NPS - why i will not invest in national pension scheme

Why am I not investing in NPS?

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Well, as you would know, under section 80CCD, an additional Rs. 50,000 of investments in National Pension Scheme or NPS can be claimed for tax deduction. Basically, you do not have to pay tax on investment upto Rs. 50,000 in NPS.

So, my friends have been calling me asking “Should I invest in NPS? There is an additional tax saving on Rs. 50,000 of investment.”

My simple answer to them is “I would not invest in NPS“, to which I receive surprised uhhs, ahhs and a variety of other expressions. In some cases, they strongly put forth their arguments as to why I am wrong.

It is amazing that tax savings still continue to drive our investment decisions. In this case too, the die hard fans of NPS are actually not the fans of NPS, but merely hunters of more tax benefit. 

The ‘bhakts’ of this benefit leave no stone unturned to make you believe that this is the best reason that one should invest in a high lock-in product like NPS.

High lock-in? Doesn’t every tax saving investment have a lock-in?

Yes, all tax saving investments have lock-in. But none like NPS.

  • Consider PPF which has only a seven year lock-in before you can make partial withdrawals, and in 15 years you can make a full withdrawal;
  • EPF – employee contribution can be withdrawn after 2 months of no job; employers contribution can be withdrawn at 58 years of age; (this is a recent change)
  • ELSS or tax saving funds only have a 3 year lock in;
  • Bank FDs for tax savings have a 5 year lock in, so do National Savings Certificates;

NPS on the other hand can only be withdrawn at age 60, that too only till 60% of the accumulated value; the rest has to be converted into an annuity that will be received like a pension. And of course, they are taxed too.

Tax on NPS maturity, really?

NPS proceeds are taxable on maturity. Yes, when you finally withdraw that money from your NPS account after turning 60, you will have to pay taxes.

Everyone is selling you the tax benefit on investment but no one is telling you about the the applicable taxes at maturity. This is how the taxation works:

  1. 40% of the maturity proceeds can be withdrawn lump sum tax-free.
  2. Another 40% (minimum) of the proceeds have to be converted into an annuity which will be taxed as per your income tax bracket.
  3. Balance you can either pay tax as per you income tax bracket and withdraw immediately or convert it into an annuity

NPS loses me right there. The inflexibility and the complicated taxation puts me off.

Let’s talk about the annuity part of NPS

On maturity, you have to compulsorily buy an annuity with at least 40% of the accumulated maturity value in your NPS account.

Now the current state of annuities leaves nothing to write home about. The yields on annuity products offered in the market today are in the range of 5 to 7%, less than what the Bank FDs offer with the same taxation. In fact, Bank FDs for senior citizens offer a higher rate.

The maximum payout you will get with an annuity is for the option where there is no return of purchase price.

Basically, what it means is that you give your money to the insurance company and forget about it. The insurance company will give you an annuity as long as you are alive and nothing comes to your spouse or your legal heirs after that.

Yes, there are options with return of purchase price too, but in those options the annuity payouts would be less. In all such cases, the money only comes to your spouse or your legal heirs after your demise.

Now, even if you made high returns while accumulating the NPS, the poor returns on the forced annuity will make sure that all the benefits are literally undone.

Did I tell you that you also pay a service tax when you buy an annuity. So, you start with a lower amount, a big disadvantage to begin with.

So many problems!

But what about the tax-saving benefit of NPS?

I know. I know. This is the loud ringing big bell of the temple which drowns out any other rational argument.

Yes, if you invest Rs. 50,000 now, you get to save Rs. 15,000 (assuming you are in the 30% tax bracket). That by itself should add significant returns, no?

Let’s do the numbers. Below is a table for an individual at 30 years of age and willing to invest for the next 30 years. There are 2 scenarios.

NPS - National Pension Scheme

Notes: The investment in Mutual Funds is done after paying tax, hence a lesser amount. The taxability is applicable on maturity and reflects the facts as of the date of this post.

