Budget 2015 had introduced a new section 80CCD (1B) which gives deduction up to Rs 50,000 for investment in NPS (National Pension Scheme) Tier 1 account This new deduction can help you save tax up to Rs 15,600 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: 31.2% (surcharge revised in Budget 2018)
- Also the tax bracket remains 31.2% 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 * (1-31.2%) = Rs 34,400) in Equity Mutual fund which gives return of 12% annually.
Also Read: NPS Tax Benefit u/s 80CCD(1), 80CCD(2) and 80CCD(1B)
Updated Comparison: After introduction of Long Term Capital Gains Tax on Equity Mutual Funds in Budget 2018
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 92.98 Lakhs.
Additionally, in case of NPS you can withdraw maximum of 60% of the total maturity amount which is 54.28 Lakhs. 20% of NPS corpus would be further subjected to 31.2% tax, which means you would be left with net amount of Rs 48.64 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, the long term capital gains in equity mutual fund is taxed at 10.4% (from FY 2018-19). At maturity you have Rs 93.39 Lakhs which after LTCG tax would be Rs 84.38 Lakhs.
If you see the taxation of both NPS and Mutual Funds have changed in last 2 years. So a long term decision (30 years in this case) cannot be made just based on present tax rules.
Significant points:
- 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.
- With the new rules you can split your withdrawal till the age of 70 – lessening you tax outgo.
- You need not purchase annuity if the NPS maturity corpus is less than Rs 2 Lakhs.
Should People nearing Retirement Invest in NPS?
I often get queries by people near retirement that if they can and should open NPS account to get tax benefit u/s 80CCD(1B). Below is my take and you can take your decision accordingly.
- Anyone who is below 65 years of age can open NPS account – so technically you can open your NPS account.
- Assuming you are 62 years or more and the tax exemption stays for next few years. You can invest 50,000 every year for 3 years. With 10% annual returns your NPS maturity amount would be less than Rs 2 lakhs.
- As per rules, you need not purchase annuity if the maturity amount is less than Rs 2 lakhs. So after retirement you can withdraw the amount without much tax burden.
- You can also time the withdrawal to a year (but before reaching 70 yeas of age) when the tax liability is lower or split the withdrawal in 10 installments.
Also Read: NPS – Maturity, Partial Withdrawal & Early Exit Rules
Even for lower age people you can start investing Rs 50K for tax saving until its provided for and keep account active by contributing minimum of Rs 1,000 per year.
Conclusion:
Budget 2016 had brought down the tax liability on NPS maturity to acceptable level while Budget 2018 introduced Long term capital gains on equity mutual funds. You get instant tax saving if you choose NPS. You may look to invest in NPS but keep the following in mind:
- The NPS tax benefit may be done away in future but you are ready to continue the same with minimum annual investment
- Tax on investments keep on changing and tax on both mutual funds & NPS can change in future
- Equity Mutual Funds would outperform NPS in most cases
- NPS would outperform if compared to fixed deposits (in most scenarios)
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.
Thanks for your comments, I am sure it would help readers 🙂
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
The NPS taxation rules were changed in Budget 2016. The calculation above was done before this change was effective.
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).
Experts have different opinion about “if you claim your compulsory contribution to NPS u/s 80CCD(1B)”. My opinion is you can claim it. Income tax department has not clarified it yet. Economic times had a story on this – might be helpful for you.
can you suggest the procedure
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
THat is not a problem, you can take this exemption while filing your IT return.
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!
Difference between ELSS and Equity mutual funds..??
I have ELSS , can i take again EMF..!! for saving taxes..
please replay to my Id please..
ELSS is a type of equity mutual fund, investments in which are eligible for tax exemption u/s 80C with a lock-in of 3 years. You cannot claim tax exemption by investing in any other mutual fund.
Ye 80ccd1(b) kya h
Amit, please clarify one thing here. 40% of corpus must be invested in annuity which is tax free. Furthermore 40% of the corpus is tax free. Does this mean effectively only 20% of the corpus is taxable if 60% is withdrawn?
If yes, then effectively your calculation for the example above (Option 1) changes to Rs. 5.591046 tax payable on maturity. This too can be significantly minimized if one does not need all the money in one go and can afford to do a phased withdrawal till the age of 70.
Regarding Option 2, you failed to take into account one crucial point, the extra tax outgo caused by not investing in NPS i.e. 30.9% of 50k = 15450/year. Over 30 years, that’s an outgo of 4,63,500.
5.59 lacs vs 4.63 lacs – Yes, option 2 still wins but the margin is ever so narrow now that most people can safely choose to go either way. And let’s not forget that the government has it’s eyes on LTCG.
Budget 2016 has made NPS more tax efficient. The calculation is pre Budget 2016 and would change with the new tax laws.
In option 2 the invested amount is Rs 35K which is after paying tax of 15K on 50K for not investing in NPS. So the calculation does not change from that perspective. Also annuity is poor yielding and taxable investment!
The above calculation is true mathematically. But the question is would a person invest in Equity mutual fund if he does not invest in NPS – as saving tax plays a big incentive and makes one disciplined. My guess is for most people might skip NPS and keep money in savings account or fixed deposit or just blow it – in which case NPS would be better option.
Can I invest only in 80CCD (1B) without investing in NPS for 1,50,000/- in the first place? Say I invest in PPF, LIC, ELSS for Rs 1,50,000/- and can I invest only for 80CCD(2)?
What will be tax treatment at the withdrawal as per the latest budget in this case?
You can invest 50K in NPS to get tax benefit u/s 80CCD(1B). You cannot get tax benefit u/s 80CCD(2) as it’s only valid for employer contribution. Budget 2016 has proposed tax on 60% of the NPS corpus at maturity. So 60% of NPS maturity amount would be added to your income for that year and taxed at marginal tax rate applicable to you.
if i invest 50k this year, i will save tax of 10k. this is not accounted, lol
Can we opt 100% equity and 0% debt in NPS? If yes, why didn’t you compare using this option?
You can opt for maximum 50% equity allocation. you can read more about NPS here.
Sir I am a govt employ my gross income is Rs 542544 and 10% contribution Rs 51532. And my insurance policy is Rs 1.52 lakh canl l get tax rebate Rs 2 lakh ?
yes
Sir I want to know What is 80CCD(1B)
The post above is about the 80CCD(1B). Let me know if you have any specific questions
Sir I am a govt employ and my gross income is rs 542544, my lic investment is rs 150000 and NPS contribution 51526 and govt contribution is same I want to know will l get how much tax rebate
You would get tax rebate of 1.5 lakh u/s 80C and Rs 50K u/s 80CCD(1B) for investment in NPS. Also the employer contribution in NPS is tax exempted.
I am a central government employee working under Ministry of Agriculture. One of my officer is GPF (General Provident Fund) A/c holder and he want to avail the additional tax benefit under NPS u/s 80CCD(1B). Please clarify that, whether all the employees can avail this tax benefit who have joined the service before 01-01-2004 or only NPS employees can avail who joined after 01-01-2004.
NPS tax deduction u/s 80CCD(1B) is available for everyone irrespective of he is government employee or not. So yes your officer can avail this benefit. Also opening NPS account takes 2-3 weeks so if you are looking to invest in the same, deposit your application form at the earliest.
So according to you, instead of investing in PPF & NSC, invest rather in Equity Mutual Fund . Am i right?
Equity Mutual funds generally give higher returns in the long run and the best part is this is tax free. PPF is good as it’s the best debt investment option as it has no risk and also the returns are tax free. NSC to me does not make sense. You can read more about 80C investment options and my take on each of them.