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TAX MANAGEMENT December 2017

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National Pension System

What is it?
The NPS is a pension scheme regulated by the Central Government. While Central Government employees are mandatorily covered by this scheme, the NPS is open to all Indian citizens on a voluntary basis. The NPS has value for anyone who works in the private sector and may require a regular pension after retirement. It also comes with the added benefit of tax-saving under Section 80C and Section 80CCD of the Income Tax Act.

Who is it for?
The NPS makes a lot of sense for anyone who wants to plan for their retirement from an early age. A regular pension after you retire can be very useful if you don’t have a regular source of income. Government employees get a pension through the government but people who have worked in the private sector or unorganized sector have to worry about the pension themselves. This is where NPS can come in more than handy. And as an added advantage, the deposits made into it every financial year earn a tax break as well.

The tax saving angle
Under Section 80C, investments in the NPS of up to Rs 1.5 lakh are eligible for tax benefits. Furthermore, under Section 80CCD(2), deductions made by your employer to your NPS account can also earn a tax break. However, deductions under this section should not exceed 10% of your salary. Deductions on your contributions come under the Section 80C limit. An added deduction you can claim comes under Section 80CCD(1B) of up to Rs 50,000 in a financial year.

How to go about it?
The NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA). You can open an NPS account by registering on npscra.nsdl.co.in or by approaching an authorized bank. You can open a Tier-I NPS account at first and later also a Tier-II account.

Rate of Return
Since one portion of the NPS is invested in equities, the scheme does not offer guaranteed returns. But at the same time, it can earn higher than traditional tax-saving investments like PPF. The NPS has been around for a few years only and so far, it has managed to deliver an average of 8% to 10% annualized returns. The good thing is that the NPS allows you to change your fund manager if you feel the performance is not as expected.

Its comparison with other tax saving options
Apart from the NPS, the other popular tax-saving investment options under Section 80C are Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF) and Tax-saving Fixed Deposits (FD). The NPS can earn higher than the PPF or FDs, but it is not tax-efficient upon maturity. At the age of 60, you can withdraw up to 60% of your accumulated amount from your NPS account. But this will be taxable. The remaining 40% has to be used to buy annuity from an insurance company. It is this annuity that will give you a regular pension.

Early Exit?
You can exit the NPS before the age of 60, but only a maximum of 20% of your accumulated savings can be withdrawn. The remaining 80% has to be invested in annuities.

The big question – Is it better than mutual funds?
The good thing about the National Pension System is that it has an equity allocation, but the equity allocation is still not as much as tax-saving mutual funds. ELSS funds invest primarily in equities and hold the capacity to generate higher returns than the NPS. The lock-in period of tax-saving mutual funds is also lesser than NPS-only 3 years as compared to the NPS where you have to stay invested till retirement. ELSS funds are also more tax-efficient upon maturity. The returns earned from them are completely tax-free, which is not the case with the NPS corpus. These are some of the reasons why ELSS funds would be a better tax-saving investment than NPS for most people.

What is the equity allocation allowed in NPS?
The NPS has different schemes that invest in different types of investments. The Scheme E of the NPS invests in equity, with a maximum allocation of 50%. However, this equity allocation is proposed to be raised to 75% so as to allow young investors to earn higher returns.
You can invest in the NPS using the auto choice or active choice options. The auto choice decides the risk profile of your investments as per your age. The older you are, the more stable and less risky investments will be chosen for you. The active choice allows you to decide the scheme and how your investments are to be split by yourself. Even under the auto choice, the maximum equity allocation will be 75%.

Different NPS account types
The two primary account types under the NPS are Tier-I and Tier-II. The Tier-I account is the default account while the Tier-II account is a voluntary addition. The Tier-I account is mandatory for all Central Government employees who have to contribute 10% of their basic salary to this account, which is matched by the government for them. For everyone else, the NPS is a voluntary investment option.

Conclusion:
It is a very long-term investment product, so make sure you understand the implications and the working of NPS before opening an account. Estimate the amount of monthly savings required to meet your post-retirement expenses, keeping the inflation and your life expectancy in mind. Diversify across various investments, including mutual funds and NPS, but do not bank entirely on the latter. 

(Shubham is a Chartered Accountant and MBA (Finance). She is on the forum of “Economic Times” experts on Taxation.   She specialises in Individual Taxation and Taxation of Freelancers & Small businesses. She can be reached on info@taxfile.in for answering your tax related questions.)
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