In Scenario 1, he invests Rs. 50,000 in a year (divided equally over 12 months) in NPS. Since the maximum amount invested in equity through NPS cannot exceed 50% in equity, the average rate of return is assumed at 10% per year.

In Scenario 2, he invests the same amount in Equity Mutual Funds, of course after coughing up 30% tax. So, the investible amount with him is not Rs. 50,000 but only Rs. 35,000. The equity component in case of mutual funds would be 80% plus, hence the average rate of return in this case is assumed at 12%.

In Scenario 1, the maturity amount after 30 years comes to Rs. 95 lacs vis-a-vis Rs. 1.03 crores in the non NPS scenario 2. As you can see, this individual ends up with more amount by ignoring the NPS and investing on his own that too after paying 30% tax.

Not to mention, our friend enjoys great flexibility and liquidity throughout his investment tenure.

Read more: NPS – Are you double counting your tax benefits?

Did the bell stop ringing?

There are other arguments in favour of NPS doing rounds including forced savings and long term benefits and hopefully better taxation along with superior annuity products which might happen in future, if and when they happen.

Frankly, my vote is for the flexibility and the liquidity in my investments. I will not invest in NPS. What about you?

Further read: Why I will still NOT invest in NPS?

If you want to know more about the NPS product, visit PFRDA site here.

Here is a list of FAQs on NPS published by PFRDA, the regulator of National Pension Scheme.

48 thoughts on “Why am I not investing in NPS?”

  1. Hello Vipin

    In 2009 – NPS was thrown open for individual investor before that time NPS was for govt sector only. I started in 2009 when NPS was a very least popular investment option and no tax benefits. In last 7 years, NPS has given me around 14% return on my investment.

    Please understand this, in a country like India there are limited investment options for people who are planning retirement and NPS is a god send for all people employed in private sector. There is no job security and no pension in private sector and not every one has the kind of discipline or exposure to Mutual Funds/Stocks.

    Best bet for middle class investor for retirement planning is NPS – it enforces investment discipline, gives you a good tax benefit, ensures that you are investing and saving in a dedicated corpus till age of 60.

    I don’t think NPS should be ruled out just as yet – mathematically your return will vary by 1 or 2 % here and there.

    But, you will have a corpus, you will have a fund to fall back on in your old age – that is a huge advantage.

    You should have a combination of investment options for financial security and NPS should definitely be one of them and not the only one is my advise.

    Thanks,

    Ankit Makoday

  2. Suppose you have 50,000/-.

    Case-1 – MF Option-
    1. your tax deduction will be 15000.
    2. you are investing only 35000.

    Case -2- SIP
    1. Your investment will be Rs. 50,000 in SIP
    2. You will get Rs. 15000 as tax benefit which in turn can be invested in MF.

  3. Factually incorrect info.Service tax is not applicable for annuity bought from NPS corpus. Also in the illustration showing MF giving 12% return and NPS 10% return shows the bias one has for MF. NPS also allows withdrawals after 10 years for certain situations. No mention of that. Also when the corpus is withdrawn one can stagger the withdrawal for 10 years to do better tax planning.

  4. Hi vipin,

    Its true, considering the current T&C, NPS is not a good option over equity mf. Many people don’t understand that, possibly because lack of proper understanding of the after maturity constraints applicable.

    However 30 years is a long time. A lot could happen in that long time. NPS might include some good benefits to attract more investment. Or in worst case, govt will make the long term capital gains taxable. There had been a subtle indication about it by the ministry about it during the deceleration of 2017-18 budget, where a statement was made like “tax free long term gains are unfair”.

    That way NPS in itself will not get any better, but restricting and cutting wings of other and better investment options, the NPS will automatically be brought at par with MF investments. That will be very shameful at the govt’s part.

    Its like what East India company did, cut down all the privileges available to the mass, and provide them the products that the company manufactures. An individual, to fulfill his needs will have to buy that good, or won’t be able to survive at all. On top of that, boast about it, that the company is providing you the means to live a better life. Without actually telling you that it was the company itself at first place that destroyed all the privileges you previously had access to, free of cost.

