The Budget for this year made the NPS more interesting by making 40% of the corpus tax-free at retirement. This changed the tax status of NPS from 100% EET to 60% EET and 40% EEE.
What followed was increased the demand from the corporate employees, indicating more companies to offer the provisions of Section 80CCD (2) that allow the companies to invest up to 10% of an employee's basic salary in the NPS on their behalf. The NPS' rising popularity is noticeable from the fact that 63.12% of the corporate employees who joined the NPS in July 2016 are from the age between 26-35 years, up from 46.38% just a month ago. Now though NPS offers enormous advantages, experts warn against hurrying in to subscribe.
Use our checklist to figure out, if NPS really suits you. First acknowledge your cash flow. The employer's input to the NPS is deducted from your salary. In most cases, the salary structure is twisted for the purpose. If an employee chooses for the maximum 10% of the basic then the take home amount will come down to that extent. Are they ready for that? Asks the employer of the company. You can accept this offer only if it does not strain your finances.
Secondly, acknowledge the liquidity of your investment. NPS is not meant for you if you want high liquidity throughout its tenure. NPS does not administer the liquidity till 60. The CEO of a company said that the Section 80CCD (2) route is the best for those who have removable income and can lock-in that for the long term.
The third factor to acknowledge is the current tax savings potential. As 60% of the NPS still works under the EET regime, treat it as the tax adjournment rather than tax saving. NPS is not useful for the employees who have not exhausted their 80C limits of Rs 1.5 lakh. Instead of NPS, they must concentrate on the other options like PPF, ELSS, etc that are still under the EEE regime. This structure suits the employees with high salaries who want tax savings avenues beyond the Rs 1.5 lakh restriction under 80C. Now acknowledge your asset allocation. The NPS is a good option, if you want to increase the liability to the equity by a bit. Therefore, this does not work for the investors who are predominately invested in the debt at present and want to route some additional investments to the equities. The NPS does not allow the equity liability beyond 50%.
Last week a new lifecycle fund was introduced which allows up to 75% equity liability up to the age of 35 and then constantly brings it down by 2% every year. So, by the time one is 40, the liability will not be more than 65% and will further drop down to 55% by age 45. Does it mean that you can resist the tax deferment option now? Since the historically equity has been generated for better returns in the long term, it makes sense to pay the tax now and invest the remaining in the equity mutual funds.
Just to test this theory, let us assume 12% return for the equities, 8% for debt and 10% for NPS, when asset allocation is 50% equity and 50% debt. In the first option, an employee routes Rs 5,000 a month to NPS (10% of a basic of Rs 50,000). In the second and third options, the employee invests the remaining money after paying 30% taxes (Rs 3,500 a month) into the equity or debt mutual funds. The return on the investments of Rs 3,500 per month into the equity funds overtakes the returns on 5,000 a month invested in the NPS after approximately 28 years.
Equity gives more from less
Assuming an employee invests Rs 3,500 every month in a debt or the equity fund instead of Rs 5,000 a month in the NPS for 30 years, the returns from the equity investment will be more than that from the NPS.
The study does not acknowledge the tax implication of the NPS at maturity. If 30% tax on 60% of the accrued corpus is acknowledged the returns from the equity will have overtaken that of the NPS earlier. Investors who want high equity exposure must wait till the equity component in the NPS goes up to 75%. The current tax slab and expected tax slab on the retirement are the fifth factors to acknowledge. This is because you are only deferring the tax. It makes little sense to defer 10% tax now end up paying it at 20% or 30% on the maturity.
On the other hand, it makes sense to defer tax now at 30% and pay it later at lower rates, say 10% or 20%. The employers' input under 80CCD (2) is more beneficial for the employees in higher tax brackets. Since the 80CCD (2) restriction is linked to the basic pay and not to a fixed amount, the tax adjournment potential is huge for highly paid employees. Now acknowledge the spending habits. Once you choose for the scheme, it acts like compulsory saving. This will be in the form of monthly deduction from the salary and will be compulsory savings for those who are not saving enough now for their retirement. Finally, acknowledge the compulsory annuity provision i.e., NPS subscribers have to invest 40% of accrued corpus into the low yielding and taxable annuities. If the interest rate structure comes down in the coming years then this low annuity rates may go down further.
Tax Assist is a professional income tax consultancy in India for both corporate houses and individual tax payers; the latter comprising Salaried Individuals, Seafarers, Professionals and Non Resident Indians.
With the help of Tax Assist and its team of income tax professionals, taxpayers can minimize their Income Tax liability, maximize their net income and create opportunities to save for current and future needs while maintaining proper accounting standards and income tax returns which are compliant with the Law.
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