Quick Facts on NPS
NPS - New Pension System (also referred as National Pension System) is a contribution based retirement system promoted by PFRDA (Pension Funds Regulatory and Development Authority)
Tax Treatment:
Similar to PF, there can be contribution by employee and employer
Max contribution: 10% of (Basic + DA)
Employee Contribution: Falls under the limit of Rs 1.5 Lakh per annum - section 80 CCD (1), with other 80C schemes. (similar to how employee contribution of EPF is treated)
Employer contribution: 10% of (Basic + DA) is exempted under Section 80CCD (2) - this is beyond Rs 1.5 Lakh limit (similar to how employer contribution of EPF is treated) - i.e, not treated as income at all.
Additional Rs 50000 per annum (beyond Rs 1.5 Lakh limit) can be availed under Section 80 CCD (1b)
NPS has 7 fund managers to choose from - HDFC Pension Fund, ICICI Prudential Pension Fund, Kotak Pension Fund, LIC Pension Fund, Reliance Capital Pension Fund, SBI Pension Fund, UTI Retirement Solutions.
There are two accounts with NPS - Tier1 and Tier2. Only Tier1 is eligible for tax benefits for investments. Tier2 is more like an add-on for investor convenience. Amount can be moved from Tier2 to Tier1 and not vice versa.
Amount contributed towards NPS gets invested in 3 different schemes - equity, corporate bonds and government securities. Investor can choose to invest in Auto mode or Active mode. Maximum possible contribution in equity scheme under both modes for any age is 50%. Investor can choose to split the investments in Active mode, whereas in Auto mode the investment contributions get split as per investor age. Rebalancing according to the target split happens yearly once on the date of birth of the investor.
The scheme details under each of equity, corporate bonds / govt. securties (E C G respectively) of Tier 1 and Tier 2 are available in the individual pension fund site
http://www.reliancepensionfund.com/navs/portfoliodetails.aspx?shortname=portfoliodetails
http://www.sbipensionfunds.com/portfolio-detail-system.html
http://www.hdfcpension.com/about-hdfc-pmc/investment-portfolio-details/
Minimum contribution
Tier1:
Minimum Number of times in a year: Once
Minimum Amount Contributed in a year: Rs 6000
Tier 2:
Once per year, Minimum Rs 250 (subject to a minimum funds available in Tier 2 of Rs 2000)
Fees
Minimum of 0.25% or Rs 20 per contribution (taken at the time of contribution)
0.0275% of funds under management for asset management, custodian and NPS Trust (adjusted in NAV)
Rs 190 per year for account maintenance taken by cancelling units in each of C, E, G
Withdrawal from NPS:
Possible only after age of 60
A minimum of 40% to be utilized in purchasing annuity
Maximum 60% can be taken as lump-sum
Premature exit
Minimum 80% to be utilized in purchasing annuity
Taxation
40% of withdrawal not taxable (only the available 20% lump-sum in case of premature exit)
60% taxable - irrespective of lump-sum or annuity. Lumpsum taxable at marginal tax rate as per investor income slab for the year.
Annuity purchase is not taxable, whereas the monthly payments from the annuity is taxable at appropriate slab.
Deferment of Withdrawal
Defer annuity for 3 years
Defer lumpsum withdrawal for 10 years
Take lumpsum in a staggered manner in 10 installments.
The entire withdrawal process can be deferred for another 10 years, during which contributions have to be made.
As of now, the following are the annuity providers from whom the annuity can be purchased.
HDFC Standard Life Insurance Company Limited
ICICI Prudential Life Insurance Company Limited
Bajaj Allianz Life Insurance Company Limited
Reliance Life Insurance Company Limited
Star Union Dai-ichi Life Insurance Company Limited
Life Insurance Corporation of India
More Info:
https://www.npscra.nsdl.co.in/all-citizens-faq.php
http://www.hdfcpension.com/national-pension-scheme/nps-account/)
Now, analysis:
Assume a person of 30 yrs age is thinking of investing Rs 50000 (under extra tax exemption limit). He falls under 30% tax bracket. He has 30 years time frame and two choices to make
1. Go with NPS
2. Pay tax and invest the after-tax amount in something similar
Let us assume the long term investment return over 30 years is 12% p.a.
Option 1:
50000 * (1.12 ^ 30) = around Rs 15 Lakh
40% withdrawal is tax free = Rs 6 Lakh
20% withdrawal is taxed @ 30% = Rs 2.1 Lakh (after tax)
40% withdrawal is utilized in purchasing annuity.
A quick look at http://www.sbilife.co.in/sbilife/images/contentimages/AnnuityPlus_bi.htm shows that for a pension plan with refund of capital, the annual return works out to be 6.43% (after adjusting for service tax while purchasing annuity) pre-income-tax and 4.5% post income-tax at 30% Rs 6 Lakh would give a monthly taxable pension of Rs 3218 and an effective post-tax pension of Rs 2252
Assume the person is living till 75 years of age and his hurdle rate is 10%. i.e he can borrow funds at 10%.
