NPS has EEE (tax free) Status! Here is why you should still not invest

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The union cabinet today has cleared five changes to the national pension scheme (NPS). The most important of which is that the NPS now has EEE status and the corpus that you can withdraw is tax-free. EEE means, that the money you invest in the scheme (up to a limit) is exempt income tax (1st E), the growth of the money or profit while you remain invested is exempt from income tax (2nd E) and the corpus that you withdraw (subject to limits) is also exempt from income tax (3rd E). Here is what you should do now.

Prior to this announcement, NPS had a mix of EET and EEE status. That is, out of the final corpus, 40% has to be annuitized (that is, given to a life insurance company for pension), 40% was tax-free (EEE) and 20% was taxable as per slab (EET, T = taxable). Now the proposal essentially makes this 20% also tax-free. So do not get carried away assuming that you withdraw 100% tax-free. You can only withdraw 60% tax-free.

The other changes are:

  1. Higher employer contributions (14%) allowed for government employees NPS accounts
  2. Investments in Tier 2 by government employees will also qualify under 80 C deductions with a lock-in of 3 years (not clear about this final taxation)
  3. interest payment to be made in the case of delayed payout from the NPS
  4. Government employees can now choose the asset allocation (earlier they had a 15% fixed equity)

All five changes (incl EEE) will come into effect from April 1st 2019.

NPS has EEE (tax free) Status! Here is why you should still not invest

Should you invest in the NPS since it now EEE?

My take is, that you should not. Why? It still suffers from poor liquidity. If you quit before 60, 80% will be locked away for pension and you can only withdraw 20%. Do not delude yourself that you will only need the money when you retire at 60. Most people who are reading this will be too tired, too stressed out, too sick to work until 60.

EEE status for the NPS is a welcome move for all subscribers who joined the NPS only to reduce their taxable income by an additional Rs. 50,000. They will now get to pay less tax upon withdrawal (not zero as the pension will be taxable as per slab). However, please do not add more to NPS just because it is EEE. You will end up locking up your money, expose yourself to the performance risk of pension fund managers and lock up more money in an annuity.

I can now invest in NPS equity free of tax is it not?!  No.  The tax-free component has only gone up from 40% to 60%. If you think this is reason enough to be at the mercy of pension fund managers then good luck. Especially those who did not like index investing!

Buying a product that does not allow you to withdraw the full amount whenever you want only because part of the proceeds will be tax-free is silly.

I will agree that buying an annuity from a part of the retirement corpus is not a bad idea and is actually necessary for most people. However, why should I commit money to a scheme that itself will not give me a pension? I need to sign up with life insurers and only then get the pension. Look at the heavy price one will have to pay for EEE status. You can only work with pension fund managers who have more or less performed the same! So switching among them is not of much use. You cannot even say, I am retiring at 55, allow me to buy a pension for 40% of the corpus and give me the rest.  You will have to wait until 60! Why? Because the government says so!

If I like a pension so much, I can get it from my EPF corpus and/or my stock or mutual fund corpus. I can manage this corpus anyhow I like, EPF gives me a high rate of return, I can withdraw anytime I want (75% of EPF before age 58) and I can do what I want with it, including getting a pension. People who appreciate this freedom will understand that the EEE status of NPS is cold comfort. I am pretty sure that most people aided by our wonderful media will not appreciate this fact.

Do not let the media fool you. EEE for NPS is not the same as EEE for PPF of EPF. Both PPF and EPF do not have any annuity requirements and a lock-in up to age 60

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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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10 Comments

  1. Buying a product that does not allow you to withdraw the full amount whenever you want only because part of the proceeds will be tax-free is silly.

    I am making this as a thought for the day.

  2. Sir as of now my org is giving the same amount what I invest over and above my ctc.

    Once I move from here can I keep my NPS active by contributing a small amount instead of the amount 4k which I give now?

  3. Well said sir! Also, an additional 50k tax exemption for somebody like me in his mid 30s translates into a 12.5 lakhs tax exemption over 25 years. In the 30% taxation slab, that translates into roughly 4 lakhs saved as tax over my lifetime. That is peanuts if you take into account inflation. On the other hand, you will be losing liquidity and shall be at the mercy of the pension fund managers for 40% of the accumulated corpus. That is why I will still not invest in NPS.

    1. If Rs 50K is the tax exemption why are you again putting a 30% tax on your 50K. Could you please explain this as I am not able to understand it.

    2. 50k tax exemption actually makes quite a difference.

      If I invest 50k per year in NPS for 34 years (I am 26 years old), I will have a corpus of Rs. 1.22 crores (10 % return).
      Out of which, I can withdraw Rs. 73.6 lakhs tax free, and remaining will go to annuity.

      Alternatively, I can invest 35k per year (I will have to pay 15k per year tax being at 30% tax bracket). Say I invest in Equity Index Funds + Debt Funds for a return of 10%, and then I will have a corpus of Rs. 85 lakhs. I will have to pay tax on this (10% LTCG equity, and 20% after indexation in Debt). So after tax (say around 6-7%), I will have 80 lakhs.

      It does look better to invest Rs. 50000 for tax benefits.

      1. You are assuming that the 50k put in stocks /Pure equity MF will have the same returns as NPS. I don’t think that will ever be true.

  4. 50k tax exemption per year over 25 years (60 – Present Age) implies 12.5 lakhs tax exemption over my life time. In the 30% tax slab that is roughly 4 lakhs in tax savings by the age of 60. Present Value of those savings is 1 lakh (assuming 6% inflation). That is a high price to be paid for the loss of liquidity and being left at the mercy of the pension managers.

  5. Pattu Sir, Like you I’m also NPS subscriber made mandatory by my employer. But I’m investing bare minimum in it. I would like to know whether I should invest 50k extra in NPS for tax exemption purpose. Please share your thoughts.

  6. The article makes valid points but the tone of the article is high handed, not objective, and in fact didactic! Those who disagree are silly.
    If the author could present both pros and cons in an objective way, readers (like me) could imbibe better.
    Anyway, thanks for sharing the knowledge.

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