Retirement planning isn’t on the top of our agenda when we start working. After all, we are young and can take on the world, right? But fact is, one should start planning for her/his retirement at the early stage of one’s career for the simple reason that accumulating wealth in the twilight years of one’s career will prove to be a tough ask, taking into consideration inflation.
Shivani, aged 30, plans to retire at 60 and currently has a monthly expenditure of Rs 50,000. Assuming 5 per cent inflation every year until her retirement at the age of 60, Shivani will need Rs 2,16,000 per month to maintain her current lifestyle. Hence, the earlier you start planning for your retirement, the better it is. One instrument that can be used for retirement planning is the National Pension Scheme (NPS).
As the name suggests, it is a pension scheme launched by the government way back in 2004 for government employees. The scheme was later extended to every citizen in 2009, but it gained prominence only in 2015 when Finance Minister Arun Jaitley allowed tax deduction up to Rs 50,000 under Section 80CCD (1B), which is over and above the Rs 1.5 lakh limit given under Section 80C. Any person residing in India aged 18-60 years is eligible to invest in NPS.
NPS is a capital-protection scheme with no guaranteed fixed returns. This means, if Shivani invests Rs 15,00,000 in 30 years, she will get her invested money back, post retirement; however, the returns on invested amount are not fixed. The scheme invests money in equities (Asset class E); corporate debt; fixed instruments (Asset class C); and government securities (Asset class G). All these instruments are market-linked and hence, the returns are not guaranteed or fixed.
It’s important that we consider the several charges levied during account opening. Around Rs 450 fixed cost is charged while opening an account and there are seven other charges that are levied in the investment tenure. These charges can be viewed on the official website of NPS. The initial contribution at the time of subscription is Rs 500 and the minimum investment, to be deposited annually, is Rs 6000.
The scheme has two Tier accounts: Tier I and Tier II.
In Tier 1 account, Shivani cannot withdraw her investment before her retirement. Furthermore, she can claim tax exemption, up to Rs 50,000 every year, for investment made in Tier 1.
In Tier 2 account, Shivani can withdraw her investment before retirement, but only for exceptional reasons. However, she will not get any tax exemption, and she will have to mandatorily open a Tier 1 account if she wants to invest in a Tier 2 account.
Shivani also has the option of selecting funds of her choice, based on her risk appetite:
Option 1 Aggressive: This fund will invest aggressively in equities up to 50 per cent of the fund corpus. It is primarily invested in index funds. It is best suited for a high-risk investor.
Option 2 Moderate: Funds are primarily allocated in corporate debt securities with partial exposure in equities and government securities.
Option 3 Safe: Fund allocation is primarily done in government securities which are safe bets. A small portion of the fund is invested in equities.
Option 4 Default: If Shivani does not select any of the above options, then by default the allocation is done in all three asset classes depending on her age. A young person like Shivani will see higher allocation in equities. As her age progresses towards retirement, the scheme will automatically reduce exposure from equities to low-risk government securities.
Investments made at the time of investing and during the investment tenure will be exempt from tax, but during maturity, the withdrawal amount will be taxed. This makes the scheme less attractive vis-à-vis a PPF and/or ELSS which enjoy tax exemption even at maturity. Let us understand the taxation part in NPS at maturity with an example.
Shivani is set to get a corpus of Rs 1 crore at the time of her retirement. However, she will only be able to withdraw 60 per cent (Rs 60 lakh) of her corpus, and of the rest 40 per cent (Rs 40 lakh), she’ll have to purchase annuity cover from LIC. Half of the 60 per cent withdrawn amount will be tax free, and Shivani will have to pay tax on the remaining half according to her income tax slab. It must be noted that the payment received from annuity, too, is taxable.
Overall, NPS is a capital-protection scheme with no guaranteed fixed returns. It allows tax exemption at investment but maturity proceeds are taxable. Individuals in higher tax bracket can look at NPS to save tax and build corpus for retirement.
(Riken Mehta is an independent financial consultant with over 10 years of experience in the finance industry)