NPS OR Mutual Fund Now The Choice Becomes Even More Difficult

Recently the government has made changes to the National Pension System (NPS), adding to its appeal DSIJ by making it more tax friendly. explains, how despite these changes mutual funds score over NPS as an instrument to save for your retirement.

The increase in life expectancy of individuals along with the rising trend towards nuclear family structure is forcing many of us to take retirement planning more seriously. This does not mean that earlier no one planned for retirement; however, the means that were used were not optimal. Physical assets, including land and gold, were the most trusted assets for assuring a good retired life in future. Nevertheless, over the years, it has been realised that these assets fail to beat the inflation on a consistent basis for a longer period of time and hence are not reliable for your future financial security. Financial assets, on the other hand, such as equity have proved to be good bets against inflation for a longer period. Hence, these are ideal instruments to plan for your future.



FAQ on NPS

What is National Pension Scheme (NPS)?
National Pension Schemes (NPS) is a low cost and portable retirement savings account. Under this, subscribers contribute regularly in a pension account and even their employer can contribute to this account during their working life. On retirement, subscribers can withdraw a part of the corpus in a lump sum and use the remaining corpus to buy an annuity to secure a regular income after retirement.

Who can subscribe to the NPS?
A citizen of India aged between 18-65 years satisfying the prescribed Know Your Customer (KYC) norms as detailed in the Subscriber Registration Form for NPS can subscribe to the NPS.

How does the scheme works?
Subscriber, along with his employer (not necessary for private companies), contribute towards NPS during his/her working life. On retirement or exit from the scheme, the corpus is made available to the investor with the mandate that some portion of the corpus (now 40%) must be invested in buying annuity to provide a monthly pension post-retirement or exit from the scheme.

If a subscriber has invested in any other Provident Fund, can he still invest in NPS?
Yes. Investment in NPS is independent of subscribers’ contribution to any provident fund.

What is a Permanent Retirement Account Number (PRAN)?
Every NPS subscriber is issued a card with 12-digit unique number called Permanent Retirement Account Number or PRAN.

What are different types of NPS accounts?
Under NPS, subscriber gets the option to open two accounts. Tier-I account (also known as pension account) is mandatory to open in order to join NPS. However, Tier-II account (also known as investment account) is voluntary. The main difference between these two is the flexibility with which you can withdraw your corpus. There are restrictions imposed on the amount that you can withdraw from Tier-I account, but there is no restriction on withdrawal from Tier-II account. Moreover, Tier-I account is necessary for opening a Tier-II account.

What are the assets permitted for NPS funds Investment?
NPS offers four asset class to subscribers. These are:
Equities (E)
Corporate Bonds (C) 
Government Securities (G)
Alternative Investment Funds, including instruments like CMBS, MBS, REITS, AIFs, Invlts (A)

Who manages the money invested in NPS?
The money invested in NPS by you is managed by PFRDA-registered pension fund managers. Currently, there are eight pension fund managers. You need to select any one of them.

What are the investment options available in NPS?

There are two options available for a subscriber to NPS 
Active Choice: Under this option, the subscriber gets the flexibility to decide on his asset allocation across asset classes. However, investment in equity is restricted to 75% of the contribution amount
Auto Choice: Under this option, the proportion of investment across securities is predefined and varies according to age. There are three different options available within ‘Auto Choice’ – Aggressive, Moderate and Conservative. These options invest in different type of funds, depending on your risk appetite.

Can I change my investment choices?
Yes, you can change your investment choices once in a financial year for both Tier-I and Tier-II accounts.

What are the tax benefits available for NPS?
While Investing

For salaried individuals,
Investment up to 10% of salary (basic+dearness allowance) is deductible from taxable income u/s 80CCD (1) of Income Tax Act, 1961, subject to the Rs. 1.5 lakh limit under section 80C.

Additionally, investment up to Rs. 50,000 is deductible from taxable income u/s 80CCD (1B) of Income Tax Act, 1961.

For self-employed individuals,

Investment up to 20% of gross annual income is deductible from taxable income u/s 80CCD (1) of Income Tax Act, 1961, subject to the Rs. 1.5 lakh limit of section 80C.

Additionally, investment up to Rs. 50,000 is deductible from taxable income u/s 80CCD (1B) of Income Tax Act, 1961.

While withdrawing

Up to 60% of the corpus withdrawn in lump sum is exempt from tax.

Balance amount invested in annuity is also fully exempt from tax.

Pension received out of investment in annuity is treated as income and will be taxed appropriately.

What are the average returns provided by different asset class in NPS?



There are a few options available among the financial assets that help an investor to plan for his/her retirement. The chief among them are PPF, mutual funds, fixed deposits, National Pension Scheme (NPS) etc. The last option NPS has not picked up on expected lines even nine year after it was launched for every citizen in India due to the way it has been designed.

Nevertheless, the recent changes introduced by the government in the NPS have once again ignited the debate on the suitability of the NPS as an right instrument for your retirement planning. 

The Recent Changes
The Pension Fund Regulatory and Development Authority (PFRDA) has changed the withdrawal norms for the NPS. The requirement of minimum period under NPS for availing the facility of partial withdrawal from the mandatory Tier-I account of the subscriber has been reduced from 10 years to 3 years. Besides, the tax exemption limit for lump sum withdrawal at the time of exit from NPS has increased to 60% from the 40% currently. In addition to the above, certain minor changes have also been introduced, thereby making NPS more attractive.

