Categories: Financial Planning

National Pension Scheme (NPS) – Why it is not a good Investment Option?
The Government of India rolled out the National Pension Scheme (NPS) for all the citizens of India from May 1, 2009 and for corporate sector from December, 2011. Any individual whether employed with private sector, self employed or professional can avail of pension benefits and plan his or her retirement by enrolling in this scheme. The person (employee/citizen) who joins the NPS will be known as “Subscriber” in the NPS. Under the NPS, each Subscriber will open an account with Central Record keeping Agency (CRA). This account is identified through unique Permanent Retirement Account Number (PRAN). The Centre made NPS scheme mandatory for all the employees who joined the service on or after January 1, 2004. It has since been adopted by most state governments also. Currently, NPS has more than 1.13 Crore subscribers with total Asset under Management (AUM) of more than Rs. 1.09 lakh crore. Most of my blog readers have chosen NPS for two main reasons – i) for tax saving purpose & ii) No other choice than to invest as contribution to NPS has been made mandatory for the Govt employees. Unfortunately, majority of the subscribers are not aware of ‘how NPS scheme works’ and invest in it just to save some taxes. Most of us are eager to know about the tax benefits that are being offered while contributing to NPS but are not worried about the applicable taxes at maturity. In this post, let’s understand – Is NPS a good investment option? What are the drawbacks of National Pension Scheme?

National Pension Scheme – Why NPS is not a good Investment?

