Use NPS tax benefit carefully

While there is a tax advantage on investment, laws are yet to be changed to provide benefits on maturity

If you have not invested in the National Pension System (NPS), this year could be a good time to start. From this financial year, there is an additional tax exemption of Rs 50,000 for investing in NPS. For someone in the 30 per cent tax bracket, this is a clear benefit of Rs 15,000 over and above the Rs 1.5 lakh allowed under Section 80 C. NPS is a product you can include in your portfolio since it is geared towards retirement savings. However, one should also take into consideration the tax on pension, say financial planners.

How does NPS compare with the options that are currently available for retirement savings? According to Manikaran Singal, a financial planner, there is definitely a case to invest in the NPS if one is looking from the tax angle. In terms of returns, it cannot be compared with mutual funds (MFs), though. NPS only invests in exchange traded funds (ETFs) and the maximum allocation allowed in equities is 50 per cent. “That is why the cost structure is much lower than MFs, which are actively managed. But, MFs offer higher returns than NPS,” Singal points out.

Some unit-linked pension plans offered by insurance companies have lower charges than MFs and also give 100 per cent exposure to equity. While they might offer higher returns than NPS, on maturity, they are also taxed, because 40 per cent of the proceeds have to be invested in annuities.

At present, NPS and pension plans offer tax deferment, rather than tax savings. While you get tax exemption at the time of investing, you are taxed on maturity. Against this, while you might not get a tax benefit at the time of investing in equity mutual funds, there is no tax on the returns if you stay invested for one year. Similarly, public provident fund (PPF) is another long-term retirement saving product on which there is clear tax benefit available, says Singal.

Investors must combine NPS with PPF, which is more tax-efficient, to ensure the tax burden does not increase. “Although the additional tax exemption is attractive, don’t go overboard with NPS because the pension is taxable. Balance it with your PPF investment,” Singal adds.

However, according to Sumit Shukla, chief executive of HDFC Pension Funds, most subscribers don’t get the tax exemption benefit from PPF because the Employee Provident Fund usually takes care of the 80C requirement.

What if you are approaching retirement? You can go for the Automatic choice, where the fund makes the choice of investing in the asset classes based on your age. For someone below 35 years of age, 50 per cent will be allocated towards equity. This reduces gradually from the age of 36 onwards till the equity portion reaches 10 per cent.

However, Singal says it is better to go for the Active choice, which gives you the option to entirely in government securities (NPS-G), or fixed income other than G-Secs (NPS-C) or up to a maximum of 50 per cent in equities (NPS-E). “Since the maximum equity allocation allowed is only 50 per cent, it makes sense to choose the Active option. You should continue with this till the age of 45-50 years, after which you can reduce the equity allocation,” advises Singal.

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