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Have the tax incentives made the NPS attractive for investment?


The National Pension Scheme or NPS which was launched on 1 May 2009 was a major move by the government to convert the pension system from a defined benefit scheme to a more flexible defined contribution scheme with a range of investment options for the investors.  But even after more than five years since it started, despite the government’s backing and low charges, it is yet to take off as a popular tool to save for retirement. This could be attributed to firstly the difficulties faced in opening the account – in post offices and the specified banks, where many times the employees themselves are not aware of the product and secondly the product limitations.

In a bid to encourage people to invest in the NPS, the government has announced additional tax incentives for investments into the scheme. Over and above the Rs 1.5 lakh limit U/S 80 C which also covers pension plans from mutual funds and insurance companies, a separate limit of Rs 50,000/- per financial year has been introduced for investment exclusively in the NPS under section 80CCD(1B). This translates to an additional tax saving of Rs 15450 for those in the highest income tax bracket. And to make this process easy for people who are already members of the EPFO and have been investing in the EPF or Employees Provident fund, they now have a choice to switch over to the NPS. In this case their EPF accounts will no longer remain operational and the amount standing to their credit will be paid to them. But at any point in time they have an option to switch back to EPF but as a new subscriber.

Do these incentives make NPS attractive enough to consider investing in them? Here are the positives and the negatives –

The advantages –

  1. One of the cheapest products available with the expense ratio being 0.01 % and a nominal charge of Rs 20 per transaction. This is much lesser than what is charged by other pension plans of mutual funds and insurance companies.
  2. Compared to the EPF, it offers greater flexibility and choice of funds. Unlike the EPF where the returns are fixed, in NPS, one can take exposure up to 50 % in equities and can even switch from one fund to another .This will especially make sense for the young people who have just started their careers as they can invest in equity and participate in the long term growth of our economy.

The disadvantages –

  1. Limited fund options compared to ULIPS and mutual funds. Also the investor cannot take an equity exposure greater than 50 % even if he wishes to.
  2. Both the lump sum withdrawals on maturity (up to 60 % of the corpus) and the annuity are fully taxable. So for most investors, it is more of a way to defer taxes than save them.
  3. One has to compulsorily opt for annuity which should be at least 40% of the corpus. Given the low current annuity rates in India the corpus may not be able to generate a sizeable regular income.

DISCLAIMER: The views/opinions expressed in this review are solely those of the author and do not constitute any investment recommendation.

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