    I think same is going to happen to NPS as well. NPS is not a good option over MF. But instead of bringing up the level of NPS scheme, govt might just bring other investment options down in terms of benefits. Very slowly and steadily. At that point NPS will start being seen as a very good option (without letting the masses know that there existed a better option like MF a decade ago).

    If even long term equity gains are taxed, and assuming indexation is applied while calculating tax, MF investment will still be a better option than NPS. What do you think?

  5. Hi Vipin
    Nice article. Can u throw more light if I slightly plan like this:
    Save 50000 in NPS and I save tax benefitof 15000( as I fall within 30% IT) in Equity MF, should I not be gaining 1.5 crore approx. Am I wrong?

    • Hi Suru
      Not sure about your calculation. I just hope you are not double counting your tax benefit. It is simple. You either get to invest the entire Rs. 50,000 (no tax) in NPS or you get to invest Rs. 35,000 (post 30% tax) in Mutual Funds.

      The saving is already accounted for in the Rs. 50,000. You cannot take Rs. 50,000 separately and another Rs. 15,000 (of so called tax saving) separately. That is double counting of your tax benefit.
      Hope this clarifies.

  6. Nice Article Vipin, apart from the other points mentioned by you, the most important point is flexibility – which is more in MFs and more important to me as the money would always be in my hands and I can decide what to do with my money. As per some comments posted by others, it is said that you cannot assume a return of 10-12% in MFs over a longer period of time as we move ahead, I would say one can always decide to switch to NPS or some other investment instrument if at a later date the returns in MFs reduce – again greater flexibility. Some people would argue that more flexibility would mean less systematic investment but I do not agree to that – if one follows discipline then investments in MFs also can be systematic

  7. What about if one invest saved tax of 15450/- in monthly SIP of 1287/- for 30 years assuming ( author’s) return of 12% in an equity MF , the corpus and return will be 4542999/- and 4079679/- respectively.Thus the corpus ( as per writer’s calculation ) will be 9497189/- ( of which 80% is tax free) + 4542999/- (completely tax free,after investing saved tax of 15450/- in monthly SIP of 1287/-) -586926 (30% tax deduction on 1899437/- ie 20% taxable portion of total corpus of 9497189) = 13453262/- which is > 30 % higher than the corpus accrued after NOT investing in NPS ( which is 10295582/-). Thus 40 % mandatory annuity amount (2849156/-) plus 308524/- surplus amount become free /bonus over and above the return on NOT investing in NPS (10295582/-). Thus NPS seems to me pretty attractive.

    It is quite surprising to know after reading a number of articles on NOT INVESTING IN NPS , authors do not pay attention of saved tax of 15450/- and resultant return on it. Actually with NPS you invest 65450/- and without it 34550/-, a difference of 30900 /-/Kindly rectify me if I am wrong.

    Thanks

    Dr Manoj Choradia

    • Dr Manoj

      There is a little problem with the argument. You are investing Rs. 50,000 and thus saving the tax outgo of Rs. 15k. So essentially, 35k + 15k is the equation.
      You are NOT earning new money because of the investment in NPS. The same 50k has to be invested either in NPS fully, or 35k (50k – 15k) in mutual funds.
      With that perspective, your calculation is flawed. Do not mislead yourself.

      Thank you

      • Mr Vipin, Your calculation is incorrect,i agree with Dr Manoj, if 2 persons have Rs 50,000 to invest. One invests in NPS and the other in MF.

        Case 1: Rs. 50000 (NPS) (10%PA returns) + 15000 tax saving (12.5% PA returns)
        Case 2: Rs 50000 (say not 35K) (12.5% PA returns) – 15000 (Deduct flat 30% tax each year.

        The above is a very positive scenario. In actuality, if you invest 50K in NPS, you have 65K to invest, whereas the net available amount to invest in MF without NPS would only be 35K. So 65K Vs 35K. Please clarify.

