Budget 2015 has introduced a new section 80CCD (1B) which gives deduction up to Rs 50,000 for investment in NPS (National Pension Scheme) Tier 1 account from next financial year of FY 2015-16. This new deduction can help you save tax up to Rs 15,450 in case you are in the 30% tax slab.
The question is should you take advantage of this new tax deduction and invest in NPS?
NPS has not taken off as expected and finance minister by giving this additional tax saving option is trying to give it a push. We all know how many people invest blindly in poor schemes just to save tax. This post is to analyze if it makes sense for us to invest in NPS to save additional tax.
For our calculation we assume that Amit is 30 year old and would retire at the age of 60. So he would make investment for 30 years.
- NPS Investment Option: Most Aggressive i.e. 50% investment in equity and 50% investment in debt
- Amount Invested Annually: Rs 50,000
- Return on Equity: 12%
- Return on Debt: 8%
- Tax Bracket: 30.9%
- Also the tax bracket remains 30.9% at the time of withdrawal at the age of 60.
Alternatively, Amit can pay tax on this Rs 50,000 and invest the remaining amount (i.e. 50,000 * (1-30.9%) = Rs 34,550) in Equity Mutual fund which gives return of 12% annually.
Below is the comparison:
As can be seen in the calculation above, the final amount generated by NPS is 90.47 Lakhs while in case of equity mutual fund its 93.38 Lakhs.
Additionally, in case of NPS you can withdraw maximum of 60% of the total maturity amount which is 54.28 Lakhs. This would be further subjected to 30.9% tax, which means you would be left with net amount of Rs 37.51 lakhs after tax. Rest Rs 36.19 lakhs should be used to purchase annuity.
The proceeds received from this annuity is again considered income and taxed according to marginal tax rate. Also annuities in India have not evolved and the return from varies in the range of 6% – 7%. This makes it a sub optimal investment choice.
In case of investment in equity mutual fund, entire long term capital gains are tax free. So you have Rs 93.39 Lakhs at maturity.
- For people in lower tax brackets, investing in Equity Mutual Fund becomes much better option as compared to NPS. This is because the tax outgo is lesser and hence more money is invested in MF.
- As the duration of investment goes up the mutual fund option becomes even better due to compounding at higher return rates.
- You might be in lower tax brackets at the time of investment; but might fall in highest tax bracket while withdrawing NPS as it would be accumulated over a long period of 25 to 40 years.
NPS comes under EET (Exempt – Exempt – Taxed) form of taxation, which essentially is deferment of tax liability to a later date. Until the taxation of NPS is EEE (Exempt – Exempt –Exempt) or the maturity amount is taxed at a lower rate, it makes sense to forgo the additional benefit of Rs 50,000 deduction and instead invest in good rated equity mutual fund.