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.
These defined expenses are for higher education, medical treatment & construction of house. There are certain other restrictions as well for making partial withdrawals.
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, orMF MIP Schemesetc.,
So, low annuity rates (pension rates) may not beatinflation.
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."
I was reading through and I believe that 20 pct that is taxable can be withdrawn in tranches over 10 years.
Age 60 to 70 years. In that case if 2 pct is withdrawn every year and assuming that the person has retired and will be in a lower tax bracket, this can still be attractive..for the following reasons
1. In India very few people commit to paying regularly if not for tax saving OR insurance. Atleast the committment is there.
2. A 20 pct or 30 pct saving now, that part has better time value of money and can be conciously re-invested, if done properly.
Regards
Shivakumar
Dear Shiva,
20 pct that is taxable can be withdrawn in tranches over 10 years - may be true.
But don't you believe that this product is too complex for the masses to understand. We need to keep looking at THE RULE BOOK to see when we can withdraw, how much we can withdraw, how much is taxed etc.,
Kindly share your views.
sir my earning is between 450000 to 500000 per annum
i want to go for mutual fund , please suggest as i do not have any knowledge about it
Agree with main thrust of the article that MFs beat NPS in most cases.
Would like to point out certain cases, where NPS could be preferred to MFs.
NPS Tier 1: if the total corpus is below 2 lakhs at time of retirement, the whole corpus can be accessed. This could be used by someone very close to retirement, say 3 years away from retirement to obtain decent returns at very low expense, get indexation benefits, and save tax at time of investment.
NPS Tier 2: no restrictions on withdrawal, indexation benefits, but no other tax benefits. Persons who are seeking exposure to debt funds can choose Tier 2 for their low expense.
Dear Jay,
Decent returns ? Again this depends on type of fund & market conditions. Very near to retirement then majority of the investors can't afford to take risk.
But again, as pointed out by you, we (you & me) are trying to put across the Pros & Cons of this investment option.
For majority of the investors, this many not be a great investment avenue.
One should take a prudent investment decision based on the positives and negatives and also as per his/her requirements.
My grouse with MFs in India are their expense ratios. The direct plans have helped,
Decent is of course relative. Absolutely, requirements vary from person to person.
Dear srikant ,
I am fan of your blog and it is pleasure to read.It provides a lot of knowledge regarding financial market.
Please publish about tier 2 of NPS .Is it a good investment?
Thanks
Dear Rose,
This is a voluntary savings account from which subscribers are free to withdraw their savings whenever he/she wishes. It is like a Savings Bank account. The facility of Tier II account was made available from December 01, 2009 to All Citizens of India including Govt. employees and Corporate sector. It is mandatory to have an active Tier I account for opening of a Tier II account.
There are no tax benefits on tier-2 contributions.
Also, only 50% can be invested in an equity fund.
So, equity mutual funds can be a better option for long term or retirement planning.
Sir
What are the investment avenues available for 65 years old senior citizen having Rs. 70 Lakhs to invest and requiring regular flow of cash?
Because, FD rates have gone down and he will have to bear TDS. In such case his actual tax liability would be much less than TDS deducted.
Any options apart from FD for a conservative senior citizen who is averse to stock market / Mutual fund?
Thanks
Dear Rupali,
Mutual fund has lot of options , high risk - moderate risk or low risk. So, it is not prudent to rule out MFs completely.
He can consider investing in Debt mutual funds or MIP funds Growth option and opt for SWP (Systematic Withdrawal option).
Other options can be ; Post office Sr Citizen savings scheme & MIS.
He can also consider secured and highly rated NCDs (periodic interest payout option).
Read: How to select best NCDs? Best MF MIPs. Best Debt funds. List of best investment options.
Thank a lot for a detailed answer
Sir,
Hi , I am LIC agent, I joined nps 2 back,
Its called swavalamban ,
Sir, swavalamban pension is in which tier.
Do I hv option to switch to ultra safe tier. ? Where 60% govt. Bond and 40% in corporate bond
Dear Siva,
NPS - Swavalamban invests only up to 15% of the total funds in the equity or stock markets. The balance funds are invested into fixed income instruments such as corporate bonds and Government securities.
This scheme is also know as NPS Lite and Tier structure is not there.
Sir
I am a great fan of you as a financial adviser. I want to do a NPS for 50,000/- per year to save tax since i am in 30% range tax slab. My age is 49 and i am doing service in a Private sector company.
By not doing NPS I am losing around Rs.16000/- per annum after covering full 80C in PPF/PF etc.
Pl. guide me if I will adopt the NPS from any Bank through on line which is the best Bank for this & I want to adopt Scheme -II NPS so that my money 60% can be invested in Share market by the Banker to get more return.
Sreekanth, you have provided very good insight on NPS. I understand the biggest drawbacks are tax on 60% corpus and low annuity rate of pension schemes. But for a salaried employee working in corporate sector where it's not mandatory to enrol. I still thought of NPS as a good option to save taxes. It can save me around 15450 INR per annum while I make 50k investment every year. Also my company provides option to get deduction of 10% of basic salary into NPS account, this may give more tax benefit every year.