        • 1 more thing, money saved is money earned. Just because a component is saved from tax does not mean we consider it not to be earned money. Take the case where you do not do a declaration of 50K NPS at the start of year and you pay tax of 15k, then 1 person invests 50K in mutual fund another 50K in NPS, the latter would get back 15K which he can invest elsewhere(MF), the former would not.

  8. Following are my queries regarding NPS.
    1> Is it mandatory to pay initial & later contributions with the bank savings account mapped to NPS? Suppose I have opened NPS and mapped my SBI a/c with it. Can I pay my initial & future contribution of NPS from other nationalized banks like Canara Bank, Bank of India, etc.?
    2> How will I update the NPS details later like change in nominee, change of fund manager, change in allocation of funds, etc.? Are there any charges for updation if I open NPS using AADHAR?
    3> How will I perform withdrawl of NPS accumulation amount from NPS after maturity from e-NPS or through online mode? OR, visiting bank branch as mapped in NPS opening is required during withdrawl?
    4> How to choose and open Annuity at maturity if NPS account opened online using AADHAR?
    5> Is it mandatory to pay service charges additionally during annuity purchase?
    6> Do SBI charges NEFT charge of Rs4+ST if I perform NPS contribution from SBI e-portal?

  9. My assumption
    1,In very near future NPS turned as.
    EEE ptoduct
    2, NPS can beat MF if market falls
    3, NPS will make you more discipline in your investment than MF
    4, NPS return wont come/fall under tax slab if your income fully depends on NPS ..even if its fall tax slab i will be more happy because it’s means i earned more money
    5, NPS is lesser risk compared to MF
    6, Mostly Govt will forced to do something if NPS funds face negative return since All central/state govt staff covered by NPS after 2004..its not the case in MF

    My assessments
    1, After 2025 or 2030 Indian market wont give any return more than 8-10%..even it may fall 3-5% if fund is overflow

    2, NPS is pension fund so govt may give compensation if NPS funds face 50% fall(rare case,may not happen)

    3, NPS is safe bet compared to MF if you invest upto 2045

    4, Govt may allow NPS subscribers to choose any option for 40% investment after maturity, probably we may get amendment in next 6 months

    Whatever it is i oppose NPS just it’s compulsory for me since iam central govt staff

    IMHO any type of plan won’t give more benefits than you invest money in proper Land

  10. Iam waiting for a feedback on the querry I wrote yesterday, 18.07.2016!

    DEAR VIPIN,
    FROM FEB.2012 TO JULY 2014 I CONTRIBUTED RS. 1237044 IN MY NPS ACCOUNT.
    ON 22.2.15 AFTER ATTAINING ,I REQUESTED FOR WITHDRAWL . ALL THIS CONTRIBUTION WAS MINE AND FROM MAY,2014 TO JULY 2014 I CONTRIBUTED RS 6,00, 000(SIX LACS). THE TOTAL INCREASE I GOT ON WITHDRAWL WAS 2,91,869.
    I GOT 9,05,804 Rs., AS 60 % LUMPSUMP AND REMAINING I GOT LIC ANNUITY SCHEME, JEEVAN AKSHAY.
    FROM THIS 9,05,804 , I BOUGHT VARISHTHA NAGRIK PENSION YOJNA/LIC OF RS. 6,39,610/-.
    WHAT ARE MY TAX LIABILITIES? IF I HAVE TO PAY TAX ON 60% LUMP SUMP, THE IT WILL BE AROUND 2,79,893/- WHICH IS ABOUT THE SAME THE BENEFIT I GOT FROM THE SCHEME.
    BASICALLY , I WILL BE LOSING THE SIMPLE INTEREST ALSO!! iS THIS TAX TO BE CALCULATED AS PER INDEXATION.
    PLEASE ADVICE.
    Regards,
    Goyal

  11. This is a good article, Vipin, providing a good overview of the various aspects of NPS. Hardly any of the articles about NPS has the clarity yours does.

    Your comparison of NPS and a mutual fund assumes an equity fund. That’s fine if you intend to invest 100% of your money in equity. But most people have some debt.

