National Pension System has a triple tax advantage post budget. Salaried people can deposit 10% of their basic plus D.A. in NPS up to Rs 1.50 lakhs, this budget gave additional benefit of Rs. 50,000 p.a. for investment in NPS by inserting a new section and also your employer contribution to your NPS account also qualifies for tax benefit. Is there any reason to cheer or investment needs to be assessed before jumping into it. Most of the experts feel it is a good choice for tax and retirement planning but to me NPS is not a promising solution. NPS was launched in the year 2004 for all Government employees and in 2009 it was opened for all to encourage investment for retirement. Surprisingly after 6 years of time still people have not opted for it. The reason could be either there is no incentive to sell NPS or scheme is not competitive compared to other investment options available. I would like to highlight few important points so that you can take informed decision before opening a NPS account.
1) Not transparent:
Investment scheme needs to be transparent about the portfolio and performance and should be easily available for comparison. After 6 years also the portfolio and performance of the different schemes under NPS is not easily available. I would not recommend any instrument for long term investment which is not transparent. You can’t keep your investment for rainy days whose details are not easily available. You should note that not only schemes details of mutual fund products and unit linked insurance plans are available at companies website but also many independent agencies also track and give their ratings which helps investors to know where his fund is moving.
2) Not Liquid:
Investment needs to be judged on three parameters, risk, reward and liquidity. There is moderate to high risk in the NPS 3 options but it is not liquid. If you want to withdraw fund before the age of 60 years, you can withdraw only 20% of the corpus and after 60 years you can withdraw 60% of the corpus only. Liquidity should be available as the life is not so smooth and every person has to pass through good time and bad time in his career. Liquidity is not always require for funding any future goal or unexpected expenses but liquidity also helps you to switch to other options if your investment is not performing well compared to other options.
3) Tax Implications:
Pension amount receivable after retirement under NPS is taxable and you have no flexibility to plan for tax free income post retirement. It is also not clear whether the lump sum withdrawal of 20% or 60% as the case may be is tax exempt or taxable. Most of the expert feels the same is taxable. Still there is confusion over this and government needs to clarify this at earliest. One need to know that even life insurance pension products allows you to commute 1/3rd of the corpus tax free on vesting date.
4) No Immediate Pension Market:
There is lack of good and matured pension market in India at present. Even today you will not get good pension rate for your retirement. I remember that even when yield of 10 year Gsec was around 9% the rate of pension were not revised upward by any life insurance companies and even today the rates are same. This clearly shows that nobody is ready to guarantee for longer duration. You can’t plan your retirement when you don’t have matured pension market and your scheme forces you to buy annuity.
5) Maximum 50% in equity:
NPS is a long term investment for retirement and allows only 50% in equity under scheme E. Normally above 10 year time horizon you need to take higher risk by taking equity exposure between 80 to 100%. If your long term investment does not beat inflation by margin then you are definitely likely to struggle in later years. To me 50% is very low exposure to equity for long term time horizon.
6) Index funds not a good idea:
Even this 50% of equity investment is done in index funds either in Sensex or Nifty stocks. Ours is a growing economy and if we are aiming at double digit growth then you need to invest in active funds. Index funds are passive funds and there is no role of fund manager in selecting the stocks whereas fund manager in active fund can identify growth or value stock from minimum 500 good companies listed on both the exchanges. Good active funds have given 3 to 5% higher returns compared to index funds over a 10 year period. Even taking exposure of 30-35% in mid and small cap funds is not a bad idea for long term time horizon.
7) Debt fund is a duration game:
Debt option under NPS is not as safe as EPF and is subject to interest risk and default risk. If you don’t understand this risk, you may have to face tough time if interest rates go up when you are near to your retirement. You have to opt for minimum 50% in debt fund under NPS either through Scheme C or scheme G. Both the debt schemes are subject to interest rate risk and scheme C is also subject to default risk. At present returns in these two schemes are good due to softening of interest rates and which may not remain permanently. Interest rate also run in cycles and could go up also if the inflation shoots up. The option of short term debt and liquid fund is a must when you reach near to your retirement.
Tax incentive is just like a sale with 20% or 30% discount but you have to be very careful while going for it only because it gives you tax benefit. The financé minister has tried his best to sell the NPS by offering additional benefit in this budget, but you have to take informed decision as the investment is meant for retirement. It is always advisable to consult a certified financial planner and prepare a comprehensive financial plan.
(Pankaaj Maalde is a certified financial planner. He can be reached at [email protected])
