NPS offers investors a low-cost option to save for retirement
National Pension Scheme (NPS) offers investors a low-cost option to save for retirement and Save tax too.
Does retirement planning mean simply putting surplus funds into a well-guarded piggy bank and never looking at it till one reaches the age of 60? How should an investor plan his/her retirement through regular investments or via cautious savings?
And the bigger question: why should I sacrifice today to safeguard tomorrow? These are never-ending questions, with no definite answers. The key point to understand is that practical investors can make careful investment decisions throughout their life span to create a savings pool, which comes handy post retirement.
Irrespective of the lifestyle, work profile or financial commitments, it is very important that an investor has a strong corpus to finance his/her post-retirement needs. Building such a corpus calls for careful planning on the part of investors, that, too, across their lifespan.
The National Pension Scheme (NPS) provides investors across age groups (18-55) a low cost avenue to do financial planning. Under NPS, an investor can start with an amount of Rs 6,000 annually and at the same time take exposure to multiple asset classes. The scheme would invest via professional fund managers and also provide tax benefits.
The Pension Fund Regulatory and Development Authority (PFRDA) opened this scheme for the general public in 2009. Having been in existence for over two years, the performance so far reflects that NPS has delivered returns higher than traditional saving instruments like corporate bond funds and government securities funds.
If this performance continues over longer time frames, then it can help generate sizeable corpus for retirement savings. Such performance clearly indicates the usefulness of the scheme to generate higher inflation-adjusted returns for a safe and secure retired life.
NPS is a savings-cum-investment alternative, which gives investors the best of both worlds. While it offers investors flexibility in terms of the amount they wish to invest, it also gives them an opportunity to diversify investments into different streams. Investors, based on their risk-bearing capacity, have the discretion to allocate funds towards any of three asset classes, E (equity), C (corporate bond fund) and G (government securities fund).
The risk-return is as follows: E - high risk and high returns; C - medium risk, moderate returns; G - low risk, low returns Investors can seek a choice of six fund managers to make their investments as well as switch across fund managers.
This ensures an element of competition between fund managers and helps the scheme generate market-linked returns. Investors can either choose the asset class/classes they want to invest in the desired proportion or choose the auto choice or lifecycle fund scheme by default.
Annuities provide retirees cash flow at regular intervals. There are several forms of annuity, most of which work on the same principle. The individual typically purchases an annuity for life from an insurance company by paying a lump sum. In return, the insurance company regularly pays an assured sum to the individual till she dies. In a joint annuity contract, the insurance company will pay annuity till either the husband or the wife lives.
More about National Pension Scheme (NPS) -A excellent tool to save tax
As you are aware, there are two types of National Pension System (NPS) accounts - Tier I & II.Tier I account is mandatory, whereas Tier II account is optional. Thus, only Tier I account is eligible for tax benefits and is, in the true sense, the core of NPS.
However, normal tax provisions of taxation of profits on sale of investments are applicable when you redeem the units credited in your Tier II account. But all deposits and withdrawals to and from the Tier II account are tax neutral. There are no limits as to number and amount of withdrawals from Tier II account.
In case you are self-employed, the restriction up to which you can claim tax benefit under Section 80CCD is capped at 10% of your gross total income. Gross total income includes sum of all your incomes computed as per provisions of the income tax laws, before any deduction is allowed to you in respect of various items broadly covered under Section 80C, 80CCC and 80D etc.
Here, at the lowest entry age (18 years), the asset allocation would be 50% in E, 30% in C and 20% in G till the investor turns 35. The ratio of investment in E and C will then decrease annually, while the proportion of G will rise. At 55 years, G will account for 80% of the corpus, while the share of E and C will fall to 10% each.
This option enables subscribers to invest in equity at an early age and can help in wealth creation over a longer horizon. Interestingly, the trade-off between risks and returns is not the only reason for investors to look at NPS. According to the Union Budget for 2011-12, investments in NPS up to 10% of an individual's salary are eligible for income-tax deductions over and above the Rs 1.2 lakh allowed under Section 80C.
However, withdrawal of any amount from NPS is taxable as per the income tax slabs. Indian markets, both on the equity and debt front, have witnessed significant volatility over the past one year. This is well-reflected in the performance of leading indicators such as the S&P CNX Nifty, which saw considerable erosion.