A long-term investment option for your retirement planning should ideally have below features;
  • It should be simple and easy to understand
  • Should be flexible
  • Should have high liquidity
  • Should be a tax efficient product and ideally should fall under Exempt – Exempt – Exempt category.
  • You should be able to withdraw the whole corpus at the time of retirement and you should be allowed to re-invest the corpus as per your choice/requirements.
Retirement planning is a long-term goal, so when we are investing for a longer period, I prefer to invest in a simple, flexible, easy to understand, tax efficient & highly liquid investment option. According to me, National Pension Scheme is not a great investment option for your retirement goal. It does not meet any of the above criteria. Let’s understand why it is not a good choice;
  • Lock-in Period : National Pension Scheme has a high lock-in period. The retirement age is fixed at 60 years. You can not withdraw the entire corpus till your reach 60 years of age. If you look at other tax saving investment options like PPF, ELSS, EPF, NSC etc., then they all have low lock-in period. PPF has a 15 year lock-in period, 3 year lock-in period for an ELSS fund, you can withdraw EPF if you are unemployed for 2 months and so on.
  • Pre-mature withdrawal : Up to 10 years, no partial withdrawals are allowed. Partial withdrawal up to 25% of own contribution (excluding contribution from the employer) only is allowed after 10 years for defined expenses. In the latest rule change, PFRDA (Pension Fund Regulatory And Development Authority) has relaxed the withdrawal norms to the effect that now the subscribers can withdraw upto 25% of contributions starting from the third year of opening of NPS (National Pension System) account. These revised NPS Partial Withdrawal rules are effective from January 10, 2018.
  • Withdrawal at maturity : After attaining 60 years of age, you are allowed to withdraw only 60% of the total Corpus amount.
  • Annuity Plan :
    • At least 40% of the accumulated wealth in the NPS account needs to be utilized for purchase of annuity/pension plan when you turn 60 years.
    • Let’s understand this with an example : If your total corpus is Rs 100 at the time of retirement (60 years), you can withdraw Rs 60 as a lump-sum amount and Rs 40 (minimum) has to be used to buy an Annuity plan from a Life insurance company. Out of the sixty rupees, Rs 20 will be taxable as per your income tax slab at the time of retirement
      • (Latest update : Dec 2018 – W.e.f 1st April, 2019, this Rs 20 would also be tax-exempt) and the Rs 40 is tax-free amount. From FY 2018-19, this partial tax-exemption on NPS withdrawal is now extended to self-employed individuals also .
    • Kindly note that the taxes are applicable on the corpus amount and not just on the Gains. (The minimum quantum of investment in Annuity product depends on WHEN you choose to exit from the NPS account).
    • If you invest Rs 40 (lump sum) in an Annuity plan offered by a life insurance company, they in-turn will give you pension/annuity at periodic intervals. Unfortunately, even this annuity income or pension income is taxable as per the current laws.
    • Annuity income is taxable under the head ‘income from other sources’. Why do you want to receive an income which is chargeable to tax during your ‘retirement age’?
  • NPs falls under EET Category : The contributions made during the accumulation phase are exempt from income taxes, the returns earned during the accumulation phase are exempted but at maturity the corpus amount (60%) is subject to taxes. Latest Update (Dec 2018) : This 60% withdrawable corpus is made tax-exempt w.e.f. April, 2019. So, we can consider NPS under EEE category. But, do note that Annuity income earned is still a taxable income. 
    • The contribution to Tier-I account of NPS is only eligible for tax benefits.
      • Latest Update (Dec 2018) : Contribution by government employees (only) under Tier-II of NPS will now be covered under Section 80 C for deduction up to Rs 1.5 lakh for the purpose of income tax provided there is a three-year lock-in period. This is w.e.f April, 2019.
    • Low Annuity rates :
      • The annuity rates offered by the life insurance companies are pretty low.  Kindly remember that the pension amount is dependent on the annuity rates.
      • What is annuity rate? – In return for a lump sum; the money you have saved in your pension pot, an annuity provider (insurance company) will give you an annual income for the rest of your life.
      • The yields on annuity products offered in the market today are in the range of 5 to 7% only. This is low when compared to other conservative products like Debt mutual funds, Senior citizens Savings Schemes, Post office MIS, or MF MIP Schemes etc.,
      • So, low annuity rates (pension rates) may not beat inflation.
      • I personally believe that it is like you accumulate wealth and lose all the wealth to Annuity Plan Provider.
    • Types of Funds & Allocation :
      • NPS Scheme has three different types of Funds – i) Equity fund, ii) Corporate Bonds & iii) Government Securities. Under Equity Fund option, subscriber is allowed to invest only up to 50% of contribution amount. When you are investing for longer period, why should you restrict your equity exposure to just 50%? In case of Govt employees, the total equity portion of the tier I account cannot be more than 15% (increased up to 50% w.e.f. April, 2019).  Government employees also do not have the option to change the contributions made to each fund.
      • Latest Update (29-Nov-2016): The existing ‘Life Cycle Fund’ with 50% max equity exposure is renamed as ‘Moderate Life Cycle Fund’. The new allocation option would be ; 50% equity exposure till the age of 35 and reduces it by 2% every year till the age of 55.  A new fund option called ‘Aggressive Life Cycle Fund (LC-75)’ has been introduced. The fund invests 75% in equities till age of 35 and then cut exposure by 4% every year. The cuts will slow down to 3% per year between 45-50 years and to 1% per year between 50 and 55 years.
      • Latest update (04-March-2017) : With effective from 1st April 2017, NPS subscribers can change their investment option and asset allocation ratio ‘twice’ in a year than the existing once in a year.
    • Equity funds Investment Strategy : Till last year (2015), equity funds of NPS were mirroring the returns of the index because pension funds were supposed to invest in index stocks (Large Cap Stocks) only. But from September 2015, fund managers (SBI/ICICI/UTI/LIC/HDFC/Kotak/Reliance) have been allowed to invest in a larger universe of stocks and follow an active investment strategy that does not mirror the index. But, most the fund managers are yet to follow or implement these new guidelines. Most of the funds do not even have more than 10% of their equity corpus allocated to non-nifty stocks (mid-cap stocks).
If it is mandatory for you to contribute to NPS then you do not have any choice but to contribute. If you want to make voluntary contributions then I believe that NPS is not a great investment avenue. (Read : List of Best Investment Options) If maturity proceeds are not taxed, and if buying an annuity product is made optional then National Pension Scheme can be a better option. But as of now, it is a complex and less tax-efficient long-term investment option. Do you prefer NPS to other investment options like Mutual funds? Kindly share your views on NPS. (Image courtesy of Mister GC at FreeDigitalPhotos.net) (Post published on : 22-July-2016) 

This post was last modified on October 4, 2023 9:52 am

Sreekanth Reddy

Sreekanth is the Man behind ReLakhs.com. He is an Independent Certified Financial Planner (CFP), engaged in blogging & property consultancy for the last 14 years through his firm ReLakhs Financial Services . He is not associated with any Financial product / service provider. The main aim of his blog is to "help investors take informed financial decisions." "Please note that the views given in this Blog/Comments Section/Forum are clarifications meant for reference and guidance of the readers to explore further on the topics/queries raised and take informed decisions. The information provided, therefore, should not be viewed as financial, legal, accounting, tax or investment advice."