Since the 80C limit is still 1.5 lacs (too low), we are not left with many options to save taxes. your views please?
Dear Tarun,
Not all investment decisions can be based just on TAX SAVING purpose!
There can be a case where the returns generated by an equity oriented fund outscore the tax savings of NPS + also considering the fact that annuity rates are low + taxation of entire corpus (not just gains) on withdrawal (if any).
Thanks for the insight Sreekanth. Seems absolutely logical, though one can still decide based on tax bracket he/she is in. For a person in 10% bracket, it seems completely illogical but for a person in 30% bracket it's little tricky. Again individual choice. :) Thanks again !
Well said dear Tarun ..PERSONAL Finance!
I hope I didn't offend you anywhere with any of my word as I am a big admirer of your blogs. Cheers !
No, not at all dear Tarun.
As a blog reader you have all the rights to comment or criticize my work.
In fact, I am more than happy to go through your valid and logical viewpoint.
Kindly keep visiting :)
Hi Reddy,
For Financial year 2013-14 my status was NRI and my only income was bank interest and bank have already deducted TDS on it. I got a letter from income tax department to response under compliance for not filling of ITR for that financial year.
So, after login to http://incometaxindiaefiling.gov.in/ there are following 2 tabs under compliance.
1# One "Filling of Income Tax Return" tab i will select option "Others" and will mention my comments.
2# But in second tab "Related Information Summary" there are couple of option under "Information Relates To" for Information Code TDS-194A.
Q1: I am wondering which option i should select under "Information Relates To" ?
Q2: Additionally, on google i found that code "TDS-194A" is applicable only to resident and not for NRI ?
Please suggest me on the above 2 points i really appreciate for your help.
Hi I am a great fan of you. You are sharing good financial knowledge in a simple language.
I am a govt. employee.
As u said NPS is compulsory, then it has to be done. But if it is optional, n employer (govt) contributes the same amount as mine amount (e.g. 5000 from me n 5000 from govt) then how is this option.
Should I opt for it or should I go for equity mutual fund??
Dear Anand,
If your employer is contributing then it becomes 'compulsory' scheme, am I right?
As of now, voluntary contributions into NPS can be avoided.
Thank you for your appreciation!
View Comments
Dear Sreekanth
I was reading through and I believe that 20 pct that is taxable can be withdrawn in tranches over 10 years.
Age 60 to 70 years. In that case if 2 pct is withdrawn every year and assuming that the person has retired and will be in a lower tax bracket, this can still be attractive..for the following reasons
1. In India very few people commit to paying regularly if not for tax saving OR insurance. Atleast the committment is there.
2. A 20 pct or 30 pct saving now, that part has better time value of money and can be conciously re-invested, if done properly.
Regards
Shivakumar
Dear Shiva,
20 pct that is taxable can be withdrawn in tranches over 10 years - may be true.
But don't you believe that this product is too complex for the masses to understand. We need to keep looking at THE RULE BOOK to see when we can withdraw, how much we can withdraw, how much is taxed etc.,
Kindly share your views.
sir my earning is between 450000 to 500000 per annum
i want to go for mutual fund , please suggest as i do not have any knowledge about it
Dear vikas,
Kindly go through below articles and you may revert to me if you need more information;
How to create a solid investment plan?
How to select best mutual fund schemes based on the Risk ratios?
My MF portfolio picks
Best Equity funds
Very clearly explained.
Agree with main thrust of the article that MFs beat NPS in most cases.
Would like to point out certain cases, where NPS could be preferred to MFs.
NPS Tier 1: if the total corpus is below 2 lakhs at time of retirement, the whole corpus can be accessed. This could be used by someone very close to retirement, say 3 years away from retirement to obtain decent returns at very low expense, get indexation benefits, and save tax at time of investment.
NPS Tier 2: no restrictions on withdrawal, indexation benefits, but no other tax benefits. Persons who are seeking exposure to debt funds can choose Tier 2 for their low expense.
Dear Jay,
Decent returns ? Again this depends on type of fund & market conditions. Very near to retirement then majority of the investors can't afford to take risk.
But again, as pointed out by you, we (you & me) are trying to put across the Pros & Cons of this investment option.
For majority of the investors, this many not be a great investment avenue.
One should take a prudent investment decision based on the positives and negatives and also as per his/her requirements.
My grouse with MFs in India are their expense ratios. The direct plans have helped,
Decent is of course relative. Absolutely, requirements vary from person to person.
Dear srikant ,
I am fan of your blog and it is pleasure to read.It provides a lot of knowledge regarding financial market.
Please publish about tier 2 of NPS .Is it a good investment?
Thanks
Dear Rose,
This is a voluntary savings account from which subscribers are free to withdraw their savings whenever he/she wishes. It is like a Savings Bank account. The facility of Tier II account was made available from December 01, 2009 to All Citizens of India including Govt. employees and Corporate sector. It is mandatory to have an active Tier I account for opening of a Tier II account.
