NPS - Do not send your money to life imprisonment

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Despite the tax advantage, investing in the NPS is akin to putting your money behind bars for life.

If the headline sounds like clickbait, let me tell you how the National Pension Scheme (NPS) can trap your hard earned money. I see a lot of investors across age groups and income levels falling for the tax saving bait of the NPS. The tax savings offered by the scheme seem so attractive that these individuals are willing to ignore all other aspects of the scheme.

Many investors have been drawn to the NPS by the additional `50,000 deduction offered under Section 80CCD(1b). What they don't realize is that once they invest, the money cannot be withdrawn before the age of 60 (there is a provision for emergency withdrawals but only for special circumstances). This may be fine for government employees and those who want to continue working till the age of 60. Whereas, the entire EPF amount can be withdrawn if you are unemployed for more than two months.

Besides, the very long lock-in, there is also a compulsory contribution clause. Once you open an NPS account, you have to contribute a minimum amount every year. While investors may feel happy that they are putting away something for retirement and saving 20-30% tax on that amount, keep in mind that NPS only defers the tax. You have to pay the tax later, at the time of withdrawal.

In fact, taxation is a key negative of the NPS. At the time of withdrawal, only 40% of the NPS corpus can be withdrawn tax free.Another 20% of the corpus, when withdrawn, will be taxable at the marginal tax rate applicable to the investor. The remaining 40% has to compulsorily be invested in an annuity to earn a monthly pension. The most insidious part of this is that this annuity is fully taxable and does not get any benefit of indexation or long-term capital gains.

This is like 60% of your money getting bail while 40% stays behind bars. Imagine a person being freed from prison after 20-25 years, but 40% of his body remains imprisoned. Grotesque as it might sound, the body is gradually released with every passing annuity payment.

There are other reasons too why annuities do not inspire confidence among the investing community. A buyer signs up for a product with a constant rate of interest, irrespective of what the inflation rate will be. He also has no control over the investment portfolio. NPS forces the individual to pour at least 40% of his corpus into the annuity blackhole. Further, he has to opt for an annuity only with one of its enrolled service providers.

Readers will note that NPS returns are not assured but market linked. If you have to pay tax and still carry the risk of marketlinked returns, why not do it at your own convenience, with more flexibility and choice?

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