When his company introduced the NPS benefit in 2015, Anil Jajoo grabbed the tax advantage with both hands. Under Section 80CCD(2), up to 10% of the basic salary of an employee put in the NPS is tax free. “It was a terrific opportunity to stash away tax free money,” says Jajoo. NPS helps one save tax in three different ways. First, NPS investments are eligible for deduction under Section 80C. If one has already exhausted the Rs 1.5 lakh ceiling under Section 80C, one can claim an additional deduction of up to Rs 50,000 under Section 80CCD (1b). Lastly, up to 10% of the basic salary put in the NPS on behalf of an employee can be claimed as deduction under Section 80CCD(2).
Anil Jajoo, 52 years, Ghaziabad
Started investing in NPS about seven years ago when he was employed, to claim tax deductions. Now puts only Rs 50,000 under Sec 80CCD(1b). A 50% allocation to equities has given good returns, so he plans to shift his superannuation fund from previous employer to the NPS.
Jajoo not only put the maximum 10% of his basic salary in NPS but also used the additional Rs 50,000 deduction under Section 80CCD(1b) to cut his tax. He has poured roughly Rs 14 lakh into the NPS since 2015 and saved almost Rs 4.36 lakh in tax.
How much can NPS give you
The additional tax deduction under Sec 80CCD(1b) can push up the overall returns significantly. Kolkata-based finance professional Gopal Kumar Gupta used to invest Rs 1-1.5 lakh in the PPF. But this year he plans to reduce this and direct Rs 50,000 into the NPS. “Contribution to the PPF does not give me a tax deduction because I have already exhausted my Section 80C limit with life insurance policies and ELSS funds. Also, the small savings rates have been declining, so I need to invest elsewhere,” he says.
Gopal Kumar Gupta, 36 years, Kolkata
His life insurance policies and ELSS funds take care of the tax saving limit under Sec 80C. With small savings rates on the decline, he plans to reduce his contribution to PPF and invest in NPS to cut tax.
The Rs 50,000 he invests in NPS will cut Gupta’s tax by Rs 15,600, so his effective outgo will be only Rs 34,400. Assuming he continues to invest Rs 50,000 in NPS every year and earns a conservative 7% annualised return, he would accumulate roughly Rs 34 lakh over the next 25 years. Of this, he would get Rs 20.4 lakh as tax-free lump sum and a pension of Rs 8,094 per month for life.
Is annuity a good option?
Not everybody is convinced that the NPS is a great investment choice. Though his company offers him the NPS benefit, Gurugram-based management consultant Sahil Garg has not opted for it. Garg plans to invest only Rs 50,000 in NPS this year because he feels the NPS requirement to compulsorily invest 40% of the maturity corpus in an annuity is restrictive and would yield suboptimal returns.
Sahil Garg, 27 years, Gurgaon
His company offers the NPS benefit, but he has not opted for it. He is wary of the rule that requires 40% to be compulsorily put in an annuity and plans to restrict his investment to Rs 50,000 for the tax deduction under Sec 80CCD(1b). This is true. The returns from the annuities are as low as 5.8% if you opt for return of principal after death. The option that doesn’t return the principal offers a much higher rate of 7.4%. Since annuity income is fully taxable, the post-tax returns are even lower for investors in the 20-30% tax brackets. It is, therefore, not surprising that investors like Garg find the compulsory annuity clause quite restrictive. At the same time, the annuity should not be a deal breaker. The NPS has seen several changes in rules since it was opened to the public 12 years ago. Annuity rules could also become more investor friendly in future. In fact, the Pension Fund Regulatory and Development Authority (PFRDA) is considering a proposal to allow subscribers to park the 40% meant for annuity with a pension fund manager to get better benefits. Speaking at a recent conference, PFRDA Chairman Supratim Bandyopadhyay said, “A lot of people were complaining about (low annuity rates), so we thought why not give them the choice to retain that 40% with the pension fund manager.” The PFRDA is in talks with pension fund managers and the government on this.
The best NPS funds
Till a few years ago, there was not much difference in the returns of the seven pension fund managers of NPS. But the gap has gradually widened, making the choices quite obvious for new investors. The returns of individual schemes do not reflect the actual returns for the investor because the portfolio is usually a mix of 2-3 different classes of funds. ET Wealth studied the blended returns of four different combinations of the equity, corporate debt and gilt funds.
Ultra-safe investors are assumed to have put 60% in gilt funds, 40% in corporate bond funds and nothing in equity funds. A conservative investor would put 20% in stocks, 30% in corporate bonds and 50% in gilts. A balanced allocation would put 33.3% in each of the three classes of funds while an aggressive investor would invest the maximum 50% in the equity fund, 30% in corporate bonds and 20% in gilts. Aggressive investors can now put up to 75%in equity but this allocation does not have a very long track record. We have also not considered the 5% allowed to be put in alternative investments.
Stock market rebound boosted returns of equity funds
SIP investors were the biggest gainers as stock markets crashed in early 2020 only to bounce back and hit new highs.
Aggressive investors with 50% in equities have made good gains. But don’t look at the past 6-12 months alone. The long-term returns are a better indicator of what investors earned.
Aggressive investors, who put the maximum 50% in equity funds, have earned the highest returns. The past one-year returns are misleading, so look at their long-term performance. HDFC Pension Fund is the best performer for this allocation. SIP investors have earned even better returns than those who invested lump sum. A balanced approach has yielded handsome rewards for investors. Note that SIP returns in past 3-5 years were higher than what lumpsum investments earned.
Balanced investors who divided the corpus equally across all three fund classes have also earned high returns. Here again, the short-term performance is skewed by the rebound in equity funds. These funds gained from the rise in gilt and bond funds as well as the surge in equities. HDFC Pension Fund is the best performing pension fund manager.
Bond funds slipped in recent months, dragging returns
But in the medium and long term, risk-averse investors have earned reasonably high returns.
Investors with a thin exposure to equity funds did much better, due to the resurgence in stock markets. These investors have earned double-digit returns in the past 3-5 years.
Conservative investors, who put a sliver of their corpus in equity funds, have not done badly either. The bond rally gave good returns while the equity rebound boosted them further. While LIC Pension Fund is the best performing fund in the short term, HDFC Pension Fund stays ahead in the longer term and in the SIP mode.
The past six months have been bad for investors in gilt and corporate bond funds. But in the past 3-5 years, they have earned more than what small savings scheme offer. Ultra-safe investors who stayed away from equities have earned the lowest returns. The past six months have been particularly bad. Even so, their long-term returns are higher than what small savings schemes offer. The LIC Pension Fund is the best performing pension fund for the ultra-safe allocation. Analysts believe the rate cycle has turned and returns of gilt and bond funds will be muted in the coming years.