With the post tax cash flows from annuity and his hurdle rate, this works out to be Rs 3.5 Lakh
With 70 years life expectancy - this number will work out to be around Rs 4 Lakh.
With 85 years life expectancy - this number will work out to be around Rs 3 Lakh
@12% hurdle rate:
70 years: 3.46 Lakh
75 years: 2.94 Lakh
85 years: 2.47 Lakh
So, the total cash proceeds @ age 60 can vary from 6 + 2.1 + 2.47 = Rs 10.57 Lakh to 6 + 2.1 + 4 = Rs 12.1 Lakh depending on life expectancy and hurdle rate.
Option 2:
35000 * (1.12 ^ 30) = around Rs 10.486 Lakh (Assume 50% equity and 50% is is Corp / Gov bonds)
50% Equity LTCG is tax free.
50% C / G LTCH is taxable in indexed fashion. So, 5.243 lakh - 17500 = Rs 5.068 Lakh is LTCG, which is Rs 88250 adjusted for indexation.
Tax payable @ 30% on Rs 88250 Lakh = Rs 26475
Net Cashflow at age 60 = Rs 10.486 - Rs 0.26475 lakh = 10.221 lakh
There are some questions to be addressed.
1. What happens on the death of NPS investor before 60 years of age? Will nominee have to pay tax - to what extent?
2. When NPS is deferred for 10 years till age 70 and contributions are made, what happens in the event of death.
40% is taken tax-free. 20% is taxed (Less 6%), 40% is taken as annuity which one never sees it again, except in the form of monthly pension - which is constant all through his life expectancy. No way to increase or decrease pension.
Even, with current tax benefit, the positive side is around Rs 0.35 Lakh to Rs 1.88 lakh which in current terms with the same long term return (12%) assumed is around Rs 1170 to 6275
All this, assuming the current 30% tax benefit. And after accounting for the 2016 change in tax treatment (that 40% of NPS corpus at age 60 is not taxable). Otherwise, NPS makes no sense at all.
Still, one loses the independence by locking in the money for long term and locking in by purchasing the annuity for even longer term (possibly)
Take away:
1. Do not purchase beyond 40% of corpus in annuity.
2. While choosing annuity option, go for annuity with corpus refund - otherwise it is too risky if the investor dies very soon after purchasing annuity.
3. Defer it by 10 years, then defer annuity by 3 years
NPS - New Pension System (also referred as National Pension System) is a contribution based retirement system promoted by PFRDA (Pension Funds Regulatory and Development Authority)
Tax Treatment:
Similar to PF, there can be contribution by employee and employer
Max contribution: 10% of (Basic + DA)
Employee Contribution: Falls under the limit of Rs 1.5 Lakh per annum - section 80 CCD (1), with other 80C schemes. (similar to how employee contribution of EPF is treated)
Employer contribution: 10% of (Basic + DA) is exempted under Section 80CCD (2) - this is beyond Rs 1.5 Lakh limit (similar to how employer contribution of EPF is treated) - i.e, not treated as income at all.
Additional Rs 50000 per annum (beyond Rs 1.5 Lakh limit) can be availed under Section 80 CCD (1b)
NPS has 7 fund managers to choose from - HDFC Pension Fund, ICICI Prudential Pension Fund, Kotak Pension Fund, LIC Pension Fund, Reliance Capital Pension Fund, SBI Pension Fund, UTI Retirement Solutions.
There are two accounts with NPS - Tier1 and Tier2. Only Tier1 is eligible for tax benefits for investments. Tier2 is more like an add-on for investor convenience. Amount can be moved from Tier2 to Tier1 and not vice versa.
Amount contributed towards NPS gets invested in 3 different schemes - equity, corporate bonds and government securities. Investor can choose to invest in Auto mode or Active mode. Maximum possible contribution in equity scheme under both modes for any age is 50%. Investor can choose to split the investments in Active mode, whereas in Auto mode the investment contributions get split as per investor age. Rebalancing according to the target split happens yearly once on the date of birth of the investor.
The scheme details under each of equity, corporate bonds / govt. securties (E C G respectively) of Tier 1 and Tier 2 are available in the individual pension fund site
http://www.reliancepensionfund.com/navs/portfoliodetails.aspx?shortname=portfoliodetails
http://www.sbipensionfunds.com/portfolio-detail-system.html
http://www.hdfcpension.com/about-hdfc-pmc/investment-portfolio-details/
Minimum contribution
Tier1:
Minimum Number of times in a year: Once
Minimum Amount Contributed in a year: Rs 6000
Tier 2:
Once per year, Minimum Rs 250 (subject to a minimum funds available in Tier 2 of Rs 2000)
Fees
Minimum of 0.25% or Rs 20 per contribution (taken at the time of contribution)
0.0275% of funds under management for asset management, custodian and NPS Trust (adjusted in NAV)
Rs 190 per year for account maintenance taken by cancelling units in each of C, E, G
Withdrawal from NPS:
Possible only after age of 60
A minimum of 40% to be utilized in purchasing annuity
Maximum 60% can be taken as lump-sum
Premature exit
Minimum 80% to be utilized in purchasing annuity
Taxation
40% of withdrawal not taxable (only the available 20% lump-sum in case of premature exit)
60% taxable - irrespective of lump-sum or annuity. Lumpsum taxable at marginal tax rate as per investor income slab for the year.