Digging Deep
The above changes make NPS more potent contender for your retirement planning. However, we have dug deep to really understand whether you should go for the NPS. Most of us get lured to investment in NPS due to its tax saving benefit, which is exclusively available to NPS only. This is over and above Rs. 1.5 lakh available under section 80C. Assuming that you come under the highest tax bracket, you could save Rs. 15,000 every year by investing in Rs. 50,000 every year in NPS.

Before it excites you and you start investing in NPS, it is important to understand the arithmetic of returns behind it. This is because everything boils down to the returns or cash flow that you get out of your investment, irrespective of where you are investing. 

Hence, we constructed three scenarios, where we assumed that you have a fixed amount of money that you can invest either in mutual fund or NPS and that you are a moderate risk taker. We have analysed the entire life cycle of investment in NPS right from investment to withdrawal.

Case I

In our first scenario, we assumed that you invested Rs. 50,000 in NPS and the total tax savings out of this investment is Rs. 15,000 (i.e. 50000*30% = Rs. 15000) assuming you are in the highest tax bracket. This saving of Rs. 15,000 is again invested in a debt fund. Assuming that you have started your investment in NPS and debt mutual fund (out of tax savings) at the age of 35 years and you are in the highest tax bracket, when you reach 60 years of age, your total investment would be Rs. 12.5 lakh (25*50,000).

Your investment in NPS would grow to around Rs. 63.5 lakh. This figure is arrived assuming your investment in NPS grows at a rate of 11%, which has been the average return of the last five years. It is also assumed that investment is done lump sum and at the start of the year. Your investment in debt mutual fund would grow to Rs. 10.15 lakh. Therefore, the total corpus would be Rs. 73.65 lakh.

Withdrawal :
Now, according to the recent changes introduced by the government, you can withdraw 60 per cent of the corpus of your NPS tax free and the balance of 40 per cent is used to buy annuity. In this case, you will necessarily invest Rs. 25.4 lakh (40%*63.5 lakh) in buying annuity and the remaining Rs. 48.25 lakh (Rs. 10.15 lakh +60%*63.5 lakh) can be invested in some balanced funds, giving you an annual return of 10%. Assuming your life expectancy is 85 years and NPS annuity return is 7%, you can withdraw total of Rs. 2.03 lakh. In case of balanced funds, you can withdraw Rs. 4.86 lakh every year. Therefore, the total annual withdrawal would be Rs. 6.9 lakh. This figure should be adjusted downward as we have not considered tax while withdrawing from both sources.

The above scenario is constructed based on the age of 35 years and tax bracket of 30 per cent. However, this might not be the case always. Hence, we did a 'what if' analysis, where we changed the age at which you start investing in NPS and the tax bracket that you come under to understand how much you can withdraw when you retire.

Following is the ‘what if' analysis of the amount you can withdraw after you retire at the age of 60 with different starting ages and tax brackets.




The above table shows how much you can annually withdraw if you start at different ages for different tax rates. Therefore, if you start as early as 30 years and you come under the highest tax bracket of 30 per cent, you can withdraw Rs. 11.7 lakh every year. The other figures can be construed accordingly.

Case II

In this scenario, we have assumed that the tax saved after investing in NPS is invested in equity funds instead of debt funds. Therefore, your Rs. 15000 investment every year will grow at a higher rate of 18% (average growth of equity funds in the last five years). Now the total corpus would be Rs. 1.24 crore when you reach 60 years (Rs. 63.5 lakh from NPS and Rs. 60.64 lakh from equity investments).

Withdrawal :
Again, as in Case-1, 40% of the NPS corpus will go into buying annuity that will give you Rs. 2.03 lakh of yearly cash flow. The balance of Rs. 98.74 lakh would be invested in equity balanced funds generating annual return of 10% that will help you withdraw Rs. 9.88 lakh every year. So, in this case, you will be able to withdraw a total of Rs. 11.93 lakh every year till the age of 85.

Following is the ‘what if' analysis of the amount you can withdraw after you retire at the age of 60 with different starting ages and tax brackets. 



Case III

In the last case, we had assumed that you are not interested in the savings of Rs. 15,000 by investing in NPS. You are in love with mutual funds and have invested total Rs. 50,000 in equitydedicated mutual funds with annualised return of 18%. At the time of your retirement when you are of 60 years, your total investment would have grown to Rs. 2.02 crore. Now you will withdraw this amount and invest in balanced funds. Once you withdraw the corpus, you need to pay long term capital gain tax of 10%, hence the total investment you will make is Rs. 1.83 crore. With the same assumption as above, you can withdraw Rs. 18.34 lakh every year for the next 25 years.

Following is the ‘what if analysis’ of the amount you can withdraw after you retire at the age of 60 with different starting ages and tax brackets.



Conclusion
The above analysis clearly shows that mutual funds still remain superior products as they give you better returns in the long run. Some of you may argue that the assumption of 18% return from equity mutual fund is too high and is not sustainable. We do agree on that, however, since we took the NPS return over the last five years as its future return potential, we did the same for equity mutual funds. Going ahead, if returns decline, the same will be true for NPS also. Nevertheless, one can approach investment in NPS purely from the viewpoint of asset diversification. You can select the debt part of the NPS fund to invest as it are likely to generate better returns due to its lower expense ratio. Going ahead, as the government continues to improve the product and give more flexibility, it might compete with mutual fund. However, considering its current avatar, one can say that mutual funds score over it.