There are no tax benefits on tier-2 contributions.
Also, only 50% can be invested in an equity fund.
So, equity mutual funds can be a better option for long term or retirement planning.
Sir
What are the investment avenues available for 65 years old senior citizen having Rs. 70 Lakhs to invest and requiring regular flow of cash?
Because, FD rates have gone down and he will have to bear TDS. In such case his actual tax liability would be much less than TDS deducted.
Any options apart from FD for a conservative senior citizen who is averse to stock market / Mutual fund?
Thanks
Dear Rupali,
Mutual fund has lot of options , high risk - moderate risk or low risk. So, it is not prudent to rule out MFs completely.
He can consider investing in Debt mutual funds or MIP funds Growth option and opt for SWP (Systematic Withdrawal option).
Other options can be ; Post office Sr Citizen savings scheme & MIS.
He can also consider secured and highly rated NCDs (periodic interest payout option).
Read:
How to select best NCDs?
Best MF MIPs.
Best Debt funds.
List of best investment options.
Thank a lot for a detailed answer
Sir,
Hi , I am LIC agent, I joined nps 2 back,
Its called swavalamban ,
Sir, swavalamban pension is in which tier.
Do I hv option to switch to ultra safe tier. ? Where 60% govt. Bond and 40% in corporate bond
Dear Siva,
NPS - Swavalamban invests only up to 15% of the total funds in the equity or stock markets. The balance funds are invested into fixed income instruments such as corporate bonds and Government securities.
This scheme is also know as NPS Lite and Tier structure is not there.
Sir
I am a great fan of you as a financial adviser. I want to do a NPS for 50,000/- per year to save tax since i am in 30% range tax slab. My age is 49 and i am doing service in a Private sector company.
By not doing NPS I am losing around Rs.16000/- per annum after covering full 80C in PPF/PF etc.
Pl. guide me if I will adopt the NPS from any Bank through on line which is the best Bank for this & I want to adopt Scheme -II NPS so that my money 60% can be invested in Share market by the Banker to get more return.
Pl. suggest the best ways as per your experience.
Regards.
Dear skmohapatra ..Kindly read : eNPs portal details..
Sreekanth, you have provided very good insight on NPS. I understand the biggest drawbacks are tax on 60% corpus and low annuity rate of pension schemes. But for a salaried employee working in corporate sector where it's not mandatory to enrol. I still thought of NPS as a good option to save taxes. It can save me around 15450 INR per annum while I make 50k investment every year. Also my company provides option to get deduction of 10% of basic salary into NPS account, this may give more tax benefit every year.
Since the 80C limit is still 1.5 lacs (too low), we are not left with many options to save taxes. your views please?
Dear Tarun,
Not all investment decisions can be based just on TAX SAVING purpose!
There can be a case where the returns generated by an equity oriented fund outscore the tax savings of NPS + also considering the fact that annuity rates are low + taxation of entire corpus (not just gains) on withdrawal (if any).
Thanks for the insight Sreekanth. Seems absolutely logical, though one can still decide based on tax bracket he/she is in. For a person in 10% bracket, it seems completely illogical but for a person in 30% bracket it's little tricky. Again individual choice. :) Thanks again !
Well said dear Tarun ..PERSONAL Finance!
I hope I didn't offend you anywhere with any of my word as I am a big admirer of your blogs. Cheers !
No, not at all dear Tarun.
As a blog reader you have all the rights to comment or criticize my work.
In fact, I am more than happy to go through your valid and logical viewpoint.
Kindly keep visiting :)
Hi Reddy,
For Financial year 2013-14 my status was NRI and my only income was bank interest and bank have already deducted TDS on it. I got a letter from income tax department to response under compliance for not filling of ITR for that financial year.
So, after login to http://incometaxindiaefiling.gov.in/ there are following 2 tabs under compliance.
1# One "Filling of Income Tax Return" tab i will select option "Others" and will mention my comments.
2# But in second tab "Related Information Summary" there are couple of option under "Information Relates To" for Information Code TDS-194A.
Q1: I am wondering which option i should select under "Information Relates To" ?
Q2: Additionally, on google i found that code "TDS-194A" is applicable only to resident and not for NRI ?
Please suggest me on the above 2 points i really appreciate for your help.
Dear BP,
Did you get your Residential status updated with your banker?
Kindly read: How to respond to non-filing of Income tax return notice?
Hi I am a great fan of you. You are sharing good financial knowledge in a simple language.
I am a govt. employee.
As u said NPS is compulsory, then it has to be done. But if it is optional, n employer (govt) contributes the same amount as mine amount (e.g. 5000 from me n 5000 from govt) then how is this option.
Should I opt for it or should I go for equity mutual fund??
Dear Anand,
If your employer is contributing then it becomes 'compulsory' scheme, am I right?
As of now, voluntary contributions into NPS can be avoided.
Thank you for your appreciation!