The S&P CNX Nifty dropped drastically from 6135.85 levels in October 2010 to the current levels of 5118.25 (as of October 17) a fall of over 16%. The debt market too is reeling under the impact of rising interest rates, with the benchmark yield on the 10-year government bond rising to a three-year high of 8.80%, the highest since August 2008.
During turbulent phases, it is important that investors have a well-diversified portfolio, which has the resilience to absorb shocks and the ability to deliver higher returns. Under such circumstances, schemes like NPS give investors the opportunity to have the cake and eat it too.
Tax treatment for contribution made by your employer:
As explained in one of my earlier articles, the contributions made by your employer towards your NPS account qualifies for deduction under Section 80CCD (2) without attracting the limit of Rs 1 lakh laid down in Section 80 CCE from the current financial year.
However, there is only one restriction that only up to 10% of your salary only qualifies for deduction without any monetary limit. It works wonders for those in the highest tax bracket, as there is no absolute limit up to which your employer can contribute towards your NPS account for claiming the deduction as long as this is within the limit of 10% of your salary.
Thus, I would advise them to get their salary restructured so as to include 10% component of your salary as contribution to NPS. This will provide a separate window for tax saving and investment.
The point to note here is that the amount of 10% contributed by your employer will be treated as salary under Section 17 and will form part of Form No 16 issued to you. However, the employer will grant you deduction for his contribution under Section 80CCD (2) before deducting any income tax from your salary.
So for all practical purposes employer’s contribution to your NPS account up to 10% of your salary becomes tax free in your hand and gets invested in NPS. Even the provisions under proposed DTC are on the similar lines with regard to tax treatment of employer’s contribution.
Tax treatment when you reach the retirement age:
The contributions made by you and your employer get accumulated in your Tier I account and the value of such corpus depends on factors like quantum of money deposited, the asset classes opted by you for investment and the returns generated by your pension fund manager.
Once you complete 60 years of age, you have to compulsorily purchase an annuity for an amount equal to minimum of 40% of the accumulated balance in your NPS account. The annuity needs to be bought from a life insurance company, which is registered with Insurance Regulation and Development Authority (Irda).
If you wish to withdraw the money before you complete 60 years of age, you can do so, but in that case you will have to purchase an annuity utilising minimum of 80% of the accumulated corpus at the time of withdrawal.
The money that is left after purchase of mandatory annuity, up to the extent of 40% of the accumulated wealth, is exempt from tax and you are free to use it the way you want. Please note that it is not mandatory for you to withdraw the whole corpus left after purchase of mandatory annuity.
You can opt to withdraw the balance amount in a phased manner. However, you need to withdraw a minimum of 10% of your accumulated corpus every year. This account has to be closed once you reach the age of 70 years. This money received by you, either lump sum or in a phased manner, is fully exempt as per the provisions proposed in DTC.
However, deductions in respect of interest paid for your housing loan is deducted before arriving at the figure of gross total income for calculating the limit of 10%.
It is important to note that there is an absolute limit of Rs 1 lakh upto which you can claim the deduction under Section 80CCD (1) (for your own contribution towards NPS account).
This limit of Rs 1 lakh covers not only your contribution to NPS, but also coversitems eligible for deduction under Section 80C, like life insurance premium, EPF, PPF, NSC, school fee, investments in equity linked saving schemes, repayment of housing loan etc.
Even payments made by you to life insurance companies for purchase of pension U/S 80 CCC are also covered within the limit of Rs 1 lakh. However, going forward with only contribution to EPF, PPF and NPS qualifying for deduction of Rs 1 lakh under proposed Direct Taxes Code (DTC), NPS will acquire more importance and prominence once the DTC comes into effect.
In case of the untimely death of a NPS account holder before completion of 60 years of age, the nominee can withdraw the corpus accumulated at the time of death of the account holder. The money received by the nominee or legal heirs is fully exempt.
The annuity which you receive is taxable on yearly basis.
From the above discussion you will realise that NPS offers you an excellent tool to save your tax and plan for your future as well. It is very tax efficient because you get the tax benefits for the whole amount of your contribution and need to use only 40% of the accumulated wealth for purchase of annuity.
It is pertinent to note that though the annuity is taxable in your hand at the time or receipt, the applicable rate of tax would in all probability be very low as compared to the rate of tax which you are paying now.
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