Self-employed should look at National Pension Scheme for retirement

With interest rates of Public Provident Fund and small savings schemes falling, other investment avenues should be explored

The self-employed, who have been investing primarily in the Public Provident Fund (PPF) for retirement, should now look at the National Pension System (NPS). Recently, the government has lowered interest rates on small savings schemes, including PPF, from January 1. Any contribution to PPF will now fetch an interest of 7.6 per cent, 20 basis points lower than a quarter before.
 
This has widened the gap between the long-term fixed-income retirement products available to the self-employed and salaried. Employees’ Provident Fund (EPF) fetched salaried individuals an interest rate of 8.65 per cent in the last financial year (2016-17). Even if the labour ministry brings down the rates on EPF by 20 basis points (bps) for the current financial year, in the same proportion as EPF, the salaried would still get 8.45 per cent or 85 bps more interest than PPF.
 
For the self-employed, PPF is the only long-term retirement product that offers exempt-exempt-exempt tax treatment. They get a tax deduction on investment, and there is no tax on either accumulation or withdrawal. “If a self-employed can stomach the volatility that comes with equity, investing in NPS makes more sense than in PPF over the long term. For those looking for a low-cost retirement product backed by the government, NPS is an excellent choice,” says Malhar Majumder, partner and consultant at Positive Vibes Consulting & Advisory.
 

NPS can fetch better returns: NPS comes with a whole host of investment options. A subscriber can choose a mix of equities, corporate bonds and government securities. NPS can deliver better returns compared to other government-backed retirement products due to the possibility of higher allocation to equities. Take the example of an individual who maintains 50:50 debt and equity allocation throughout his  working life. He can get better returns than PPF (see table). The longer he gets to be in NPS, the better are his returns. A 50-year-old, whose NPS matures at 60, can make anywhere between four per cent and 21 per cent more returns from NPS compared to PPF depending on his fund performance. A 35-year-old, who has 25 years for NPS to mature, can make 14 per cent to 79 per cent higher returns than PPF.
 
Strategies to shift: As a self-employed, the shift to NPS depends on how long you have been investing in PPF and the corpus you have accumulated. If you have created a big corpus with PPF, say over
 
Rs 1-1.5 million, then investment advisors say it makes sense to continue contributing to PPF. “Once an individual has created a significant corpus, he gets the benefit of compounding over the long term. A person, who has contributed most of his working life to PPF, should, therefore, continue with it despite the fall in interest rates,” says Arnav Pandya, a certified financial planner. They should, however, contribute at least Rs 50,000 to NPS that offers them additional income tax deduction.
 
Those self-employed, who are above 50, should follow the same strategy and stick to PPF because equities are volatile and need a longer investment horizon to deliver superior returns. But, if you don’t have a big PPF corpus, you may shift to NPS, while restricting your PPF allocation to Rs 12,000-24,000 a year or Rs 1,000-2,000 a month. You need to contribute to PPF to keep it active and earn interest on the existing amount.
 
Some financial planners also suggest that an individual should look at his risk profile before opting for NPS. If they do not have an appetite for volatility, they should avoid NPS. “It’s not just equities, even debt investments can get volatile in NPS and might deliver returns lower than PPF in certain periods,” says Lovaii Navlakhi, founder and chief executive officer, International Money Matters. At present, for example, the yield on government securities (G-Secs) has shot up and, therefore, bond prices are falling. While the five-year G-Sec return in NPS tier-1 is over 8.71 per cent, the one-year return is in the range of 0.53 -2.5 per cent.
 
Annuity, tax are not deal breakers: An NPS subscriber needs to mandatorily buy an annuity with 40 per cent of the corpus he accumulates on maturity at 60 years. If you accumulate Rs 10 million, you can withdraw a maximum of Rs 6 million. But, if you withdraw 60 per cent from the corpus, 20 per cent of the funds will be taxed. In the example, there will be a tax on Rs 1.2 million. “Despite the mandatory annuity and tax on 20 per cent of the corpus, if withdrawn, NPS is still attractive,” says Suresh Sadagopan, founder, Ladder7 Financial Advisories.
 
Most financial advisors also say NPS has come a long way and is getting better. Investors can expect more features and better annuity products going forward.