Previously, we discussed what the National Pension System (NPS) is. How it invests your funds and helps you build a retirement corpus in this post.
We covered all most everything about NPS. But one thing remained unclear. Should you invest in NPS or not? Does investing in NPS build a better retirement corpus for you or not?
Let’s do some math and find it out.
Estimated read time: 3 minutes and 19 seconds
Buckle up, here we go!
To freshen up things, NPS is a voluntary defined contribution pension system in India. The scheme is open to all Indian citizens between the ages of 18 and 60. It is intended to provide individuals with a retirement savings option.
Under the NPS, you can make regular contributions to your pension account. Your investment is invested in various assets, such as government bonds, corporate bonds, alternative investments, and equities.
As each asset class has distinct risks and returns. Under NPS, you can select between two investment strategies – Active Choice and Auto Choice. Through these options, you can decide how much of your investment should be invested in equity, debt and others.
Read more about these options here.
The returns on these investments will be used to provide pension income to you after retirement.
Now, let’s get to the point and start crunching numbers.
Does NPS help in building a better retirement corpus than index funds?
Let’s say you start investing ₹50k every year in NPS at the age of 30. You decide to invest the maximum amount allowed in equity (75%) and the rest in debt (25%).
For this calculation, let’s keep the long-term equity returns at 12% and debt returns at 7%.
With the split of 75:25 between equity and debt, you will receive an average return of 10.75%. You will be investing ₹4,166 every month for the next 30 years till the age of 60.
So, at the age of 60, you will be able to build a corpus of ₹1.12 crores (rounded off). And as per NPS rules, you have to invest a minimum of 40% of the corpus in annuity plans. These annuity plans will offer you monthly or yearly payout as a pension until death.
Therefore, you can withdraw a lump sum amount of ₹67 lakhs from the corpus and invest the rest in annuity plans.
But what if you invested the ₹50k in an index fund instead of NPS?
First, if you are in the 30% tax bracket, you pay taxes, so after deducting the tax, you will be investing ₹2,916 every month till the age of 60 (instead of ₹4,166 you invested in NPS).
With an average return of 12%, at the age of 60, you will be able to build a corpus of ₹1.03 crores. This is ₹9 lakhs lesser than the NPS corpus of ₹1.12 crores.
But you have no restriction on the withdrawal. You don’t have to invest in annuity plans. You have complete control over the corpus.
I know that you will have to pay a 10% long-term capital gains tax on your equity corpus, but I am assuming that you will be using tax harvesting over the 30 years to reduce some tax.
Also, we simplified the NPS calculation too much. According to NPS rules, after the age of 50, your max contribution towards equity reduces every year until it reaches 50% at the age of 60. You can check this out here.
So, in the last 10 years, from 50 to 60, your returns will be lower because your equity exposure reduces.
Even when you increase your investment amount from ₹50k to ₹1 lakh or more, things look the same.
This leads us to think there is not much of a difference when it comes to building a corpus. Even after saving tax with NPS, you build a corpus similar to equity (index fund).
But when you look at things beyond the corpus numbers, things get very subjective.
Like NPS has liquidity issues. You can’t withdraw your money anytime you want. You also have to invest in an annuity plan at maturity. I can see this issue as a positive for people who don’t have much knowledge about investments and don’t have control over themselves.
If you are someone who doesn’t have much knowledge about investments. You think you will spend your money quickly without any restrictions. Then NPS can help you build a good retirement corpus.
If you are someone who wants to plan their finances themselves and have some control over them. You can invest in equity and bonds directly too. Recent changes in the new tax regime make this decision easier.
To keep your investments simple, invest in plain old index funds.
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