Should you Invest Rs 50,000 in NPS to Save Tax u/s 80CCD (1B)?

Should you Invest in NPS to Save Tax u/s 80CCD (1B)?

Should you Invest in NPS to Save Tax u/s 80CCD (1B)?

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.

Assumptions:

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.

Also Read: NPS – New Maturity, Partial Withdrawal & Early Exit Rules

Below is the comparison:

Should you Invest in NPS to Save Tax u/s 80CCD (1B)?

Should you Invest in NPS to Save Tax u/s 80CCD (1B)?

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.

Significant points:

  1. 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.
  2. As the duration of investment goes up the mutual fund option becomes even better due to compounding at higher return rates.
  3. 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.

Conclusion:

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.

255 thoughts on “Should you Invest Rs 50,000 in NPS to Save Tax u/s 80CCD (1B)?

  1. Well, this article is one sided if not misleading. Let me put some benefits of NPS below:

    1. It is more secure: its like a balance fund. There are higher changes that you may lose your money in Equity MF than NPS. Ideally calculation should be done considering the investment in Balance Fund. So both NPS and MF with 10% return

    2. MFs are very very costly! MFs charge around 2000 RS per 1 Lakh RS / per year! so the actual amount invested in MFs over a period of time is much lower than MFs!

    3. Annuity investment is not taxable, the return on Annuity is. This is same as MF returns. Will you put the MF returns bank to MF for saving the tax at the age of 60? probably not! So you will put in some safe avenue FD or Post Office etc. Well the return on that is also taxable.

    Only advantage of MFs over NPS is liquidity and yes it indeed is a big one. But if you can live with that sure put your money in NPS.

    • Correction: **so the actual amount invested in MFs over a period of time is much lower than NPS!

    • @Arup thanks for reading and sharing your feedback.

      Any calculation/prediction is based on certain assumptions – which one may not agree.

      1. Yes NPS is more like balanced mutual fund but the idea here is to invest in higher yielding product so I choose Equity fund. What product would get what return is totally debatable – so we make fair assumptions.

      2. Agreed Mutual funds are higher cost product but still most of them have been able to justify this cost by delivering higher returns than their benchmark index. NPS managers can only invest in NIFTY stocks thereby limiting their portfolio and returns potential. You might look to ETFs which are again lower cost.

      3. Annuity is not only taxable, has poor returns but also non-liquid as compared to fixed deposits/ government bonds or tax free bonds etc. You would do better to invest in FD for regular interest payout than go for annuity – atleast till the time you can monitor those (may be till age of 70 or 80 years).

      Also with recent flip-flops from government on NPS/EPF we do have lot of regulatory risk in long term government schemes. You never know government might restrict investment only to PSUs/Government bonds for NPS.

      NPS as a product might suit some while others would do better without it. As its personal finance the judgment should be personal.

      • Yes Amit. Agree on your points. However it is important to acknowledge that we are talking about people in 30% tax bracket. Considering that following are my views:

        1. Sure invest in Equity MFs for long team. They are liquid, tax friendly and hassle free. However investing 50K yearly in NPS still make sense. Rather than investing in a debt/balance fund put it in NPS, it is safe and would yield much better returns (given you save 30% on tax)

        2. About governments flip-flops and uncertainty: well the markets are more uncertain, anybody investing in equity by any means is embracing that anyway. Look at the HDFC funds, the fund managers get huge payments even after going so wrong with the investments (and I dont blame them, its the way market behave). So whatever government would do, would do to safeguard the retirement of the people. Got to trust that.

        3. On returns on liquidity, annuity and tax: If you are in 30% bracket, you would most probably have other liquid investments (if not blame it on your advisor). Also 60% of NPS amount liquid, use it the way you want. 40% that goes in annuity is not taxable. Return of any debt instrument is taxable. At age of 60 and above its good to have some peace-of-mind returns amongst other options.

        All in all, if you earn good (30% taxable), and you are not a person who puts all eggs in one basket (say, equity MFs) then 50K yearly in NPS is surely is a good and safe basket to opt for. Your financial advisor might not be paid for that but thats okay, a share of your other MF investments is going to him/her if you are not investing in Direct MF plans.

  2. Sir, below points i got from http://www.hdfcpension.com/national-pension-scheme/tax-benefits/, which says 40% is the withdrawn amount and it is excempt from tax. It differs from your point, please advice on this
    -Up to 40% of Corpus withdrawn in lump sum is exempt from tax
    -Balance amount invested in Annuity is also fully exempt from tax
    -Pension received out of investment in Annuity is treated as income and will be taxed appropriately

  3. SIR I AM A CENTRAL GOVT. EMPLOYEE AND 10% CONTRIBUTION OF MY BASIC+DA IS COMPULSORY TOWARDS MY NPS ACCOUNT TIER-I AS PER CENTRAL GOVT. RULES. CAN I CLAIM THIS CONTRIBUTION AS DEDUCTION UNDER SECTION 80CCD(1B) OR NOT. MY BOSS SAYS THIS CONTRIBUTION CANNOT BE CLAIMED UNDER SECTION 80CCD(1B). IN ORDER TO GET BENEFIT OF ADDITIONAL 50000 UNDER 80CCD(1B) I HAVE TO CONTRIBUTE SEPARATELY (EXTRA THAN MANDATORY 10% OF MY BASIC +DA).

  4. can you suggest the procedure

  5. SRINIVASA RAO says:

    SIR, I HAVE TAKEN NPS ACCOUNT NO.110006701850 . AND PAY THE AN AMOUNT OF Rs.50000/- through axis bank i have alloted to tier 1 a/c. but my apspdcl offficials has not allowed for full excemption u/s 80ccd(2) kindly given a letter and details my email address. thanking you sir. yours faithfully asrao

  6. vijay prasad says:

    Dear Amit Jee,

    Will Axis LT Mutual Fund (G) will fit as equity mutual fund (as given in option 2). I am laymen in this field. I want to invest in Axis LT MF (G) for a period of 20 years as a SIP. Kindly suggest.

    thanks.

    • Axis LT MF is a good equity based mututal fund. But you cannot just invest and forget about it. You should keep on monitoring the fund performance at least every 1 to 2 years!

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