View Comments

  • Hi Sreekanth,

    I am 28 and I had started contributions to Superannuation Fund six years back. Now,an option has arisen in my company to opt out of it and transfer all its accumulations to a NPS account.

    I desperately want to close my superannuation account and withdraw all its accumulations but since that is not possible,should I create a NPS account and then transfer all the SAF's accumulated money to it.

    PS: The growth of money in the SAF has been pathetic - 25% over the course of 6 years.

    Thanks in advance.

    Regards,
    Rohit

  • Hi Sreekanth,

    I am 34 & I have exhausted my 80C limit through PF contribution, ELSS (Axis), Term Insurance & Home loan.

    I have 2.5k monthy SIP running in each of the following MFs:
    1) SBI Magnum Midcap Fund (G)
    2) Mirae Asset Emerging BCF (D) (G)
    3) SBI Small Cap Fund (D) (G)
    4) Motilal Multicap 35 Fund (D) (G)
    5) SBI Small Cap Fund (D) (G)

    As i am in 20% tax bracket, should i invest 50k in NPS to save tax.
    Else suggest some retirement corpus options with free will to withdraw the money.

    Thanks in advance.
    Regards,
    Sankar Kumar.

  • I m west Bengal state government employee. No nps schem provide for wb govt. Employee in wb govt rules.
    Can I invest in NPS scheme individual ?

    • Dear Mr SARKAR,
      Yes, you can invest..
      Kindly go through the above points and take an informed decision!

  • Hi Sreekanth, Thanks for the great article. Please provide some details on Rate of Return of NPS. Thanks.

  • Hi Sreekanth,

    Thanks for this article. My question is with regard to additional tax benefit for investment up to Rs 50,000 in NPS. I am a government employee, already having nps tier 1 account so if I invest Rs.50k in tier 2 for additional tax benefit then, when can I redeem this amount from tier 2 ? Is this amount under lock-in-period ? how much ? As far as I know, in tier 2 account, the subscriber can deposit and redeem any time so, is there anything special about this investment of Rs.50k ?

    • Dear Pankaj,
      Contribution by government employees (only) under Tier-II of NPS will now be covered under Section 80 C for deduction up to Rs 1.5 lakh for the purpose of income tax provided there is a three-year lock-in period. This is w.e.f April, 2019.

      • Thanks, not only for your reply but also for such quick reply. I wish almighty give you all strength to continue this generous work.

  • That is quiet an information. I did recently hear about NPS and I was planning to invest in it. And the of course I though of it just considering the immediate Tax exemption. Now I have clarity on this product and I do not want to go for it.
    Thank you Sreekanth.

  • Will 40% principal amount invested into annuity be returned to nominee in case of demise of the account holder (say at the age of 70)

  • Hi Sreekanth,
    People contribute Rs 50,000/yr towards NPS. I am 29yrs old. If I do SIP of 5-6k per month in small cap funds for the next 30 yrs, do you think that will be the best retirement planning or replacement of NPS?

  • HI Sreekanth,

    What is your view on the Tier II in NPS. It is completly flexible with very low expense ratios. Also with new aggresive guideline of 75% in stocks is it not the best investment option

    • Dear kolukula .. Even then I would prefer to invest in Equity mutual funds which are more transparent, tax effective, and have wider choice.

  • Dear Sir,

    I want to invest Rs.20,000 per month through SIP mode for short capital gain in option to FD/RD, so request you to suggest suitable Debt fund(Short Term,Ultra Short Term, MIPs ,Liquid)

    Regards,
    Ajay Mokani

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Published by
Sreekanth Reddy
Tags: National Pension Scheme
October 4, 2023

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