your last question. I think the first NPS batch will retire from 2030 onwards. My advice has always been the same: pay tax corresponding to 50K and invest rest in equity mfs

      Reply
  13. Surinder Mehta

    Dear Sir my DOB 06-May-1982, I want to join National Pension Scheme. I want to know that agar mein 2000/- per month invest kru toh meri 60 yrs umar ke baad kitni pension per month milegi...actually mujhe kahi de bhi NPS calculator detail nahi mili, so pls peovide me full detail of NPS..

    Reply
  14. George Mathews

    Hi,

    Nice article.
    Just one clarification. For someone taxed at 30% on Salaried income,

    If he invests 50000 in nps, and is able to get a return of say, 10%;cash outflow would be only 33000 due to savings on tax (said investment being exempt over and above 80c 1.5 lakhs) and actual return would be 15%. However principle for taxation is yet to be clarified.

    Kindly point out any errors in what I have written as I have been reading up multiple articles to get clarity on the same.

    Thanks in advance.

    Regards,
    George Mathews

    Reply
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