National Pension Scheme (NPS)

By September 25, 2017 Blog

Investor’s Query: A lot of my colleagues are investing in NPS towards their Retirement. Let me know investing in NPS towards retirement corpus is good?

Mr. Gerard Colaco: I don’t have an NPS account and would not recommend it for anyone.  My arguments against the NPS are as follows:

First, even after decades of disciplined investing, you do not have the freedom to decide what to do with the corpus when the time comes to liquidate the investment.   The amount in the NPS can accumulate to quite a bit over several decades of regular investing.

When you reach 60, only a maximum of 60% of the corpus can be withdrawn.  With the remaining 40%, you are compelled to purchase annuities.  This brings me to my second argument against the NPS.  Annuities are truly horrible investment products.

In a normal annuity, you do not get your principal back.  This is so important, that I drive home the point by reproducing some short passages by an investment adviser named Vipin Khandelwal:

The maximum payout you will get with an annuity is for the option where there is no return of purchase price. Basically, what it means is that you give your money to the insurance company and forget about it. The insurance company will give you an annuity as long as you are alive and nothing comes to your spouse or your legal heirs after that.

Yes, there are options with return of purchase price too, but in those options the annuity payouts would be less. In all such cases, the money only comes to your spouse or your legal heirs after your demise.  Now, even if you made high returns while accumulating the NPS, the poor returns on the forced annuity will make sure that all the benefits are literally undone.

I am vehemently against locking in annuity principal for a lifetime.  What if the annuitant contracts a deadly disease and has only a very short time to live?  At that time, the principal may be needed for medical or palliative care.  Long-term income streams are irrelevant for someone who has days, weeks or months, rather than decades, to live.

Third, annuity returns are low.  From what we have seen so far in India, annuity returns are perhaps between 5% and 7% per annum.  Returns equal to or lower than bank deposits, without return of capital?  Shouldn’t it be compulsory for those purchasing annuities to seek therapy?

Fourth, to add injury to insult, annuity receipts are fully taxable.

Fifth, annuities are so structured that a portion of the annuity ‘income’ also includes the investor’s own capital, that is, the amount used to purchase the annuity.  Since the entire ‘income’ or, more accurately, receipt of annuity is taxed, it means that tax is also paid on the capital and not just on the income earned!  This militates against the very concept of income-tax.

Sixth, when you buy an annuity, there is also an element of service tax that you pay.  This is one more nail in the coffin of the unfortunate annuitant.  Don’t forget that by the time you are ready to buy an annuity, you will most probably be a senior citizen.  Service tax further reducing the returns of senior citizens who buy annuities, is injustice of the highest order.

Seventh, I draw your attention to the remaining NPS corpus that can be withdrawn.  40% of the amount withdrawn is tax-free.  The remaining 20% is taxed.  At present, 100% of withdrawals from the PPF are tax-free.  In any listed equity investment or equity mutual fund, including tax-exempt mutual funds, everything is tax-free after a one-year period of holding.

If you want to avoid tax on the 20% portion of withdrawals that is taxable, you must purchase further annuities with it!  The NPS rules appear to have been drafted by and for the insurance industry!  The main beneficiaries of annuities are the insurance companies that sell them, not the poor victims who buy them.

Eighth, the only way of avoiding tax on the taxable 20% portion of the NPS withdrawal, is to defer withdrawals until the age of 70.  But this may not be in the interest of investors in the NPS.  As individuals age, there may be circumstances that demand early withdrawal.  Liquidity is very important for the elderly.  The NPS is designed to present you with the lose-lose situation of paying tax or choking liquidity.

Finally, in the NPS, there is no 100% equity option.  Such a choice is eminently suitable for systematic investments that will last for ten years or more.  On the other hand, the ELSS (tax saving mutual fund plans) have this option, which will probably give the best long-term returns on investment.

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