Why NPS should be part of your retirement portfolio

Should it be mutual funds or the national pension scheme (NPS)? Most investors, particularly salaried individuals, are divided on their opinions. But, financial planners recommend the pension scheme because of the sheer tax advantage it enjoys over mutual funds. Now, with the flexibility to opt for periodic withdrawal of a lump sum at retirement, it bolsters their case even more.

- Sashind Ningthoukhongjam, Neil Borate

For starters, NPS was introduced by the government in 2004 to overhaul its pension plan by transitioning from a defined benefit plan to a defined contribution plan. In the former, the government distributed a certain amount periodically after retirement. Post the transition, there is a fixed contribution amount and the amount to be disbursed depends on the size of the corpus that has accumulated at the time of retirement.

Contribution to NPS enjoys superior tax treatment compared to mutual funds on two fronts. Firstly, tax deductions of up to ₹50,000 can be claimed per year, over and above the ceiling of ₹1.5 lakh that an individual is eligible for under section 80C of the income tax Act.

To illustrate its benefit, let us assume that a person in the 30% income tax bracket wants to invest ₹50,000 in an NPS account. The individual can claim tax deductions for contribution towards NPS at the end of the financial year while filing returns and can so save ₹15,000, a sum which would otherwise be deducted from salary as tax

This is not the case with mutual funds, unless they are equity linked savings schemes (ELSS) that one can claim as deduction under section 80C. There are no deductions for investments in other types of mutual funds. Thus, investing in NPS gives a 15% head start over that in mutual funds (non-ELSS).

Besides the ₹50,000 per year, about 10% of a corporate employee’s basic salary and dearness allowance up to ₹7.5 lakh can be claimed as deductions if it is registered as an employer’s contribution.

Subscribers to NPS also get another benefit. There is no tax at the time of withdrawing the corpus (although NPS annuity is taxed). However, capital gains on equity mutual funds are taxed at 10% at the time of redemption and that for debt mutual funds at the slab rate.