    If an investor wants 50:50 allocation to equity and debt, which of the following gives better returns:
    a) NPS with the 50% equity option.
    b) MFs, with a 50% investment in equity. To minimise tax, you’d structure this as a hybrid fund + an ultra-short-term fund. Assuming the hybrid fund puts 65% of its money in equity, you’d invest 76% of your money in the hybrid fund, and the rest in the ultra-short-term fund. That way, you’d maintain your 50:50 allocation, with minimum tax.

    Which of the two would have higher returns? This way, we can compare the tax and annuity aspects of NPS leaving aside the asset allocation part (equity: debt ratio). The fact that the NPS may not have the asset allocation you want doesn’t prevent it from playing a role in your portfolio, because it’s the overall portfolio’s asset allocation that matters. For example, if I want an 80:20 asset allocation, I can still invest 50K every year in NPS, and invest some money in equity MFs to reach my desired 80:20 allocation. In such a scenario, I should compare the performance of the NPS with that of MFs that have 50% allocation to equity. Correct?

    BTW, your comparison between NPS and MFs compares the maturity amount. You need to account for the forced annuity purchase. If two people retire with a corpus of 10 lac, say, one from NPS and one from MFs, the former is poorer because he has to buy an annuity for at least 4 lac, which gives lower returns. So we need to discount the maturity amount for NPS. What discount rate would you apply?

    • Good observations Kartick. As for the fund type, I guess with the returns assumed I have actually taken one for a hybrid fund (given the current past performance). I have used the current past performance for NPS too. So, the basis of the assumption is the same.

      For the maturity amount, the present value remains the same. It is the future payouts (net of taxes) that could be hugely different. That needs to be a more detailed calculation. Will try and take it up in a subsequent post.

      Thanks for the comment.

  12. Nice article Vipin. What’s your thought when one withdraws 40% of corpus at maturity and invest rest in annuity scheme? It’s total exempt from tax. And coming to returns mf returns on long term reduces to 4-6% anyway.

    • Hi Vishal, Thanks for the comment.
      That is the point I have made in the post too. you get 40% (tax-free). But the 60% is converted into an annuity on which you pay tax every year based on your income tax bracket. So, it is NOT tax-free. you only defer the taxes.
      The options for buying an annuity are very limited and the yields are so awful (as of today) that any gains (if at all) that you made would be wiped off.
      Once you buy an annuity, you have no way out of it at all. You will have to continue it till your lifetime.
      Too many restrictions.

      Coming to the second point of MF returns, I am not sure what’s the logic of 4 to 6% returns.

      If you ask people who are invested today in the Equity option of NPS, they are getting about 10% XIRR. That is because 50% of their contribution is getting invested into equities.

      If with 50% contribution into equities the returns are 10% (that is what I have used in the calculation too), then the MF which happens to invest 80 to 100% of its money into equities will deliver a higher return?

      If you still feel, that the MF returns will only be 4 to 6% from equity investing, then the returns from NPS would also come down (since it is invested in equities too).

      Hope this helps.

      • Present return are around 11.2% in NPS. With govt pushing more for NPS, AUM for NPS will beat any MF in around 10 years time.

  13. Three things should be considered 1) 10 % of basic 2) additional 50k 3) 80C benefit
    Mine is as below:-
    1) 10% of basic = 42000
    2) addtional 50 k= 50000
    3) under 80C =150000
    —————————————-
    Total tax benefit = 2,42,000/- per year
    —————————————–
    Now can you tell me ELSS gives this much of tax benefit than NPS?

    • First things first. The 2.42 lacs is the amount eligible for tax deduction. If you are in the 30% tax bracket, 30% of 2.42 lacs is what you save as tax.
      The question remains the same. Are you better off managing your own money (even post tax) or giving it to NPS?

      Finally, what after maturity?

