It’s tax saving season, so it’s apt to ask: Should you buy into the New Pension Scheme (NPS) for which the government has given you a phenomenal extra tax benefit of Rs. 50,000 next year?

The answer is complicated, so let’s go through the motions. Your choices are:

a) Invest the Rs. 50,000 into an NPS scheme, every year, for the next 20 years.

b) Pay taxes on the Rs. 50,000 (say at 30%) and invest the remaining Rs. 35,000 in a mutual fund instead.

**Your Goal**: To maximize what you earn out after taxes when you retire.

### The NPS

So you put in Rs. 50,000 a year into the NPS for 20 years. Since 2009, the average return in the NPS schemes has been between 10% and 12% annualized, even including equity. Let’s take 11% as the growth number going forward.

You will end up with Rs. 32.10 lakh.

According to NPS rules you can “commute” 60% of that – meaning, take that much out as a lump sum. Currently about 50% of the 60% is not taxed, you have to pay tax on the remaining 10%. (See this tax department document that gives details) If you receive gratuity, the tax is even higher.

Let’s just take 10% as taxed – on reaching 60, 10% of Rs. 32.1 lakh will be considered, of which only 16.05 lakh commuted is tax free. You commute 60%, which is Rs. 19.2 lakh. Assume tax at 30% on the rest and you pay Rs. 96,000 in taxes, leaving you with Rs. 18.30 lakh.

So:

- You can take out Rs. 19.26 lakh (60%), pay tax and be left with Rs. 18.3 lakh.
- You buy an annuity with the remaining 12.84 lakh. At current LIC annuity rates, you’ll make 7.5% a year (your principal goes to your next of kin when you die). This translates to Rs. 8020 per month.
- This pension payment is taxable, so assume a lower 20% slab you’ll get Rs. 6420 per month net of taxes. (Effectively, 6% post tax)

What of the amount of money you’ve taken out? The 19.26 lakh? Let’s say you just put it into an avenue that gives you a post-tax return of 8%.

That gives you a **monthly income of Rs. 12,198. **

Add it to the annuity, **post tax monthly income is Rs. 18,618.**

**Negatives**:

- No flexibility till the age of 60. Cannot retire early, as premature withdrawals are added to income and taxed.
- The need to buy an annuity reduces returns substantially, taking the net return to just 7%.

### The Equity Strategy

Let’s say you buy the Nifty or a large and mid cap diversified mutual fund. These funds have, in the same time frame as the NPS, returned between around 14% annualized. Check this Value Research comparison, where out of 56 funds, even the median – 28th fund ranked by 5 year returns – has returned 14% in the 5 year term. Even five year returns of hybrid balanced funds are 13%+. Let’s still take just 13%.

We are investing Rs. 35,000 per year (since we decide to pay tax on the Rs. 50,000 and invest here).

We will end up with a corpus of Rs. 28.33 lakh. Since this is our own investment, there is no need to buy an annuity. Long term investments in equity are not taxed, currently. So we get all of the money, tax free.

Let’s say we take it all and put it again at 8% return post tax.

That yields us an income of **Rs. 18,888 post tax**.

**Negatives:**

- There is higher risk of course. You never know that when you retire there may be this worldwide depression.

Note: If you see something wrong in the calculations, please let us know.

### Wow: NPS is Not Good Enough!

**All this drama of saving some extra tax with the NPS gives you no real advantage, it turns out**. You get 18,888 per month if you buy the longer-term equity fund, versus Rs. 18,618 per month with the NPS. This is due to the convoluted taxable nature of the returns of the NPS.

We assumed 11% return for NPS and 13% for long term equity investment. If long term equity returns are 2% greater than the NPS, it is simply better to invest with long term equity mutual funds and pay the tax to the government instead. The return is substantially lowered because of tax implications at this point.

