In the previous episode of Question of Money, we talked about why your salary is being docked towards Employees’ Provident Fund (EPF) contributions. If you don’t like this, we don’t blame you, because who likes compulsory savings forced on you by the government? If you need to save for retirement but don’t like to commit yourself to the compulsory EPF deductions, you can make the National Pension System or NPS your main retirement vehicle. You can just contribute the minimum requirement of Rs 1500 per month to EPF. There are 6 aspects on which NPS scores over EPF.
Not employer dependent
Heard of cases where start-ups didn’t deposit their employees’ EPF contributions with the EPFO? Or friends struggling to get their EPF account closed or transferred? There are no such problems with NPS because you can open the account electronically as an individual, without the involvement of any employer or intermediary. NPS is not just open to salaried employees but also to gig workers, free lancers and self-employed people who don’t have access to EPF.
The EPF requires you to commit to contribute a fixed proportion of your salary every month. But you can open an NPS account with just Rs 500. Thereafter, to keep your account active, you need to invest only Rs 1000 per year. Unlike the EPF, the NPS lets you vary your contributions from month to month or even skip them. This helps people with lumpy or erratic income. If you need the discipline, NPS allows you to register for Systematic Investment Plans (SIPs) like mutual funds.
Added tax breaks
NPS contributions of upto Rs 1.5 lakh a year are not added to your income for calculating income tax, and get tax exemptions under section 80C. This is the same as for the EPF. But NPS can fetch you an extra tax break too. An investment of upto Rs 50,000 a year in the NPS Tier 1 account, is eligible for tax breaks under section 80CCD (1B). This goes beyond your Rs 1.5 lakh limit under section 80C. So, NPS can help you save tax, when you already have a number of 80C investments that have exhausted the Rs 1.5 lakh limit. This is applicable only to the Tier 1 NPS account and not Tier 2.
In the EPF, you returns depend on the interest that the scheme and the government choose to ‘declare’ on the fund every year. So you don’t know if the 8% plus EPF return in recent years will sustain, if interest rates in India decline in future. But NPS works like a mutual fund. Its fund managers disclose NAV on a daily basis and its portfolio on a monthly basis. So, you get to know exactly where the money you contributed is being invested and also where your returns stand on any given day.
Choice of asset and manager
With EPF you cannot dictate where your money will be invested. Over 85% of it goes into debt instruments. But NPS allows you to decide on your allocation between equities, government bonds and corporate bonds. This allows you to earn higher returns through a higher equity allocation. If you are risk-averse, you can choose not to allocate any of your NPS money to equities and stick only to bonds. If you have a high risk appetite you can allocate upto 75% of your contribution to equities and put the rest in bonds. Young people in their 20s or 30s can afford to max out their equity allocation in the NPS. Those closer to retirement may choose a higher bond allocation. The good thing is you can change your asset mix at any time based on your life situation or risk appetite.
Apart from deciding on your mix of stocks, corporate and government bonds, you also get to decide who will manage your money under NPS. NPS has seven empanelled fund managers and you can choose any of the seven to manage your money, after looking at their track record of delivering returns under the NPS.
Many folks prefer the EPF for its high guaranteed returns and avoid NPS because its returns are not fixed, but market-linked. Its true that NPS returns can move up and down based on how stock and bond market perform in any given year. But NPS’ long holding period tends to smooth out these bumps and deliver good results in the long run. The equity schemes of the 7 NPS Tier 1 managers have delivered returns of 12.5-13.7% per annum in the last ten years. The corporate bond options have delivered returns of 7.8-9.1% pa. The government bond schemes have managed 8.2-9.2%. NPS debt options have in fact fared better than mutual funds because NPS charges lower fees. Apart from flat fees for account opening and maintenance, NPS charges an annual management fee capped at 0.09% of NAV.
While all this is good, NPS has some minuses too.
Your NPS investments are locked in until your turn 60. You can withdraw only 25% of your contributions early. Whereas, EPF allows early withdrawal by way of advance or if you are unemployed for 2 months. The EPF simply pays you a maturity amount and you can decide what to do with it. In NPS, 60% of the final maturity amount can be withdrawn, tax-free, but 40% is compulsorily converted into a pension payment for the rest of your life. This pension will be taxable at your slab rate. NPS offers a Tier 2 account (which can be opened only after Tier 1) which allows anytime entry or withdrawal, and does not have rules regarding pension. But Tier 2 does not earn you any tax breaks.