Should I Invest in NPS to claim tax benefit on extra Rs 50,000

National Pension Scheme was launched on 1^st January 2004 by the government of India to provide financial security for its citizen post retirement. Since then NPS has received lukewarm response from the market mainly because for the following reasons:-

• Withdrawal before retirement is very restricted
• After retirement, it is made compulsory to invest at least 40% of corpus in annuity plan
• NPS is EET scheme. It means amount received after retirement is taxable
• NPS has exposure to equity market and hence it is considered riskier investment as compared to EPF or PPF scheme

To increase the popularity of NPS, Finance minister Arun Jaitley had announced additional tax deduction of Rs 50,000 over and above limit of 1.5 lacs if investment is made in NPS scheme. The tax deduction of Rs 50,000 is especially beneficial for 30% tax bracket tax payee as it will help in saving Rs 15,000+ Cess annually.

The announcement certainly helps in raising awareness of the NPS among common public but it is still not preferred choice of investment. There are many who argue that inspite of tax benefits, NPS is still not attractive investment option for pension planning.

But I believe, after the announcement of tax deduction, investment of Rs 50,000 in NPS makes sense for high tax bracket (30%) taxpayer. Here in this blog, I have tried and prepare a comparative analysis between investment as an option in NPS and any other scheme.

In the analysis, it is assumed that taxpayer is in 30% tax bracket even after claiming maximum tax deduction of 1.5 lacs limit as per Chapter VI-A (section 80C). Age of investor is assumed to be 30 years and retirement age is 60 years.

The analysis is carried out to quantitatively observe the impact of tax benefits on saving if investment is made under NPS. Rs 50,000 are taken as basis for the analysis as tax benefit is valid only for that amount. Below table compares the amount you will receive after retirement if you invest Rs 50,000 in NPS or Other than NPS.

	NPS	Other Than NPS
Amount available for investment	50,000	50,000
Actual amount available for investment post tax	50,000	50,000-15,000 = 35000 (Taxable @30%)
Duration of Investment	30	30
Amount receivable after 30 years (10% rate of return)	9330566	6530948
Re-investment in annuity (40%)	3732226	Annuity not Compulsory
Amount Receivable in lump sum pre tax	5598340	6530948
Taxable Amount	3359004 ( 60% of the lump- sum amount received )	5481188 (Only Interest Income will be taxable & not your contribution)
Tax Payable @ 30.9%	1037932	1693687
Lump sum available on maturity post tax	4560408	4837261
Total Amount available on maturity	8292634	4837261
Total Difference		3455373/-
Summary for NPS
Amount to be re-invested in Annuity (assuming 40% of corpus)		3732226
Lump Sum Receivable on Retirement after tax & investing in 40% annuity – NPS		4560408

Note:- Previously NPS was taxable at the time of maturity. But in the Budget 2016 announcement- Withdrawal from NPS on maturity made tax free upto 40%. In the above analysis same 40% tax deduction on corpus is assumed

Hence total saving corpus is more in NPS than any other scheme for the same rate of return. Lump sum amount received after retirement (or 60 years of age) is only marginally higher in NPS. From the above estimation, it is clear that NPS has a clear advantage over other investment scheme.

It should also be noted that amount re-invested in Annuity (assuming 40% of the corpus) is taxable as per the tax slab of individual.

Deferred Withdrawal of Lump Sum from NPS after Maturity

As per noticed issued by PFRDA dated 29^th October, 2015 – Investor can deferred withdrawal of lump sum amount in up to 10 annual installments till the age of 70 years.

How is this beneficial?

Lump sum amount can be huge. Withdrawing the whole amount in a single year would have had serious tax implication as it would have taken you to highest income tax slab (30% tax slab) for that fiscal year. Therefore, withdrawing the entire amount at one go will lead to huge tax liability and put a huge dent in your pocket.

This is where, deferred withdrawal becomes beneficial. Now you can spread the lump sum withdrawal across 10 installments (assuming retirement age as 60 years) to reduce tax liability.

Let’s understand this with an example!

From the table above, lump sum available on maturity before tax is 5598340/- i.e. approximately 55 lacs. For the rest of the corpus Rs 3732226/-, you are required to purchase annuity. Suppose annuity provides 8% annual return which are approximately 3 lacs per year.

Withdrawal at a single go:-

If you do not have any other source of income, your total income will be (55+3) 58 lacs for the withdrawal year and you will be taxed according to your tax slab which is 30%. Therefore, total tax liability for the year will be ~ 17 lacs which are huge.

Withdrawal in Installment:-

If you chose to withdraw in 10 installment, your income for the year after retirement will be (55/10+3) 8.5 lacs. You will fall in 20% tax bracket. Tax liability for 8.5 lacs comes in the range of Rs 90,000. Therefore, for the next 10 years, you will be taxed 90,000 per annum and total tax paid by you at the end of 10 years will be 9 lacs.

So you see the difference. Withdrawal at a single goes put tax liability of approximately 17 lacs and if you chose to spread your lump sum withdrawal in 10 years, total tax paid is 9 lacs. Total saving worth 8 lacs!!

Note: – For simplicity, in the above example, I have not considered any tax deductions. If you consider tax saving as per chapter VI-A (Section 80), total saving would be much higher. It should also be noted that lump sum amount still with NPS (not withdrawn) will continue to grow for the duration of 10 years.

Points to Consider

• You can defer the withdrawal till the age of 70 years. After that you need to withdraw whole amount.
• Lump sum withdrawals need not to be in equal installment. You can withdraw as much money as you required for the coming years. The only limitation is that you can make only one lump sum withdrawal per year.
• The main advantage of spreading the lump sum withdrawal comes from the fact that it reduces tax liability by shifting your tax slab from 30% to 20% or 10% as the case may be. But if you have other sources of income and even after spreading your lump sum amount you fall in 30% tax bracket, Deferred Withdrawal will not matter.

Why NPS is still not popular?

There are several reasons for the same & some of which are as follows:-

• There is no guarantee of minimum return on investment made in NPS. Exposure to equity market certainly makes it riskier than other scheme.
• We have estimated above figures with assumption of 10% return. Though 10% return is conservative, but return on NPS can be less than the presumed value.
• There are other investment options which can give return of more than 10% on investment. Even with tax disadvantage on other than NPS option, if you can achieve return of more than 11.65%, it may prove to be more beneficial.
• The lock-in period for NPS is very long with very limited withdrawal option. So for many investor, Liquidity concern in NPS instrument is deal breaker. (Read revised withdrawal and exit rules from NPS)

Invest in NPS if:-

• If you lie in 30% (or 20%) tax brackets.
• If you do not mind long lock-in period & can afford to remain invested for long time.
• If you do not think you can get return of more than 11.65% if invest in other investment scheme.
• If you already have utilized limit of 1.5 lacs in chapter VI deduction.

Planning for your post-retirement life is very important. Plan Well and Stay Happy.

Source : http://taxdesign.in/should-i-invest-in-nps-to-claim-tax-benefit-on-extra-rs-50000/