In this year's budget, Finance Minister Arun Jaitley tried to resurrect the National Pension System (NPS) by offering an additional Rs 50,000 tax break over and above the existing Rs 1.50 lakh. The saving works out to a little over Rs 16,000 for those in the 30 per cent tax bracket. While the government hopes this will finally drive people to the scheme that was meant to fix India's looming pension crisis, it may well be proved wrong.
Leading financial planners are already drawing up the numbers and comparisons and these do not seem to indicate any reason to rush for the NPS even with the additional tax break. And the blame lies with the government itself. For some reason that defies conventional logic, the NPS has since its inception been given stepmotherly treatment with regard to its tax structure.
Returns from the NPS are taxed on maturity and so is the annuity component through which one draws a fixed pension after retirement. This is unlike all other products including any equity mutual fund, insurance and even provident fund (PF) or public provident fund (PPF), where the returns are tax-free.
When one puts aside small amounts of money regularly over the years, the aim is to build a big corpus to take care of one's post-retirement years. Now imagine, if at the time of maturity, your returns were to be taxed and one-third of the amount taken away! It is for this reason that for many long-term savings products, the government had followed an Exempt-Exempt-Exempt (EEE) regime, which meant there were tax exemptions at every stage: entry into the product, dividends, interest and returns during the phase of investment and finally on the returns one garners at the time of exit or sale of the investments.
PPF, PF, equity-linked savings schemes (ELSS) and insurance have all been in the EEE category. Moreover, investments in any equity or balanced mutual fund scheme are tax-free after one year of holding period. But strangely, the NPS is not an EEE scheme. And Finance Minister Arun Jaitley chose not to change this legacy of the past. He could have put the baby back in the bathtub, instead he merely stuck to enhancing the first "E" by giving additional sops at the time of entry.
"There is no logic whatsoever in keeping the NPS within an EET (Exempt-Exempt-Taxed) regime when all other long-term products are in EEE mode. Moreover, the NPS was designed as a wholesale product where companies and institutions, both government and private, would subscribe for it on behalf of their employees," says economist Ajay Shah, who has been at the forefront of pension reforms in India at the National Institute of Public Finance and Policy. "Its cost structure does not allow it to be sold as a retail product. It was never meant to compete with mutual funds and insurance. The NPS and its struggles are part of a larger systemic malaise with our administrative structures," he adds.
Financial planners say you may be far better off being in a balanced fund that could come closest to an NPS with an equity option, and the difference in returns could be several lakh rupees over decades. "From a pure returns perspective, the benefits of investing in a balanced fund outweigh an NPS option by far," says Shifali Satsangee, founder and CEO, Funds V'edaa. "The benefit over long periods could be significant. We are recommending balanced funds over the NPS based on factors such as liquidity, tax efficiency and returns as these are important points of consideration for investors."
There are, however, some pluses of the NPS. For one, it was conceived as a scheme that would encourage people to put aside money during their working years to take care of their post-retirement financial needs. The one big difference with retirement schemes such as the PPF and PF is the absence in the NPS of a fixed interest rate that could be adjusted by the government on a yearly basis - averaging around 8 per cent per annum. Owing to this guaranteed return structure, PPF and PF schemes could not invest in equities and hence not generate a huge uptick in returns through a reasonable exposure to equities. The NPS provided this option, by giving investors the right to choose, from equities, corporate debt and government securities. This choice is subject to certain norms: for instance, your equity exposure would be brought down in proportion to you reaching your retirement age and could only be a maximum of 50 per cent.
NPS also bargained hard with entities that wanted to manage these funds by slashing fund management costs to a mere 0.01 per cent. This makes it way cheaper than any other financial product and, in the long term, can enhance returns on the investment. But the lack of incentive also means that no one - including banks - is aggressively selling them.
Most banks have only picked a few branches where you can buy these products. The Pension Fund Regulatory and Development Authority (PFRDA), which manages the scheme, is now planning to increase distribution fees to give sales a push. It may not be enough. The NPS is a complicated product and has multiple options and different types of schemes and the awareness level is very low. It will take a far greater effort on the part of the PFRDA to popularise the scheme.
And yet, for someone who has never invested before and needs to build a retirement corpus, the NPS could be a sound starting point. It is well regulated and is extremely cost-effective. But for those who are familiar with mutual funds, experts say a far more effective tool for someone with a similar risk profile could be a balanced fund.
Balanced funds invest in both equity and debt and thereby seek to garner gains from either of the asset classes and de-risk the investment. To that extent, they come closest to comparison with an NPS with the 50 per cent equity option. "Till I compare the NPS with the PPF, the returns seem better although there is no guaranteed return. But the minute I compare it to a balanced fund, the returns picture changes completely," says Surya Bhatia, certified financial planner and CEO at Asset Managers.
If you are someone who lacks the discipline of investing regularly, then perhaps it may be worth making the extra effort to get yourself the NPS. If not, then you are better off sticking with mutual funds.
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