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Advantages and Disadvantages of NPS

9 Mins 02 Dec 2021 0 COMMENT

Introduction:

The National Pension Scheme is a government-backed voluntary contribution scheme designed to help you save for retirement. The NPS is a safe and secure savings tool managed by fund managers regulated by the Pension Fund Regulatory and Development Authority (PFRDA). The invested money offers market-linked returns until maturity. Post maturity, a minimum of 40% of the total contribution is used to buy an annuity, while the remaining 60% is given to you in a lump sum payment.

As with any other financial tool, there can be an advantage and disadvantage of NPS too. Let's view what these are:

Advantage of NPS

  • The flexibility of choice: NPS offers two options – the auto choice and the active choice. Under the auto choice option, the fund manager manages your investments and invests in a combination of equity, corporate bonds, government securities, and alternative investment funds, as per their understanding and assessment. That is ideal if you have little knowledge of asset allocation and want a professional to manage your investments. However, if you prefer managing the asset allocation yourself, you can select the active choice. Under this, you can invest up to 75% in equities up to the age of 50 years, 5% in alternative investment funds, and the remaining in corporate bonds and government securities.
  • Partial withdrawals: A primary advantage of NPS is that it lets you use a portion of your funds and cater to emergencies or any other cash requirement. You can withdraw 25% of your contributions under the Tier I scheme after a minimum of 10 years. However, you can make only three such withdrawals, and there should be a gap of at least five years between two withdrawals.
  • Tax benefits: NPS offers tax benefits under various sections of the Income Tax Act, 1961. You can claim a tax deduction of up to Rs. 1.5 lakh under Section 80CCD-1. Additionally, you can also claim a deduction of 10% of the employer's basic salary invested in NPS. Lastly, there is an exemption of Rs. 50,000 for voluntary contributions in NPS.
  • Significant diversification: NPS offers a considerable level of diversification by investing in a combination of equity and debt. The scheme provides favourable market-linked returns and helps you safeguard your older years.
  • Flexible contributions: There is no limit on the number of contributions you can make in a year. Moreover, there are also no upper or lower limits for contributing to the scheme. You can invest as much or as little into your account, and the contributions can be made yearly, half-yearly, quarterly, or monthly.
  • Option to change the fund manager: If you are not satisfied with the performance of your current fund manager, you can switch to a new one anytime you want.
  • Enhanced convenience: Opening and managing the NPS account is simple. You can manage your contributions online using your Permanent Retirement Account Number (PRAN).
  • Tax liability: Despite the tax exemptions, NPS ends up attracting a lot of tax upon maturity. 60% of the corpus is added to your taxable income. That increases your tax output in retirement.
  • Limited withdrawals: Since the NPS is a pension scheme, only a limited amount and number of withdrawals are allowed before maturity. This may pose a problem if you find yourself in a financial emergency and need urgent lump sum funds.
  • Limited exposure to equity: After the age of 50, NPS reduces the percentage of equityexposure by 2.5% every year. The equity exposure is reduced to 50% by the age of 60. This may be unfavourable for some.

Disadvantages of NPS

  • Tax liability: Despite the tax exemptions, NPS ends up attracting a lot of tax upon maturity. 60% of the corpus is added to your taxable income. That increases your tax output in retirement.
  • Limited withdrawals: Since the NPS is a pension scheme, only a limited amount and number of withdrawals are allowed before maturity. This may pose a problem if you find yourself in a financial emergency and need urgent lump sum funds.
  • Limited exposure to equity: After the age of 50, NPS reduces the percentage of equityexposure by 2.5% every year. The equity exposure is reduced to 50% by the age of 60. This may be unfavourable for some.

To sum it up

Despite a few cons, NPS still remains one of the most popular pension plans in the country, and the advantage of NPS is hard to ignore. The decision to invest in it is ultimately your own, but adding NPS to your list of investments can offer you security and financial protection in retirement. Moreover, since this is a government backed scheme, you have little to worry about.  

Disclaimer: ICICI Securities Ltd. ( I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. PFRDA registration numbers:  POP no -05092018. We are distributors of National Pension Scheme. Please note, National Pension Scheme related services are not Exchange traded products and I-Sec is just acting as distributor to solicit these products. All disputes with respect to the distribution activity, would not have access to Exchange investor redressal forum or Arbitration mechanism. The contents herein above shall not be considered as an invitation or persuasion to trade or invest.  I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. Investments in securities market are subject to market risks, read all the related documents carefully before investing. The contents herein mentioned are solely for informational and educational purpose.