The do-it-yourself approach gives you additional flexibility of adding more money when you like, and taking out money early if you want an earlier retirement, with almost zero tax implications. And then, if you have a medical emergency at the age of 59 and need money desperately, you can’t touch your NPS money without “explaining” to the government why you need it early, and even then you have to pay tax on it. With your own money in equity, you don’t get no questions, and you don’t get no tax either. The additional tax-work of NP

Tax policies may change. Annuities may increase. But as it stands today, it’s just plain better to put your money into long term equity investments. Mutual funds are one thing, long term direct equity investments might be just as good, if you can spend some time understanding markets. I have personally seen instances of 40X returns over 18 years and that is 23% annualized, greater than anything else available since. Today, market’s are at a high, but it doesn’t mean markets stay that way – the simplest way to invest is to just keep investing over a long period of time, and take out money only when you need it.

The complications of an NPS and the tax-mess that they involve, plus the resulting lack of access to your own money is a huge bummer. It might also not even be as lucrative as an equivalent long term investment in equity funds, as we have seen above.

Beautiful article. You saved a full evening’s time of mine by a] explaining the NPS noodle [2] doing the math.

Thanks, you made my day!

Excellent article.. For now, I will wait and watch when it comes to NPS.. I guess if Govt makes it exempt on tax at withdrawal, the balance will tilt in favour of NPS

What about the money you save in taxes each year by going by the NPS route? Shouldn’t you factor that in as well? By this I mean the slighter lesser amount you will pay the taxman on account of the 50k tax break.Also given the higher risk profile of equity does the extra Rs. 200 per month really vindicate equity over NPS? 200 inr ain’t worth much today so one wonders what it might be worth 30 years from now and if its really worth taking the additional risk for that small an additional return ….

That’s why I compard investing 50K in NPS, with investing 35K in equity. The difference is the 15K you pay in taxes.

Remember that this is 200 rupees more if you invest 30% lesser in equity. IN a par scenario, NPS would fare worse…

Excellent point Deepak !!! I missed that. I guess the only thing is whether INR 200 per month is good enough additional return for additional risk of equity. But yes, from a tax perspective, NPS is screwed !!!

Dear sir,

The taxation of NPS should be calculated after indexation benefit.

NPS has no indexation benefit AFAIK. Return from NPS is not considered investment return…

We should also see the risk part…..NPS does not invest 100% in equity…..its blend of equity, G-sec and corporate bonds….so if at 59/60 year age there is drastic stock market crash……then mutual fund corpus will get wiped out more than NPS (due to fixed income blend in it)……

Deepak,

1. What we get after tax ( in 30% bracket ) is not 35000 but 34550 due to cess ( which is 3 % of income tax i.e 450 INR ). This will alter the final figure and might even have a result in favor of NPS due to compounding

2. On the other hand, for people in lower tax brackets, it is almost a no brainer to pay the tax and invest in Equity MFs

Nice analysis!!

Sir

Nice article.

One thing what is the NPS return together if we invest tax saved of 15k in a LONG TERM EQITY MUTUAL FUND

By your chart Rs15000 tax saved can earn pension of 8094.85 This will add to NPS return.

No no it includes the 15,000. See we invested Rs. 50K in NPS versus just Rs. 35K in the ELSS…

Makes sense but in most companies, there is an arrangement for NPS contributions to be deducted automatically. I know SIPs are easier but such is the level of financial ignorance that many will still prefer it.

Another case, my wife’s company (won’t name it for obvious reasons). They match NPS contributions up to a certain amount. This is EXTRA money that they wouldn’t get unless they opt for NPS. Who wants to walk away from free money?

Agree completely – free money is way better than tax benefits 🙂

Thanks for these inputs.

It will be interesting to know how these calculations pan out if you take an equity return exactly as reflected each year for the past 20 years…data that we already know.. Rather than assuming something for the future..If we invest the same amounts every year since 1995 & assuming the current tax treatments & slabs…what wd the amounts become today in both the streams. ( Assuming a 80:20 treatment ratio of equity: debt for the first 5 years…and equity in the ratio going down to 60:40 by the 20 th year in a 1/yr decline ie after 1st year we keep it as 59:21, after 2nd year as 58:22…and so on…which is allowed in the NPS scheme)

Dear Deepak,

We can invest 15000 saved in tax in equity and make extra returns. Shouldn’t we consider this as additional income in favor of NPS in our comparison ?