  14. What about NPS – corporate. Did you forget about the tax benefit of 1) 10% of basic 2) addtional 50K?

    NPS investment is very useful to employees who ever have the NPS-corporate account

  15. great article and many informative comments.MFs for 30 yrs will deliver 12% returns.is just too much expectation and bias towards MFs(if even this happens taxman are ready for yet another tax)
    NPS is backed by gov. from last two budget its making it more and more lucrative hopefully it won’t stop here. so my research says one should go for it.liquidity should not be concern because its 50k per annum only

    • Thanks Dr Rajeev for the comment.
      I am not sure what would you mean by ‘lucrative’ changes by the government. The only thing the government has done is to give tax breaks to contributions to NPS and 40% tax free withdrawal at maturity. Nothing else.

      If you notice, for returns the assumption has been the current observed returns for NPS. If MF returns would be much lower, so would be NPS returns. The net argument is not about the returns only – but the liquidity (which you are saying can be ignored) and choice of investments at maturity.

      I believe most people are ignoring the “after maturity” part. That’s where the issues are.

  16. First of all, good article. Thanks

    Still I will invest in NPS. Here’s why?

    12% annualized return from MFs!!!! Currently Indian market is not that undervalued like 80’s so that you can extrapolate past 30yrs return for next 30 years; rather it is in overvalued zone so negative returns are highly probable. SIP in MF’s might reap some benefit of systematic investment but no-way annualized return is going to be 12% for next 30 years. You would be lucky to get 4-5%.

    Most importantly due to lower charges, NPS funds would always have better return w.r.t. comparable MFs.

    What if long term capital gain is taxed at 10%? Highly probable.

    Yes, currently annuity market is immature. As it matures, it is bound to be competitive and we can expect to get much better options for buying annuity to emerge. Like, Government may come up with inflation adjusted sovereign fund specifically for investment from annuity buyers. So if you are close to 60 yrs age, this might not worth waiting.

    Please note that it is not mandatory for you to withdraw the whole corpus left after purchase of mandatory annuity. You can opt to withdraw the balance amount in a phased manner. However you need to withdraw a minimum of 10% of your accumulated corpus every year. This account has to be closed once you reach the age of 70 years. http://www.moneycontrol.com/master_your_money/stocks_news_consumption.php?autono=627643

    This is a kind of deferred tax with more flexibility. If you retire after 60, your regular income is expected to be zero; you will get income from your investments only. Now you can choose a flexible amount to withdraw from NPS corpus (you will want to 60% of the corpus after buying annuity) each year for next 10 years in such a way that your total income for any year may be well below taxable income.

    • Thanks Arghya for the comment and inputs. Respect your views.

      If equity returns are lower, returns from NPS would be lower too.

      Even if there is long term capital gains tax, the benefit of indexation would be available.

      Rest is as and when. I would opt for the flexibility.

      Much thanks again.

    • What if long term capital gain is taxed at 10%? Highly probable.

      For any economy, long term investment is must. I don’t think any government would do the mistake of taxing long term capital gain.

  17. I wish we had a vibrant market for inflation-adjusted annuities (with no return of purchase price). This will pool and therefore reduce risk — if a particular retiree dies sooner than the average, and another later, the risk is spread out, and the second one doesn’t run out of money.

  18. Dear Vipin,

    Very much important article. Also you explained in very crystal clear and graceful way.

    By reading your article and PFRDA site I also decided that I will never go for NPS (provided the limitation of NPS remains same as of today in future).

    Actually two week ago, my 4/5 colleague (who are in 30% slab :)) asked me about NPS and should preferred it or not.

    Today noon, I forwarded this link to them and they also got convinced.

    ………..
    Vipin, In future, you will definitely becomes shiny star in Personal Finance domain.

    I also admire you that in very short period your blog counted in Top 50 Personal Finance Blogs in India 2015 (47: Vipin Khandelwal (Rank: 1,889,372)).

    Also very soon your transparent and unbiased efforts in financial literacy will make you “Top 10 Most Liked Personal Finance Blogs” in India.

    Good Luck.

    Thank you,
    Anup Kulkarni.

  19. Vipin, Thanks for putting light on the mystery of NPS. I was waiting a one from you on this and its here. I really wonder why governments bring out such bad investment options and people like us get into this ugly Web in the name of tax savings.
    Thanks Again

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