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Why NPS should be part of your retirement portfolio


Initially, the government introduced NPS in 2004 to reform its pension plan by switching from a defined benefit plan to a defined contribution plan. In the former, the government distributed a certain amount periodically after retirement. After the transfer, there is a fixed amount of contribution and the amount to be paid depends on the amount of corpus accumulated at the time of retirement.

Contribution to NPS has better tax treatment compared to mutual funds on two fronts. Firstly, tax deductions of up to 50,000 can be claimed per year, in addition to the maximum limit 1.5 lakh to which a person is entitled under section 80C of the income tax act.

To illustrate its benefit, let us assume that a person in the 30% income tax bracket wants to invest 50,000 in NPS account. The individual can claim tax deductions for contribution towards NPS at the end of the financial year while filing returns and can save that amount. 15,000, a sum which would otherwise be deducted from salary as tax

This is not the case with mutual funds, except that they are equity linked savings schemes (ELSS) which one can claim as a deduction under section 80C. There are no deductions for investments in other types of mutual funds. Hence, investment in NPS gives a head start of 15% over that in mutual funds (non-ELSS).

Apart from the 50,000 per annum, approximately 10% of the basic salary of a corporate employee and dearness allowance up to 7.5 lakh can be claimed as deductions if it is registered as employer contribution.

Subscribers to NPS also get another benefit. There is no tax when the corpus is withdrawn (although the NPS annuity is taxed). However, capital gains on equity mutual funds are taxed at 10% at the time of redemption and that for debt mutual funds at the flat rate.

Ravi Saraogi, co-founder of Samasthiti Advisors, said that NPS is suitable for most individuals who do not have much time to spend on investments, while those with the necessary expertise or support from advisors can achieve better asset allocation do with mutual funds. However, NPS is better than solution oriented funds like retirement mutual funds, as such funds cannot create a specific asset allocation and all investors in a retirement mutual fund are assigned the same asset allocation portfolio whereas, in NPS , the asset allocation changes dynamically for each. subscriber based on their age.

To be sure, any amount invested in the NPS is locked in till the age of 60. After that, you can withdraw 60% of the corpus as a lump sum and the rest can be invested in an annuity product. The periodic interest from the annuity is fully taxable at the flat rate. After a person attains the age of 75, it is mandatory to leave NPS and invest 40% of the corpus in an annuity product.

On October 30, the NPS received a new update. The Pension Fund Regulatory and Development Authority (PFRDA), which regulates NPS, has issued a circular allowing systematic lump sum withdrawal (SLW) plan for its pensioners. This simply means that investors can now withdraw a portion of the 60% lump sum based on their desired periods (monthly, quarterly, semi-annually, or annually) and also decide how much they want to withdraw each time.

Before that mechanism, people had to withdraw the entire lump sum amount in one go after reaching the age of 60 or make redemption orders every year to withdraw their funds. With the SLW, which is similar to the mutual fund withdrawal plan, they can now automate this process.

Assuming one is accumulated 2 crore in NPS account at age 60, so 1.2 crore or 60% of the corpus can be withdrawn as tax free lump sum and the balance 80 lakh can be annuity. The interest on the annuity portion will be taxed at the flat rate.

One criticism facing NPS is the mandate to compulsorily invest 40% of the corpus in annuity products. This is because annuities give a paltry 6-7% interest compared to NPS Tier 1 Equity funds which give returns of 13.31% on an average per annum. The 10 year average return of NPS Equity funds (13.31%) is also better than Nifty Bees (13.27%) and large cap mutual fund (12.21%).

Sumit Shukla, managing director and CEO of Axis Pension Fund, said that people can use the SLW facility for regular pension and delay the annuity till they reach 75. That way, the 40% can that are invested in annuities enjoy longer tax-free compounding. for another 15 years until the person is 75 years old.

Before SLW, NPS subscribers could take the 60% lump sum and put it in a debt or equity mutual fund and opt for systematic withdrawal. The disadvantage here is that capital gains tax has to be paid during such withdrawals, apart from the applicable entry and exit loads. Also, if, at any time, MF unit holders want to change the scheme they have invested in, they will have to pay the applicable capital gains tax and exit charges. In NPS, however, the fund manager could be chosen once or twice a year without any fees.

You can also withdraw up to 25% from the NPS corpus before you reach 60 years of age. This function is called ‘partial withdrawal’. The NPS Trust website has specified certain situations where you can avail this withdrawal facility. These include higher education of children, marriage of children, purchase or construction of a house, hospitalization of yourself or a family member, medical expenses arising from disability, retraining (as permitted by PFRDA), or to start or start a new enterprise . You can avail this withdrawal facility only three times during the NPS account tenure.

On the other hand, if you want to opt out of the NPS scheme completely, you will get only 20% of the corpus amount as lump sum and the rest has to be invested in annuities. Corpus of up to 2.5 lakh can be fully withdrawn as a lump sum. “These are tough conditions and early departure is not recommended. In case of death, all the money goes to the family,” said Shukla.

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(Graphic: Mint)

NPS allows people to choose where they want to invest their money. There are four asset classes to choose from: equity, corporate debt, government bonds and alternative investments. The maximum allocation one can have in equities is 75%. The maximum allocation for alternative funds is capped at 5%.

On the other hand, the National Procurement Service has an automated option called a ‘lifetime fund’ which pre-determines the allocation to each asset class by age. As age progresses, more volatile assets such as equity and corporate debt continue to decline from the portfolio.

According to your risk appetite, you can choose one of the three ‘lifetime funds’ available, namely: aggressive, moderate and conservative life funds.

An aggressive fund starts with a maximum equity exposure of 75% till the age of 35 and gradually reduces it to 15% when the individual is 55 years old. In a moderate life fund, the maximum equity allocation is 50% till 35 years and is kept at 10% after 55 years of age. In a conservative lifetime fund, the maximum equity allocation is capped at 25% until age 35. reducing from there to 5% among people aged 55 and over.

NPS subscribers must also choose a pension fund manager from among three government firms and 5 private pension managers.

“Mutual funds are for short-term goals, whereas NPS is built for long-term goals like retirement. Here, the structure and the fund managers are so good that the funds are managed keeping the retirement needs in mind. In pension products, we cannot be swayed by short-term euphoria like how small-cap funds are picking up in the MF space,” said Shukla of Axis Pension Fund.

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