Sir the calculation says 50K in NPS versus 35K in equity, so in reality the tax saved is already invested. It has been considered…

Most people are saying 15k can be invested too. If you are investing 50k in NPS, it is growing as you described. But why can’t I invest the saved 15k in equity. That’s like 65k total investment at cost of 50k? If I declare 50k for NPS, my annual salary increases by 15k.

That’s double. I consider 50K in NPS versus 35K in equity. In your example you would consider 65K in NPS case versus 50K in equity. The difference will be the same (or bigger, since percentages on larger amounts are larger)

Excellent article Deepak. Clear and uncluttered approach as ever.

While the arguments in favour of MFs are pretty obvious, it may still be a good option to invest partly in NPS on case one already has significant exposure in mutual funds. Also movement of NPS to EEE category may materialize over a period of time and should increase returns from NPS.

Good article but one error.

The graph mentions annuity amount as 19 lakhs. It should be 12 lakhs.

Deepak, couple of questions –

Why my annuity return is as low as 7.5%? Do I have to buy annuity only from LIC or you have chosen LIC as it has the best return? Do I have a choice to select annuity provider? I don’t understand why the return on annuity corpus is so low!!! Even if the entire annuity corpus is invested in Gov securities, how can the return be lower than 8.5% ? If you use 8.5%, you will receive ~9095 instead of 8020. That’s change the decision making.

Can I choose anyone of the annuity provider mentioned in NSDL website? https://npscra.nsdl.co.in/annuity-service-providers.php

Wow !!! when I was searching for a reason of low return on annuity, I got this – https://www.capitalmind.in/2010/01/low-annuity-returns-in-india/

Surprisingly, I couldn’t find any source to compare the return of those annuity providers mentioned on NSDL website. Anyone to help?

Moreover, annualized return on equity of 13%? I will say PLEASE. It’s no longer 1995 (20 yrs back) when base was low and that’s how we have got such phenomenal returns in equity market. Imagine the scenario of a Japanese market!!!! But it’s entirely my opinion and I don’t expect anyone else to support my view.

Sadly LIC was the best of the lot! Here’s teh returns of the rest, I just rechecked:

Bajaj 6714

ICICI 6351

HDFC 6683.5

Reliance 5611

Star Union 7304

SBI 6875

(per lakh, for a 60 year old)

This sucks, I know.

Deepak, Thanks for your reply.

I don’t know how you calculated the numbers but I researched only of Bajaj-Allianz and HDFC-Life and I have got the following numbers from their website –

NPA Provider Bajaj Allianz HDFC Life(1) HDFC Life (2)

Purchase Amount 1,926,000 1,926,000 1,926,000

Yearly Return 146,390 132,274 132,647

Half Yearly Return 71,731 64,318 64,500

Quarterly Return 35,134 31,580 31,669

Monthly Return 11,565 10,251 10,280

Monthly PostTax (20%) 9,252 8,201 8,224

Yearly-Monthly Implied Interest Rate 4.90% 5.23% 5.23%

Scheme Name

Bajaj Allianz ANNUITY GUARANTEED & ROC-DEATH

HDFC Life(1) Lifetime Annuity- ROPP on CI

HDFC Life (2) Lifetime Annuity

Things are bit complex as there are so many options. But for apple-to-apple comparison I have chosen the products which return back the capital on death or detection of critical illness which is HDFC Life (1). This shows NPS has edge over equity-MFs, especially for Bajaj-Allianz. What am I missing?

Moreover in next 20 years, things are going to evolve. LIC or anyone can’t have so much margin on NPS schemes.

Arghya,

APologies. There is a typo in the image. The image should say 12.84 lakh annuity, 19.26 lakh commute. So if you use the figures at 12.84 lakh you will find it even lower…