Retirement income is a crucial subject. With our work lives becoming shorter but life expectancy rising, the risk of outliving your wealth is very real today. Traditionally, non-government individuals have sought shelter in the evergreen investment scheme known as the Public Provident Fund (PPF). Giving 12% return at one time, the return on PPF today is market-linked and gives only 8%. On the other hand, over the last few years, a considerable amount of attention has been given to the National Pension System (NPS), a defined contribution retirement savings scheme whose returns are also market-linked.
Recently the Indian government, in a bid to make NPS more friendly, gave complete tax exemption to 60% of the corpus that investor can withdraw on maturity. A little while ago, NPS partial withdrawal norms and investment allocation rules were also made friendlier. So, is NPS a better product than PPF now? The answer depends on how you as an investor define ‘better’.
As you may be aware, the maturity amount of PPF that you get is 100% tax-free. This is a big draw for investors looking for tax-free income. The entire money at your hands after maturity is tax-free. There is no compulsion on what you should do with the maturity amount, i.e. you can invest it in stocks, debt, bank deposits or keep it as cash.
In the case of NPS, the government has approved a proposal to make NPS fully tax-free on withdrawal. This means NPS subscribers will get full tax exemption on the 60% of the corpus that an investor is allowed to withdraw on maturity. The rest 40% (which is also tax-exempt), like previously, has to be invested in annuity plans for getting regular pension payouts. Do remember the balance 40% amount has to be mandatorily used for purchasing an annuity.
Equity investment freedom
The returns of PPF are market-linked. However, this does not mean a subscriber has full say in where the funds would be invested. PPF subscribers are allowed to have up to 15% of equity exposure and PPF remains a fixed-income oriented investment avenue. There has been talk of how the equity market cap is likely to be removed soon. If we consider inflation at 5%, PPF is giving just 3% inflation adjusted return per year.
In case of NPS, subscribers enjoy a lot more freedom. Since August 31, 2018, private sector NPS subscribers have been able to opt for a maximum equity exposure of 75% under the active choice option (where the subscriber actively decides where his contribution is to be invested). The earlier cap was 50%. With 75% window, equities can form a larger play for NPS subscribers and this can enhance returns in a big way. If we assume inflation as 5% (just like above), NPS returns, though not fixed, will look much better. For example, the last 5 year returns of NPS equity funds are between 11% and 14%. This means inflation adjusted returns are 6% to 9% — twice/thrice of the same PPF return.
Partial withdrawal facility
In case of PPF, the account can be closed prematurely before 15 years but only under specific conditions. A PPF subscriber can prematurely close the scheme after completing 5 years for specific reasons such as higher education or expenditure towards medical treatment. Do remember, there is a penalty for premature closure of the account i.e. a subscriber will get 1% less interest. Starting from the 7th year, a PPF account holder can make one partial withdrawal per year. The withdrawal is limited to 50% of the total balance at the end of the 4th year immediately preceding the year of withdrawal, or the year immediately preceding the year of withdrawal (whichever is lower).
The government has allowed premature withdrawal from NPS. Subscriber should be in NPS at least for 3 years. The withdrawal amount will not exceed 25% of the contributions made by the subscriber. Withdrawal can happen a maximum of three times during the entire tenure of subscription. Withdrawal is allowed only against the specified reasons like higher education of children, the marriage of children, for the purchase/construction of the residential house (in specified conditions) and for treatment of critical illnesses.
Summary: The compulsory annuity purchase requirement in case of NPS maturity is still a disadvantage for those subscribers who want full and unconditional access to tax-free proceeds. In that perspective, PPF is a better avenue. However, the equity investment exposure freedom (up to 75%) and shorter lock-in related to partial withdrawal do give NPS the edge over PPF. Smart investors should use a combination of NPS, PPF and mutual fund products to build a better-diversified retirement corpus over the long run.
(By Anil Rego, CEO, Right Horizons)