The Employee Provident Fund (EPF) and the National Pension System (NPS) are both retirement-oriented investments with tax- saving benefits. Let’s take a closer look at how these schemes work and how they benefit the investor.
EPF, allowing for certain terms and conditions, expects the eligible employees to make a monthly contribution to the scheme and the employer to match it. On retirement, the employee gets a lump sum amount, comprising of both the total principal and the accrued interest. The contributions made by the employee are tax deductible under Section 80C of the Income Tax Act, and the interest earned on the fund is fully exempt from tax as well.
NPS is a government initiative to extend pension benefits to all Indian citizens. It is mandatory for Central-government employees and the employees of some state governments to invest in the NPS. It’s a product where one can regularly contribute to a pension account during the course of one’s working life. Once retired, the investor can withdraw a portion of the corpus as a lump sum and can buy an annuity with the remainder, to ensure a steady income during retirement. The NPS is effectively tax-free.
The EPF offers insurance and pension benefits to the subscriber. In the hour of need, such as medical emergencies, financial crunch or any unexpected expenses, premature withdrawal of the EPF is permitted. The withdrawals at maturity or after 5 years are entirely exempt from tax. The EPF is mainly a debt-oriented product and currently earns an interest rate of 8.65% p.a. With easy online access, the investor can view the account balance using the EPF number.
NPS gives the option to an investor to diversify the portfolio between Equity, Government Securities and Fixed Income instruments. An investor can invest up to 75% in equity funds. Equity investments are a great advantage that the NPS offer. While equity investments can be volatile, over the long horizons of a typical NPS investment, they are likely to generate much higher returns than fixed income securities (Like PPF/EPF).
There are two types of NPS accounts:
# Tier I: Pension Account with Tax Benefits
The tax deduction on investments under this scheme is up to Rs 1.5 lakh (under Section 80CCD) and Rs 50,000 (under Section 80CCD (1B)) can be availed for self-contribution in a single financial year.
It is proposed that from the FY2019-2020 onwards, at the time of retirement, 60% of the value can be withdrawn without any tax implication and the remaining 40% is mandatorily converted to an annuity. The annuity corpus, although locked, is tax-free. The income received from the annuity, however, is taxable as regular income.
# Tier II: A Savings Account with no Tax Benefits
From FY 2019-20, it is proposed that Tier II accounts will enjoy tax benefits up to Rs 1.5 lakh, under Section 80C, but with a lock-in period of 3 years, like an Equity Linked Saving Scheme (ELSS) Fund.
Like all investment decisions, this too should be made depending upon the investors’ financial goals, risk, and time horizon. The NPS is suitable for conservative investors, who are working to build their retirement corpus at a minimum risk level. If you have the luxury of time and aren’t entirely risk averse, you may consider investing in ELSS mutual funds to save tax. Investors who have a larger risk appetite might be better off investing in ELSS for tax benefits and build their retirement corpus with a mix of open-ended equity and debt mutual funds.
Investors would save the same tax in both options, but the ELSS and NPS combination has the potential to earn higher returns and therefore build more wealth in the long run.
Evaluate your options with a financial advisor and make the choice that fits your life goals.
(By Amar Pandit, CFA, and Founder, Happyness Factory)