‘In the light of budget 2016 recommendations, should I now switch or shift to the national pension scheme?’ More and more EPF and other pension scheme subscriber are asking this question. While it is clear that we need to wait for the budget recommendations to become a law, here are some important points to keep in mind regardless of what happens from now on.
In his budget speech, the finance minister said,
Exemption is proposed to be provided for one-time portability from a recognised provident fund or superannuation fund to National Pension System.
Therefore, it is clear that the government is keen on making the NPS first choice (if not only choice) regardless of whether EPF taxation is rolled back or not.
The government wants to ensure all types of pension plans, defined benefit like EPF, and defined contribution like NPS are treated on par upon withdrawal.
This means that the tax and withdrawal rules will sooner or later be the same.
Should I Now Switch to the National Pension Scheme (NPS)?
1 First ask yourself why you want to? Because of higher returns? If so, why do you think the NPS will provide better returns than the EPF?
If your answer is ‘NPS has equity exposure up to 50%’, excuse me, you are confused and way off the mark.
The EPF is a rock-solid fixed income product. Sure the interest rates can vary, but it is still solid enough. If you wish to switch to the NPS, then the comparison can only be with the fixed income part of the NPS portfolio.
Unfortunately, the NPS is a mutual fund and the EPF a recurring deposit. Mutual fund holdings are marked to market on a daily basis. That is, the value of the holdings and hence the NAV will fluctuate due to the market demand, credit rating changes and interest rate movements.
NPS has three asset classes:
Option G –> Long-term government bond which can oscillate wildly with interest rates and can take months to recover from a fall. Primary source of gain here is ‘capital gain’ due to price movements.
Option C –> Short-term bonds from banks, corporates and PSUs. They are sensitive to credit rating changes. However, the NPS has a mandate to operate close to a ultra-short term fund and therefore, the risk is minimized. The primary source of gain here is ‘income’ from the bonds. That is the interest payment when the bond is held up to maturity.
Option E –>
Nifty Index fund Manoj Nagpal, CEO of Outlook Asia Capital pointed out that this has been changed and it now active management. Will dig up more details on this.
If you must compare EPF with NPS, do so with the C option of NPS.
Do not make the mistake of switching from EPF to NPS with 50% equity exposure ‘for better returns’.
2 Prior to the budget, the NPS had mandatory annuity requirements
- 80% has to be annuitized if withdrawn before age 60
- 40% has to be annuitized if withdrawn after age 60.
Now the finance bill includes this clause
(12A) any payment from the National Pension System Trust to an employee on closure of his account or on his opting out of the pension scheme referred to in section 80CCD, to the extent it does not exceed forty per cent. of the total amount payable to him at the time of such closure or his opting out of the scheme
This means that I can exit at any time and get 40% tax free and pay tax as per slab on 60%. This is great news for early retirees if made law.
It also implies that the 80% annuity requirement for early exit has been done away with. We need confirmation that the 40% after age 60 is also out.
Once this confirmation is available the NPS (C option only) becomes as a good a product as EPF, but with a small chance of outperformance since it is market linked.
At this point in time, you can ask yourself ‘Should I Now Switch to the NPS?’.
The answer is yes, if you are several years away from retirement. If your retirement is within say 10 years, then I would not recommend it.
The answer is yes, only if the portability rules are crystal clear. Meaning we have a lot of time to not just fine the answer, but even ask the question!
Never forget that the key to sucessful investing is not better returns. It is efficient diversification across asset classes. Switching from EPF to NPS should not skew your asset allocation. Use NPS as a debt product and use stocks or equity mutual funds for equity exposure.
What about the additional 50,000 tax saving under section 80CCD(1B)?
Earlier the corpus created from this was 100% taxable as per slab. Now 40% of such a corpus is tax-free and the rest taxable as per slab. This rule also applies to any contribution made to the NPS whether before April 1st 2016 or after!
Update: Manoj Nagpal is of the opinion that the annuity is not done away with (unless explicity mentioned otherwise)
In which case he points out,
the minimum annuity require is 40% after 60. So at retirement, 60% is withdrawable & 40% of that i.e. 24% is tax-free. Similary before 58, 20% is withdrawable and 40% of that i.e. 8% is tax-free.
If the minium annuity requirements are not modified, I think it is better not to switch to NPS.