National Pension System (NPS) scheme was started by GOI in order to provide financial security and stability during old age when people don't have a regular source of income. The subscription to NPS is rising with the lure of additional tax break but still NPS has not got the traction it was supposed to get.
That is because of some of the drawbacks of NPS and some of the fears of the investors. In this post we’ll see some of these drawbacks so that investor gets the necessary knowledge and make an informed decision.
Points that go against NPS
Here are some of the drawbacks of NPS. Mind you some of these may be perceived as drawbacks by investors and not actually be a drawback if seen from a slightly different angle.
- Very long duration – In NPS you need to contribute till the age of 60. If you are starting to contribute at
the age of 25 that would mean a duration of 35 years where you invest money in NPS. While I do admit that exit and partial
withdrawal rules are a bit complex but it is the long duration of the NPS that will help you to build a big corpus. Also
don’t forget some of the amount is going to equity and it is a well documented fact that equities pay in a long term.
You have to see it as a pension plan which should start giving you back only after the age of 60, so long duration should not be a deterrence.
- NPS corpus is taxed on maturity – Now this is one sore point and when compared to other long term products
available like
PPF (which is
EEE), the idea of paying tax on the accumulated corpus makes people a bit wary of NPS.
Though there are ways to reduce tax liability, 40% of the corpus can anyway be withdrawn tax free and 40% has to be used to buy annuity. That leaves 20% of the corpus, which if withdrawn, will attract tax at the applicable tax rate. There is another option though, you can use that 20% also to buy annuity then it will not be taxed.
But beware of the fact that the amount you get monthly from the purchased annuity will also be taxed as per the applicable tax rates.
Another way to reduce tax is to defer the withdrawal of lump sum amount of 60%. NPS allows to stay invested till the age of 70 so you can withdraw in instalments and structure it in such a way that your tax liability is reduced.
- Mandatory annuity – Another point that is making people not opt for NPS is the mandatory buying of annuity with at least 40% of the corpus. Most of us want to have full control of the amount after investing for so long. Moreover annuity return rate in India are in the range 5.5 – 7 percent. Which means for the amount of 50 Lakhs in annuity your monthly pension will come to about Rs. 30000-32000 and to add to that income from pension is fully taxable.
- Partial withdrawal and exit rules - Exit and partial withdrawal rules are not very flexible are another reason
given by investors to stay away from NPS.
If you want to exit before attaining the age of 60, at least 80% of the accumulated corpus should be utilized for purchase of an annuity which means you can only withdraw 20% of the corpus.
For partial withdrawal you should have been invested in NPS at least for a period of 10 years. Moreover only 3 withdrawals are allowed during the whole tenure of your NPS subscription that too for very specific reasons like like Child's marriage, higher education, treatment of critical illnesses etc.
There should also be a gap of at least 5 years between two successive withdrawals. Some relaxation in this gap is given only in the case of treatment for specified illness.
These rules put off few investors who want access to their money with in the tenure of subscription. But don’t forget NPS is supposed to be a long term investment exiting in between without any real emergency or partial withdrawal with out specific purpose will dent the effect of compounding where your accumulated corpus (prinicipal + interest) starts earning an interest.
- Investment in equity – Many investors are conservative and don’t want to invest in equities. NPS does provide
an option through
Active choice to put the whole contribution in Government Securities or Corporate Bond Fund. But Active
choice means you have to decide on the asset class and the fund manager. Investors find all that research too intimidating
and want to go with Auto choice but in Auto choice equity percentage will be there. To avoid this dilemma people go
with other debt options rather than opting for NPS.
At the same time there is another group of investor who want to be in control of their investment and want to decide how their contribution is invested. For them 50% cap on equity allocation even in Active choice is a source of concern.
Now we can see it as a balancing act by NPS (50% cap on equity) to keep both classes of investors happy. Investors who prefer equity should opt for some other mutual funds too with more exposure to equity.
- Returns are not assured – In NPS returns are market linked. You are not given n black and white that these are
your assured returns under NPS. Investors who want to have a clear picture where their money is going and how much they will
get after the specific duration find it a bit risky.
This concern is valid in case market crashes in the year you are retiring which would mean a much smaller corpus than planned.
That is also one reason equity percentage is capped to 50% and you can also look into the option of keeping your investment with in NPS till the age of 70 and withdraw only in instalments.
That's all for this topic Drawbacks of NPS. If you have any doubt or any suggestions to make please drop a comment. Thanks!
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