While PPF and EPF (annual investment up to Rs 2.5 lakh) enjoy exempt-exempt-exempt (EEE) treatment, maturity proceeds of NPS is not completely tax-exempt.
New Delhi: National Pension System (NPS) has some unique advantages as a retirement savings instrument. It is low-cost and also provides wide investment choices over other retirement savings products like Employees Provident Fund (EPF) and Public Provident Fund (PPF). While in PPF and EPF the investor does not get any option to decide about the instrument where his savings would be invested, in NPS he gets multiple options to choose from.
Advantages of NPS
One can take up to 75% exposure in equities in NPS which increases the return potential from NPS. At the same time, at least 25% of the savings remain invested in debt instruments which ensures downside protection of the retirement savings in case of any sudden correction in the equity markets.
NPS funds have delivered solid returns over the past years. Last five-year returns from NPS equity schemes range between 14.50%-15.80% while its government bond funds and corporate debt funds have delivered between 10.29%-11.90% over the past five years. These types of returns can never be expected from EPF or PPF.
Another biggest advantage of NPS is its tax benefits. NPS contributions are eligible for tax deduction under Section 80C of the Income-tax Act, 1961, up to Rs 1.5 lakh and also under Section 80 CCD (1B) up to an additional Rs 50,000. So one can get tax deduction of up to Rs 2 lakh in NPS as compared to maximum Rs 1.5 lakh deduction in the case of EPF or PPF.
Further, NPS is extremely cost-effective. Pension fund manager fees in NPS is currently capped at 0.01% as compared to maximum expense ratio of 2.25% for mutual fund schemes.
Limitations of NPS
Despite the above benefits of NPS may not be the best retirement savings instrument for all. While PPF and EPF (annual investment up to Rs 2.5 lakh) enjoy exempt-exempt-exempt (EEE) treatment, maturity proceeds of NPS are not completely tax-exempt. One can withdraw maximum 60% of the accumulated corpus in NPS fund as tax-free at the time of retirement and the remaining 40% needs to be invested for buying an annuity, which provides paltry pre-tax returns. At present annuity plans provide pre-tax yields of 3.5-6%. Annuity income is taxable in the hands of the receiver as per his/her tax slab. In comparison, if you plan well and park your retirement savings in ELSS schemes, you can generate NPS-like or even better returns and returns from the fund in excess of Rs 1 lakh per year are taxed at 10% (long-term capital gains from equity).
The second disadvantage of NPS is its long lock-in period. The amount invested in NPS remains locked in till the age of 60. Although partial withdrawals of up to 25% of your contributions is allowed in NPS, it is only for specific purposes like higher education or marriage of children and specific illness, among others.
If you want a greater degree of control over your finances and do not want your money to remain locked in for such a long period of time then NPS may not be a suitable option for you. Lack of flexibility in reinvestment options post maturity and longer lock-in period of the invested amount make NPS less attractive in comparison to EPF, PPF and ELSS.
