1) Very long lock-in period
All tax saving instruments have lock-in periods, but none as long as that of the NPS. The lock-in period of the PPF is only seven years, after which you can make partial withdrawals and a full withdrawal can be made after 15 years. An individuals own contribution to the EPF can be withdrawn two months after leaving the job. There is a five- years lock-in for bank fixed deposits and NSCs, while ELSS funds lock-in your money for only three years. The NPS can only be withdrawn at the age of 60. If you start at the age of 25-30, the lock-in period is 30-35 years. Even then, only 60% of the corpus can be withdrawn, and 40% will have to be put into an annuity.
2) Taxation on maturity
Every one tries to sell you the tax benefit on NPS, but no one mentions the taxes that will apply at maturity. Out of the 60%, this year’s Budget has proposed to make 40% tax free on withdrawal, but 20% will be taxed as income. You can avoid taxation by putting this amount in an annuity, but this will only defer the tax. Pension received from an annuity is a mix of the principal from an annuity and the interest it earns, and is fully taxable.
3) Low annuity returns
The annuity market in India is nothing to write home about. The yields offered range from 5% to 7%, less than what a bank deposit offers. In fact, banks offer senior citizens a higher rate of interest. The highest annuity rate can be earned if you give money to the insurance company and get a pension for life, without return of principal.That is, if you put in Rs 50 lakh, , you will receive Rs 37,500=per month for life but your heirs will not get anything. If you opt for the annuity that returns the principal on death of the investor, the payouts would be Rs 28,250= per month. Even if your investment earns high returns during the accumulation phase, the poor returns on the annuity will undo much of the gains.
4) What about tax savings
Fans of the NPS argue that the tax saved at the beginning more than makes up for the other drawbacks of the scheme . For instance, if you invest Rs 50,000= in NPS, you save Rs 15,000=in tax, assuming you are in the 30%tax bracket. To test this claim , compare the NPS returns with those of a mutual fund. The NPS corpus is assumed to earn annualised returns of 10% (don’t expect more because equity exposure is capped at 50%), while the equity mutual fund is assumed to have earned 12% annualised returns.The NPS investor invests Rs 50,000= each year for 30 years , while the mutual fund investor pays 30% tax ( Rs15,000) and invests the remaining 35,000=. After 30 years, there is a marked difference in the corpus accumulated by the two investors. While the NPS investor amasses Rs 94.97 lakh and stands to be taxable for 20% of it , the mutual fund investment yields Rs 1.02 crore, tax free.
5) Other benefits
The other benefits include low charges and compulsory savings.
Hopefully, with better taxation and superior annuity products , the dream of a pensioned society will come true.
SOURCE; THE TIMES OF INDIA, NEW DELHI, APRIL 4, 2016, PAGE 20
