Should I Now Switch to the National Pension Scheme (NPS)?

'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 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.

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20 thoughts on “Should I Now Switch to the National Pension Scheme (NPS)?

  1. Deepesh

    Hi Pattu,
    Excellent as always.
    This pertains to premature exit from NPS.
    NPS rules are framed by PFRDA. Income tax laws may allow tax exemption up to 40% of the accumulated corpus. However, it does not matter much if PFRDA allows only 20% lump sum withdrawal.
    PFRDA NPS rules will prevail over income tax laws when it comes to product structure.
    What do you say?

    Reply
    1. freefincal

      Yes that is quite possible. Manoj Nagpal pointed this out and I have added this as a counterview to the post. Thanks.

      Reply
    1. freefincal

      Because it will take at least a year for full clarity (if rules are changed). Then you are moving from a RD to a mutual fund which can be dangerous close to retirement.

      Reply
  2. Soumyadeep Banerjee

    Hi,
    Within the EPF component along with Employee share and Employer share, we also have a Pension contribution which generally in PF statement referred as Employee Pension Scheme. Is this anyhow related to the NPS? What is this account? Could you please elaborate on this.

    Reply
    1. freefincal

      The EPS has nothing to do with the NPS. About 3.5% of the employer contribution goes there, earns no interest and is used to derive a measly pension. That has nothing to do with this budget.

      Reply
  3. Rukmesh

    Sir,
    Need your advice on NPS.
    Should I invest 50k in NPS to save tax.
    I am in 20% tax bracket at the moment. I am an average performer. SO may not reach 30% bracket in future too. Because even though salary would increase in future, but so would the slabs.
    I will not buy annuity on retirement, so I will pay the tax on the remaining 60% (40% is taxfree). I am prepared for lockin till retirement as I would not need the money till then. I would choose C or G option and not E. My returns expectation from NPS is that of a debt instrument. So vis-a-vis PPF,EPF, taxfree bonds, debt mutual funds, does it STILL make sense for me to invest the 50k in NPS (as per the prevailing IT rules). Please respond fast, as I will need to invest in NPS in next couple of days, as the proof needs to be submitted to employer. I am NOT an existing NPS investor.

    Reply
    1. freefincal

      If you are not an existing investor, I see no reason why you should open an acct just to save this tax. Use PPF+EPF for debt and mutual funds for equity.

      Reply
  4. Karthik

    Only one reason I want to switch to NPS from EPF is that they are deducting RS.1250 every month (which is about 20% of my monthly epf) towards EPS. This amount doesn't read interest and I don't have any clarity on what pension will be given.

    Reply
  5. Rukmesh

    Read somewhere,
    EPS = x * y / 70
    Where x = monthly slaryvcapped at 15k
    y = no. Of years in Service capped at 35
    And Max Pension comes to 7.5k p.m.

    Min value of y should be 10 to be eligible for Pension.

    Reply
  6. vimal

    Dear pattu sir
    I have query regarding active choice in nps.
    Suppose I select E 50% G 25 %and C 25%. .
    Is it the amount invested in above proportion at time of investment or they rebalance corpus (after more gain in one class ie E ) accordingly in between as in balanced mutual fund.
    Thank u sir.

    For example today I invest 100 rs( 50 E + 25C +25C) after 9 month or 1year I loose in E class
    Will they rebalance my corpus accordingly

    Reply
    1. freefincal

      If you invest in active choice, the equity allocation will decrease each year gradually until age 60. Therefore, there will be proportional rebalancing.

      Reply
  7. kalyan

    As long as there is an annuity requirement I will avoid a product, unless the deal is too good. Even with EPF, pay the tax and take the money would be better than buying annuity in present conditions. When I retire it may change if annuity products improve but I doubt it. One lesson from this is don't commit your money long term to any financial product as you are not guaranteed to get what is promised.

    Reply
  8. ASHAL

    A small correction, 24% of gross corpus is not tax free. It's 40% of gross corpus, which is tax free. Total withdrawable corpus is 60% of Gross. Out of this 40% of gross is tax free and remaining 20% of gross is taxable.

    Thanks

    Ashal

    Reply
    1. freefincal

      I am with you. Manoj Nagpal said that because he feels PFRDA may still impose madatory annuity and interpret it that way.

      Reply
  9. Kumar Appaiah

    One thing you might want to add is that the NPS amounts to double taxation if you contribute over and above the 80C+80CCD deduction. For instance, if you contribute more than the 80C+80CCD amount in NPS (either through voluntary contribution or by automatic deduction from salary), the amount over and above the deduction is actually post tax money. And this amount is subject to tax once again upon withdrawal, both capital and growth.

    Even in debt mutual funds, only the capital gains are taxed. That too, with indexation. Here, if someone is (under current circumstances) foolish enough to open an NPS account and go put any money over the 80C+80CCD deduction, that amount is now locked and tax will be deducted on that upon withdrawal, even though the exemption was not available during investing.

    Is this correct?

    Reply
    1. TU27

      This is my first comment on this awesome blog.

      "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." -- Mr. Nagpal

      I'm not sure I agree with Mr. Nagpal's interpretation.

      Quoting the FM from his budget speech: "I propose to make withdrawal up to 40% of the corpus at the time of retirement tax exempt in the case of National Pension Scheme." This sounds fairly unambiguous to me: 40% of the corpus, not 40% of the amount withdrawn.

      In addition, the many post-budget matryoshka doll-esque clarifications from the FM mention that if (hypothetically) the retiree were to invest 60% of the corpus in an annuity, no tax will be payable (other than on the monthly/quarterly income from the annuity). This applies to both EPF and NPS. This implies that the remaining 40% of the total corpus (the amount withdrawn at retirement, in this scenario) would not be taxed at all. Based on Mr. Nagpal's logic, 60% of this withdrawn amount will be taxed.

      Reply

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