Planning For Retirement? Why You Should Consider NPS

Retirement is also known as the second innings. It is that stage of life where you do not earn, or do not have a regular job, but still require an income to lead a good life. Retirement planning has become more important now because we are seeing increased life expectancies which means that people are living longer and hence need to plan for a bigger retirement corpus.

While investing through mutual funds have their advantage, the (national pension system) NPS also scores when it comes to a few distinct advantages it provides. We take a look.

"There is an endless debate between NPS and mutual funds, however both have their own advantages and disadvantages," says Vivek Banka, Co-Founder, Goalteller, a financial planning firm.

Managing asset allocation: The importance of asset allocation when planning your investments cannot be overstated. When investing in your retirement corpus through mutual funds, you need to plan your asset allocation. NPS, as a retirement product, helps you do that within NPS itself.

"Under NPS, there are four asset classes: Equity (E), Corporate Debt (C), Government Bonds (G), and Alternative Investment Funds (A). Anyone looking to invest first needs to select a pension fund manager (PFM) and then choose between two options: Active Choice or Auto Choice," says Shashank Pal, Chief Business Officer, PL Wealth Management.

Active Choice: Individual Funds

In this investment option, the subscriber selects the PFM, asset classes, and percentage allocation for each scheme managed by the PFM. Subscribers can allocate as follows:

o    Up to 50 years of age, the maximum permitted equity investment is 75 per cent of the total asset allocation.
o    From 51 years and above, the maximum permitted equity investment will taper off as defined by the government, which can be checked on the NSDL website.
o    The percentage allocation for alternative investment funds cannot exceed 5 per cent.
o    The total allocation across E, C, G, and A asset classes must equal 100 per cent.

Auto Choice: Lifecycle Fund

"NPS offers an easy option for subscribers who may not have the required knowledge to manage their NPS investments. In this option, investments are made in a life-cycle fund where the proportion of funds invested across the three asset classes is determined by a predefined portfolio that changes with the subscriber's age," says Pal.

For subscribers who want to automatically reduce their exposure to riskier investments as they get older, Auto Choice is the best option. As age increases, the individual's exposure to Equity and Corporate Debt tends to decrease. "Depending on the subscriber's risk appetite, there are three different options available within 'Auto Choice' - Aggressive, Moderate, and Conservative," he adds.

Aggressive Life Cycle Fund: This lifecycle fund caps equity investment at 75 per cent of the total assets. The exposure to equity starts at 75 per cent until 35 years of age and gradually reduces as the subscriber ages.

Moderate Life Cycle Fund: This lifecycle fund caps equity investment at 50 per cent of the total assets. The exposure to equity starts at 50 per cent until 35 years of age and gradually reduces as the subscriber ages.

Conservative Life Cycle Fund: This lifecycle fund caps equity investment at 25 per cent of the total assets. The exposure to equity starts at 25 per cent until 35 years of age and gradually reduces as the subscriber ages.

The Tax Advantage

NPS also has an advantage when it comes to taxes.

On Investment: You can claim a tax deduction of up to 10 per cent of your salary (basic + dearness allowance) under Section 80CCD(1) of the Income Tax Act. This deduction is subject to an overall ceiling of Rs 1.5 lakh.

In addition to the above, you can claim a tax deduction of up to Rs 50,000 on your voluntary contributions to your Tier I NPS account under Section 80CCD(1B). This deduction is available over and above the Rs 1.5 lakh limit under Section 80CCE.

On Maturity: Further, in NPS, upon maturity, a maximum of 60 per cent can be withdrawn, with up to 40 per cent being tax-free. The remaining minimum of 40 per cent must be used to compulsorily purchase an annuity.

Says Banka, "Unlike mutual funds, if we wish to reduce or increase equity, it leads to a capital gains tax incidence, in NPS this has no tax repercussion especially at the time of the switch and the tax impact would only be at the age of 60 at maturity. Though for long term investors it would be wise to let equities keep growing, some individuals might prefer a more balanced approach which can help them reduce equities in case of a market euphoria and vice versa," says Banka.

However, one needs to note that even though there is a tax incidence, mutual funds have an advantage here. "In mutual funds, these conditions do not exist; there are only short-term capital gains and long-term capital gains, taxed at 15 per cent and 10 per cent respectively. Withdrawing a fixed amount at regular intervals through a systematic withdrawal plan can be very tax-efficient for mutual fund investors," says Pal.

Take An Informed Decision
Assessing liquidity needs to meet goals other than retirement goals should be an important consideration before going ahead with NPS," says Abhishek Kumar, founder and chief investment advisor at SahajMoney, a financial planning firm.

Also, Kumar says that while NPS is a low cost way for building a retirement corpus compared to MF it currently comes with its own set of challenges. "Unlike mutual funds where one can redeem units based on liquidity needs, partial withdrawal from NPS before retirement has limitations attached to it.

Consider NPS for retirement if you value tax benefits and a hands-off approach to investing. It offers pre-set asset allocation and tax deductions on contributions. However, unlike mutual funds, accessing your money before retirement is limited. Weigh your liquidity needs carefully before making a decision.