Over the years of my professional life in the private organisations in India, I have come across multiple financial instruments for retirement planning. Most popular among those are Employee Provident Fund (EPF), Public Provident Fund (PPF) and National Pension System (NPS). If used wisely, these instruments bring significant tax benefits and create huge retirement corpus over the years.
While most people are generally aware of the process and benefits of the EPF and PPF, I have found NPS as the most under-rated one and least known among the three. Thus, I will focus on how to effectively use the latter in this article.
NPS gets covered under Section 80CCD which itself is a part of the Section 80C of the Income Tax Act 1961. Section 80CCD has three sub-sections:
Section 80CCD(1):
The maximum limit is capped at INR 1.5 lakhs per annum. I personally do not find this section much useful as this limit is clubbed with EPF (employee contribution) & PPF investments where most individuals at mid-career stage consistently are able to exhaust their annual limit comfortably. This would have been important if someone is not getting either EPF from the company or is not investing into PPF or neither of them So, no additional benefit here - unless you are not happy with 7-8% fixed return and want likely higher but riskier returns through NPS. NPS corpus is invested into equity markets and govt. bonds; thus, have higher risks associated with them as compared to the fixed but lower returns that come from investments into EPF & PPF schemes. Recently, it seems EPFO has also started investing 5% corpus investment into the markets which may further increase in the future.
This tax benefit exist under the old tax regime.
Section 80CCD(1B):The maximum investment limit under this section is capped at INR 50,000 per annum (a). This limit is over and above the INR 1.5 lakhs limit and any investment is absolutely tax free. For someone who falls under the highest income tax bracket (30% tax + 4% cess@30% = 31.2%), it is equivalent to saving of INR 15,600 per annum (b) in outgoing tax. If you have noticed, this effectively means that if the individual had not made this investment, they would have got only INR 34,400 per annum (c) in hand after tax deduction. So, just by investing this INR 50000 per annum (a) in NPS (Tier 1) through 80CCD(1B), they are getting 45.35% (d) return on day 0 itself.
To give you an idea on the returns, let say an individual starts investing at the age of 30 years and their taxable income already falls in the top bracket of 30% (+ 4% cess@30%).
As NPS corpus is invested into equity markets & govt. bonds, further returns are linked to that. On an average, the annualised returns revolve around 10% (see details) which is additional income on the top of initial tax benefits.
Average annualized return across PFMs (using std. weightage of schemes):
The compounding takes over from there onwards which means one would make a huge money corpus by the time they get to withdraw it at their retirement age of 60 years (one can withdraw partial amounts before that too or can defer the withdrawals up to the age of 75 years but those are special scenarios).
Now if someone invests INR 4,167 monthly or INR 50,000 per annum (a) - effectively INR 2,867 monthly or INR 34,400 per annum (c) after tax benefits) for 30 years (up to 60 years of age), they will accumulate INR 95 lakhs (g) by then assuming continuing 10% annual returns. Please note that they have overall invested INR 15 lakh (e) (effectively INR 10 lakh after tax benefits (f)) in these 30 years.
The NPS corpus growth can be tracked over the years as:
At the age of 60 years, there are 2 scenarios.
Scenario 1:
They can withdraw maximum 60% of the corpus (i.e. INR 57 lakhs) (h) free of tax and they will have to mandatorily invest remaining 40% (i.e. INR 38 lakhs) (i) in an annuity. Assuming 6% (j) returns on the annuity, they shall get INR 19,000 (k) monthly pension for the rest of their life.
Scenario 2:
If they choose to take annuity for the entire corpus of 1 crore and assuming 6% annualized returns, they shall get INR 47,500 (k) monthly pension for the rest of their life.
You can play around with these numbers here.
Please note that upon the death of the investor, the entire base annuity amount shall get paid to their nominee.
This tax benefit exist under the old tax regime.
Section 80CCD(2):This section is mostly unheard of by individuals and is meant for salaried class only. It falls under the ambit of employer contribution (though it still be part of your CTC) wherein an individual can opt for a maximum of 10% of their basic salary to be transferred to their NPS account by the employer. This portion is also completely tax free and is over & above the tax benefits buckets that are covered in the two sub-sections above. Moreover, the companies can also claim this amount under their business expenses and hence, can save a portion of their corporate taxes too. However, there aren't many companies that have introduced this benefit, probably because:
- individuals are either unaware of this section & associated benefits or
- they do not have the capacity or the desire to invest more money into retirement planning as it reduces their take-home salary.
If someone has the appetite, however, they can reap a lot of benefits using this instrument too.
To give an idea, let's say someone has a basic salary of INR 5 lakh per annum (typically 50% of total fixed salary). Under this section, the individual can allow the employer to deduct maximum 10% (i.e. INR 50,000 per annum) of their salary and get that transferred to their NPS account. Doing this, they will gain returns similar to the calculations done in Section 80CCD(1B) example above.
One additional advantage with this section is that their basic salary shall increase every year and hence, one can invest exceedingly more than INR 50,000 year over year creating even bigger corpus for their retirement years.
This tax benefit exists under the new tax regime as well.
Hopefully it is apparent now why these schemes are great financial investment tools to save taxes on hard earned money and effectively plan better retirement goals. If there are any suggestions or questions, use the comments section for discussion.
Disclaimer: I am not a professional financial expert / adviser. I wrote this article from my personal experiences while investing in these schemes over the years. Please use your own discretion while taking any action on your retirement planning.
Very informative article Nitin. Presented very crisply with detailed examples.
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