NPS is worthy despite being taxable at maturity

The finance minister didn't increase your threshold exemption limit in the Budget this year. But one powerful tax-saving tool handed to individuals – both employed and self employed – is the Rs 50,000 of additional deduction for investments in the New Pension Scheme (NPS). This throws NPS into limelight as Indians have a tendency to merely save for tax. But you better not jump into NPS for tax saving alone as there aren't any exit options available until you retire. Unlike the other tax saving investments where maturity is not taxable, apart from bank FDs, every rupee paid out of NPS is taxed. Assess the NPS instrument against other retirement-saving options on the following parameters, especially if you are choosing between the EPF or the NPS as permitted by the finance minister.

NPS account

A person between the age of 18-55 years can invest in two types of accounts under NPS – Tier I and II. The amount invested in Tier I cannot be withdrawn till maturity and only sum invested in this account is eligible for tax benefit. This Tier I account is mandatory and a minimum of Rs 500 per month or Rs 6,000 per year would have to be deposited till the retirement age, pegged at 60 years irrespective of your actual retirement. The amount invested in Tier II can be withdrawn under special events.

Charges:
To open these Tier I and II accounts you would first need to get a Permanent Retirement Account number (PRAN). In the first year you would spend Rs 470 including the account opening and registration charges. Second year onward an annual maintenance charge of Rs 350 would be levied.
"A fixed fee model of Rs 470 works much better than an expense ratio of 1.75-2.5% levied as a percentage of the assets held," says Aziz.
Once you start investing at intervals a transaction charge (higher of 0.25% or Rs 20) is applicable. But the cost applicable on managing funds is the lowest across investment options such as life insurance, mutual funds, PMS and the likes. An annual expense ratio of 0.01% is charged as against an expense ratio levy of 1.35-3% per annum on mutual funds.
People fail to understand the impact of 2% lower expense. But the difference in the maturity value would raise eye brows, says Aziz. "The savings of 2% on expense would result in a benefit of Rs 400 on an investment of Rs 100. If we look at a higher savings, then the one with 2% expense would end up with merely Rs 10 lakh, while the one with negligible expense cost would have bulged to Rs 40 lakh."
The expertise of mutual fund houses is offered at a lower cost as the NPS funds are managed by their divisions.
At present, HDFC Pension Management Co Ltd, ICICI Prudential Pension Fund Management Co Ltd, Kotak Mahindra Pension Fund Ltd, LIC Pension Fund Ltd, Reliance Capital Pension Fund Ltd, SBI Pension Funds Pvt Ltd and UTI Retirement Solutions Ltd are the managers you can choose between.

Asset classes

Unlike other long-term instruments such as Public Provident Fund and Employees Provident Fund, which invests only in debt, NPS allows one to invest in three different asset classes. One can invest as high as 50% in equity and select assets classes as explained in table 1.
"It has been proven that over the long-term equity is the best asset class to invest in, which EPF and PPF weren't able to offer even though they are long-term instruments," says Feroze Azeez, executive director - investment products, Anand Rathi Private Wealth Management.
Another auto-option exists for those who aren't sure where to invest. Based on the lifecycle of a person, the auto option funds reduces equity investments from 50% to 10% and increases the debt allocation from 50% to 90% as the person inches closer to retirement.

Taxability

A major disadvantage of NPS as an instrument is that the crop you harvest is completely taxable at the time of maturity. EPF (after five consecutive years of service) and PPF income is tax-free and available in lumpsum.
Under NPS, only 60% of the corpus can be withdrawn as cash and it is detrimental to invest 40% of the corpus into annuity – which is a life-insurance product that helps you get monthly pension. The percentage of mandatory annuity stands at steep 80% for those withdrawing before the retirement age of 60 years.
The amount you receive each month as pension based on the annuity purchase too would be taxed in your hands. However, Aziz hails the annuity clause under NPS saying, "If there is no mandatory purchase of annuity the investors fail to equally consume the retirement funds over the next 20-25 years (considering a life expectancy of 80-85 years). The annuity isn't a large benefit from the return perspective, but a big benefit from the discipline perspective."
Back-of-the-envelope calculations show that if a person is able to generate return which is 0.95% higher than those earned under EPF, PPF then the tax gap can be filled.

Turnaround time

Though account opening and investing isn't cumbersome, withdrawals from NPS are time-consuming.
"Redeeming money from NPS might take one month. A premature withdrawal from the NPS Tier II account too takes a long period of about 20 days to get credited, which on the contrary is relatively easier under PPF," Aziz warns.