Pension calls: Why NPS may not be ideal for the disciplined, tax-aware investor - expert explains

Retirement planning is crucial for a secure and stress-free future. The National Pension System (NPS) is often promoted as a reliable way to build long-term savings, backed by the government to help individuals accumulate a retirement corpus over time.

Contributions to NPS come with tax benefits: under the old tax regime, employees can claim deductions of up to Rs 2 lakh (Rs 1.5 lakh under Section 80C and Rs 50,000 under Section 80CCD(1B)), while employer contributions up to 10% of salary are also deductible. Under the new tax regime, only the employer’s 14% contribution is deductible. Upon maturity, 60% of the NPS corpus is tax-free, while the remaining 40% must be used to purchase an annuity, which is fully taxable.

However, experts have raised several concerns about the limitations of NPS—especially when it comes to taxation and liquidity.

Wealth advisor Manoj Arora pointed out that one of the most overlooked aspects of NPS is its unfavourable tax treatment at maturity.

“NPS gives you tax benefits during the accumulation phase. But what you get back as monthly pension (annuity) after retirement is fully taxable—not just on your investment gains, but on the entire 40% of your accumulated corpus that is mandatorily diverted into an annuity. That includes both your invested principal and the returns earned on it,” Arora explained.

He added, “You build your retirement corpus patiently over decades. But the moment it converts into pension income, you're taxed on every rupee—even the money you originally invested.”

In a post on X (formerly Twitter), Arora wrote: "What you get back in the form of pension is fully taxable. And remember that the tax is not only on the gains—it's on the entire accumulated 40% corpus (investment + gains) that comes back in the form of pension. Top that up with the lack of liquidity of your own money until you retire. Well, that's not how efficient portfolios work. NPS, per me, is only good for an undisciplined investor."

Liquidity Constraints

Another major downside, he noted, is the lack of liquidity. With NPS, your money is locked in with almost no access until retirement. There are no partial withdrawals allowed for emergencies, limited flexibility in rebalancing your portfolio as markets change, and restricted control over asset allocation as you approach retirement.

“That’s not how efficient portfolios are supposed to work,” Arora said. “Flexibility, tax efficiency, and accessibility are the pillars of good long-term investing—and NPS falters on each.”

Who should opt for NPS?

According to Arora, NPS may still work well for investors who struggle with discipline and need a rigid, government-backed structure to force consistent retirement savings. But for financially aware or seasoned investors, he believes there are far more efficient ways to build a retirement corpus—without being penalised on liquidity or tax.

A balanced mix of equity mutual funds, debt instruments, and strategic tax planning, he said, can offer better results with more control, transparency, and flexibility.

Why Systematic Withdrawals Beat Annuities

Arora recommends opting for systematic withdrawals from equity mutual funds instead of relying solely on NPS, as this approach offers greater control and tax benefits. Here's how:

1. Tax Efficiency

With equity mutual funds, only the gains above ₹1 lakh annually are taxed at 10% under long-term capital gains (LTCG). By staggering withdrawals, the effective tax outgo stays around 12.5% or lower. In contrast, annuity income from NPS is taxed at your full slab rate—up to 30%—with no tax exemption on the principal.

2. Tax Only on Gains

Mutual fund withdrawals are taxed only on the gains, not on the full withdrawal amount. But in NPS, annuity income is fully taxable, even though it includes the principal.

3. Control Over Withdrawals

In mutual funds, you decide how much to withdraw and when, adjusting it to your lifestyle or emergencies. NPS, however, locks you into a fixed annuity payout, limiting flexibility.

4. Full Liquidity

Mutual funds offer 100% liquidity—you can access your full corpus anytime. In contrast, once NPS is converted into an annuity, the money becomes non-redeemable, and you lose flexibility.

While NPS is a solid option for those who need structure and forced savings, it may not suit investors who prioritise flexibility, tax optimisation, and full control over their retirement funds. For them, alternative strategies—built around disciplined mutual fund investing—may prove far more rewarding in the long run.

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