All the commercials about various financial products are aired/printed with a disclaimer that asks investors to carefully read all the offer documents before putting their money in it. There are specific reasons for this disclaimer. One of the financial products that individuals readily put their money into without giving second thoughts is the NPS or National Pension System. This scheme offers very attractive tax saving options, and hence investors chose to ignore all other shortcomings.
National Pension System has a long lock-in period
NPS offers an extra INR 50,000 deduction under Section 80 CCD (1b), drawing in many investors. However, most people are not aware of the fact that once the money is put into NPS, it cannot be withdrawn before the investor turns 60 years of age. Such a long lock-in period may work for government employees and/or those willing to work until 60. NPS does have a clause for emergency withdrawals, but it can be availed only under unique situations.
NPS has a clause for mandatory contribution
All investors in NPS have to make a compulsory deposit of a minimum sum every year. This is a really good way to save, and NPS also offers 20 to 30 percent tax savings on such saved amounts. It may, however, be noted that the product only defers the amount that will be taxed. Investors will need to pay tax later when it is time for you to withdraw the corpus.
The huge negative of taxation
When the lock-in period is over, and you wish to withdraw the money, only 40 percent of the NPS corpus money can be tax-free. The investor must pay a marginal tax rate when withdrawing another 20 percent of the total corpus. The rest of the 40 percent has to be mandatory put into an annuity to get a pension every month. This annuity is also fully open to taxation. Also, investors do not get any benefit from long-term capital gains or indexation.
Compulsory Investment in Annuity Plan after Maturity
Investors in NPS are forced to contribute a minimum of 40 percent of the total corpus into an annuity plan of an Insurance company at the time of maturity. Additionally, investors must select an annuity from only any service providers enrolled with NPS. The annuity plans are not transparent and not the best investment. They are also fully taxable.
Final Verdict – Don’t invest in National Pension System.
Pros of the National Pension System
- Low Cost
- Tax deferment
Cons of the National Pension System
- Poor Liquidity
- Long Time Horizon
- Inefficient Taxation
- Forced Purchase of Annuity
- Full Equity Exposure is not allowed