Is the National Pension System (NPS) the right instrument for tax saving and building a retirement corpus?

Thanks to the joint family system, children were considered as a “pensionable asset” and parents could count on their financial support during their old age.

For better or for worse, the trend is changing. More and more people are now living in nuclear families and people have begun to independently plan and build a retirement corpus for their golden years.

Supporting this trend, the Pension Fund Regulatory Development Authority (PFRDA) came up with a product called the National Pension System in 2004. Initially, it was for Government Employees and later, it was opened up to all sectors in 2009. The objective of this scheme is to provide an old age income to citizens who contribute to it by generating safe market-based returns, over the long term. Subscribers to this scheme invest regularly in pension accounts and receive the returns at retirement and anyone between the age of 18 – 65 years can begin contributing to the NPS.

In addition, NPS has been made attractive by providing tax breaks. NPS allows subscribers to claim additional exemptions of Rs. 50,000, u/s 80CCD (1B) over and above the limit of Rs. 1,50,000, u/s 80C. Further, the lumpsum amount is completely tax free when withdrawn.

We undertook an analysis to see if NPS is advisable as a tax saving instrument and a means of building a retirement corpus for any investor. What we realized is that the benefit that accrues from the NPS are clearly a function of what age you begin to invest in it, the tax bracket you fall into and the amount you can put away every year.

Here are the highlights of our study…

Investment starting at an early age (30 – 50 years):

Let’s start with the case of individuals who begin contributing Rs. 50,000 p.a. at different ages to see how they can benefit from it. NPS now allows any subscriber to invest 75% of the contribution in equity (upto age 50 and thereafter, reducing by 2.5% p.a. going upto 50%)

At the age of 60, the subscriber can either opt to extend the withdrawal upto 70. If he opts to redeem his corpus, then upto60% will be tax free and the balance 40% will be converted into an annuity from which he will get a regular income after retirement. On death, the nominee of the subscriber will receive the 40% value. So, as per the example below, Rs. 45.10 lacs will be received by the nominee.

What if you are near the age of retirement (57 – 65 years):

There is also an option available for a subscriber who begins investing at a later age.  Below is an example of how one can still benefit by investing in NPS. Let us assume that an investor begins investing Rs. 50,000 p.a. at the age of 57-

If the total accumulated corpus is less than Rs. 2 lakhs then the entire amount can be withdrawn and this amount will be considered as tax-free. In the above example, the value of the investment is less than Rs. 2 lacs hence the investor can withdraw the entire amount and that entire amount is completely tax free. By investing for 3 years, the subscriber saves tax of Rs. 45,000 and earns a return of 23% on his investment.

From both the above illustrations, it can be seen that NPS is beneficial for long term investment in order to create a retirement corpus and also for short term tax saving. Hence, subscribers should opt for NPS and take advantage of this relatively new product.

Performance:

So, the quick takeaway of our analysis is:

• For subscribers who are in their early years, NPS is a clear winner and hence should not be ignored, especially by those individuals who are in the 30% tax slab.
• Similarly, for subscribers in the age bracket of 57 years and above, it is a short-term plan which can be capitalized upon.
• Those in the age group of 50-57 are in a twilight zone - they benefit only if they can stretch the contribution upto 70 years of age.

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Disclaimer:

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.