Annuity purchase is not taxable, whereas the monthly payments from the annuity is taxable at appropriate slab.
Deferment of Withdrawal
Defer annuity for 3 years
Defer lumpsum withdrawal for 10 years
Take lumpsum in a staggered manner in 10 installments.
The entire withdrawal process can be deferred for another 10 years, during which contributions have to be made.
As of now, the following are the annuity providers from whom the annuity can be purchased.
HDFC Standard Life Insurance Company Limited
ICICI Prudential Life Insurance Company Limited
Bajaj Allianz Life Insurance Company Limited
Reliance Life Insurance Company Limited
Star Union Dai-ichi Life Insurance Company Limited
Life Insurance Corporation of India
More Info:
https://www.npscra.nsdl.co.in/all-citizens-faq.php
http://www.hdfcpension.com/national-pension-scheme/nps-account/)
Now, analysis:
Assume a person of 30 yrs age is thinking of investing Rs 50000 (under extra tax exemption limit). He falls under 30% tax bracket. He has 30 years time frame and two choices to make
1. Go with NPS
2. Pay tax and invest the after-tax amount in something similar
Let us assume the long term investment return over 30 years is 12% p.a.
Option 1:
50000 * (1.12 ^ 30) = around Rs 15 Lakh
40% withdrawal is tax free = Rs 6 Lakh
20% withdrawal is taxed @ 30% = Rs 2.1 Lakh (after tax)
40% withdrawal is utilized in purchasing annuity.
A quick look at http://www.sbilife.co.in/sbilife/images/contentimages/AnnuityPlus_bi.htm shows that for a pension plan with refund of capital, the annual return works out to be 6.43% (after adjusting for service tax while purchasing annuity) pre-income-tax and 4.5% post income-tax at 30% Rs 6 Lakh would give a monthly taxable pension of Rs 3218 and an effective post-tax pension of Rs 2252
Assume the person is living till 75 years of age and his hurdle rate is 10%. i.e he can borrow funds at 10%.
With the post tax cash flows from annuity and his hurdle rate, this works out to be Rs 3.5 Lakh
With 70 years life expectancy - this number will work out to be around Rs 4 Lakh.
With 85 years life expectancy - this number will work out to be around Rs 3 Lakh
@12% hurdle rate:
70 years: 3.46 Lakh
75 years: 2.94 Lakh
85 years: 2.47 Lakh
So, the total cash proceeds @ age 60 can vary from 6 + 2.1 + 2.47 = Rs 10.57 Lakh to 6 + 2.1 + 4 = Rs 12.1 Lakh depending on life expectancy and hurdle rate.
Option 2:
35000 * (1.12 ^ 30) = around Rs 10.486 Lakh (Assume 50% equity and 50% is is Corp / Gov bonds)
50% Equity LTCG is tax free.
50% C / G LTCH is taxable in indexed fashion. So, 5.243 lakh - 17500 = Rs 5.068 Lakh is LTCG, which is Rs 88250 adjusted for indexation.
Tax payable @ 30% on Rs 88250 Lakh = Rs 26475
Net Cashflow at age 60 = Rs 10.486 - Rs 0.26475 lakh = 10.221 lakh
There are some questions to be addressed.
1. What happens on the death of NPS investor before 60 years of age? Will nominee have to pay tax - to what extent?
2. When NPS is deferred for 10 years till age 70 and contributions are made, what happens in the event of death.
40% is taken tax-free. 20% is taxed (Less 6%), 40% is taken as annuity which one never sees it again, except in the form of monthly pension - which is constant all through his life expectancy. No way to increase or decrease pension.
Even, with current tax benefit, the positive side is around Rs 0.35 Lakh to Rs 1.88 lakh which in current terms with the same long term return (12%) assumed is around Rs 1170 to 6275
All this, assuming the current 30% tax benefit. And after accounting for the 2016 change in tax treatment (that 40% of NPS corpus at age 60 is not taxable). Otherwise, NPS makes no sense at all.
Still, one loses the independence by locking in the money for long term and locking in by purchasing the annuity for even longer term (possibly)
Take away:
1. Do not purchase beyond 40% of corpus in annuity.
2. While choosing annuity option, go for annuity with corpus refund - otherwise it is too risky if the investor dies very soon after purchasing annuity.
3. Defer it by 10 years, then defer annuity by 3 years
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