We spoke a lot about how to plan for long term, how to invest for long term, how to save some cost when investing, etc. Also we discussed on how to diversify your portfolio as you age in our previous posts. Today, we are going to see what is NPS in short since there are lot of articles which explains what NPS is. If you want to read in depth, you can refer to this article. To sum up,

1. We should create a NPS account.
2. Select tier 1 (lock in and tax benefits) for our investments.
3. Select the fund manager.
4. Select the investment split(Debt and Equity) or choose auto.
5. Invest monthly.
6. End of 60th year, get 60% of the final amount with no tax.
7. Invest the 40% of the final amount in schemes that gives monthly returns(pension).

The amount that you are investing is locked in until you are 60. There are some rules to withdraw partially but our focus is to keep the amount for our retirement.

NPS Benefits

1. Lock In – I see people start their SIPs in mutual funds and invest for their retirement which is very good. Things will go smooth for few years. Suddenly there will be some war, some disease spreads, some economy drawdown, then we think our self as so smart and try to time market. We may think market is going to crash so let me withdraw my funds and have cash. We will think, we will invest when the market bounces. I have been a victim of this too. Sometime we come out at right time, but we may not enter again thinking it will drop even more, or it has moved a bit so lets wait for some correction. While doing all these speculations, we end up using that cash for our consumptions. We will see a new Car, or the sudden plan to visit a foreign country, people will say buy this that, etc. Anything could come to our dirty mind and spoil our retirement plan. As we have learned from many experts, the key to achieve a good returns is only by staying invested as long as we can. This is one reason why assets like Real estate are more talked about as wealth creation since liquidity is not that easy and we end up locked in for many many years. So to enforce the disciple of staying invested, NPS wins when compared to all other retirement plans.
2. Diversification – We discussed how to move our funds from Equity to Debt as we are nearing our retirement. To do so, we have to withdraw some percentage of equity corpus and invest in debt every few years. Any transaction that result in moving the amount to your bank is risky since we end up doing what we discussed in the above section. NPS helps us to do this without any amount coming to us. They give two options. Active – We can decide how much should we allocate between Equity and Debt. Auto – NPS will decide your allocation based on your age and risk profile. We can only set a max of 75% allocation to Equity.
3. Cost savings – NPS comes under EEE model. When you invest – Tax exemption on section 80C. When it grows, the interest are exempted from tax and added to corpus. When it matures at the age of 60, the returns are exempted from tax. There are only handful of instruments where we get this benefit and this is the only instrument with Equity. Also the expense ratio of the fund managers are very less compared to the Mutual fund schemes.

I don’t see any red flags so far here. The only restriction here is 75% allocation to equity. I don’t see this as a big issue since this will protect our capital in down times. Along with PF, if one choose to save for retirement, NPS is the best option. Lets do some math on NPS vs Mutual funds.

Tax benefits

Lets consider a person with 20% tax slab starts a NPS account at the age of 30 and invests 20,000 monthly to NPS. He can save tax in 80C and additional 50k in additional contribution. Assuming he is saving 1lakh with the help of NPS in 80C then he can claim tax exception of 1.5 lakh yearly. This is 30K per year. Assuming the tax slab(80C) increases 30% every 10 year( last time from 1 lakh, it increased to 1.5 lakh 9 years back), let see how much we can save in tax while investing considering we are utilizing 80C.

This comes to a total of 89.5 lakh tax saving

Let see how much can we save compared to traditional mutual fund while maturing.

NPS is clearly the winner here with lot of benefits. We could save around 1.38 Cr at the end of 30 years. This is the best instrument for retirement planning. Few may argue that we should control our money and not get into lock in, etc. Not everyone will be able to control emotions during market falls, some might hear about some new fancy investments and wanted to move to that. So they tend to withdraw the mutual funds for retirement and invest there and move around most of the times. This is best for people

1. Who don’t have any time or knowledge to make more than 10.5% returns per year. If you know a sound proof strategy to make more than 10% returns every year, then you may not need NPS.
2. If you want to be so aggressive and invest more than 75% to equity, then NPS is not for you.

I hope this post will be helpful for your retirement planning. Please subscribe and share it to your friends and family if you find it useful.