Executive Summary: Budget 2015 witnessed an increase in tax benefits for investments in National Pension System (NPS) which is a voluntary pension scheme, up to a maximum of Rs. 50,000 a year. This was under a separate section 80CCD, in addition to Sec 80C benefits. Investors can invest upto 50% of the corpus in equity in order to enjoy higher returns. Over the long term, NPS can deliver better returns than a pure debt retirement saving option.
Way back in October 2012, we had written about the NPS scheme and why it could be a good retirement saving option. To read this article, please click here. Even back then, we realised that awareness of NPS was pretty limited among the investor community. In light of the poor interest in the scheme by investors, the Finance Minister has announced the additional tax benefit for NPS in Budget 2015. Post the Budget, we see that this investment avenue has been gaining popularity. And in good measure too!
So what does the additional tax benefit mean to you? Before getting into this, let’s quickly understand some basics of the NPS as it stands today. There is a popular perception that NPS is only meant for Government sector employees or if pension was offered by the employer. However, the beauty of NPS is that anyone aged between 18 and 60 years can open an NPS account. It is open to investment on a voluntary basis even if there is no employer contribution. The minimum annual contribution is Rs. 6000, while there is no maximum investment limit.
An individual can open a NPS account with a Point of Purchase Service Provider (POP-SP). Several institutions across the country have been designated by the Pension Fund Regulatory and Development Authority (PFRDA) as POPs for opening the NPS accounts. By submitting the necessary application form and KYC documents, one can open a NPS account with the POP. There are two types of accounts which can be opened - Tier 1 account and Tier 2 account. Tier 1 account is the main account and does not allow premature withdrawal of the retirement savings. The Tier 2 account can be opened only if the investor holds Tier 1 account. This is a voluntary savings account and the amount can be withdrawn as required.
In the Budget 2015 announcement, the Finance Minister has not done away with the tax on withdrawal. The accumulated corpus will continue to be taxable on withdrawal. However, what he has done is to increase the tax benefit associated with the contribution towards NPS. This is expected to bring more and more people under the pension net in the country. Earlier, investments in NPS qualified under the Sec 80C limit. This means that if you have exhausted the Rs. 1.5 lakh limit under Sec 80C even without considering NPS investments, you will not be able to claim benefit for the amount you invest in NPS. However, after this announcement, you can claim this under Sec 80CCD upto Rs. 50,000 in a year. This can logically bring down your tax liability. Employees have also been given the option to choose between EPF and NPS for their retirement savings.
So does it make sense to invest in NPS or to choose it over EPF? Investing in NPS gives you an additional tax benefit, unlike investing in EPF, which falls under the overall limit of Sec 80C. As a part of the NPS corpus is invested in equity, the returns over the long term can be better than a pure debt product, as equity generally performs better than debt over the long term. However, there may be short term fluctuations in the returns on this component, which largely mirror equity market movements. Understand your risk - return preferences and asset allocation patterns. Over the long term, investing in NPS can give you good returns and also help in lowering tax liability due to the additional tax benefits recently announced.