Should senior citizens take advantage of the new NPS opportunity?

How much pension does NPS give?

The pension is determined by your NPS corpus. Assuming your NPS corpus is ₹50 lakhs on maturity. you can use ₹50 lakh to buy an annuity-essentially, a pension plan. At the current annuity rates of 9-10%, this means that you will get an annual pension of approx. ₹5 lakh on this fund. This pension stops when you die. However, there is a variant in which your heirs get the purchase price back ( ₹50 lakh in example). The annuity rate for this type of pension type is less than 5-6% (Annual Pension ₹from 2.5 ₹3 lakh). So the key to getting more pension is to increase your corpus as much as possible.

What if you don’t want an annuity?

Annuities are a pain point for many people, especially since annuity rates seem low. But note that you need to use only 40% of the corpus to buy an annuity. You can let the remaining 60% grow till the age of 75 and get it tax free on maturity. As shown in the chart, if you use ₹12 lakh to buy annuity at the age of 63, balance amount ₹Increases by 18 lakhs ₹43 lakhs at the age of 75. You can do this tax-free in a lump sum or in 10 instalments, which is called a phased withdrawal. Each such withdrawal is tax-free. The regulator may change the annuity purchase rule from three years to maturity (which can be up to 75 years), which can increase your corpus.

How are NPS contributions, withdrawals taxed?

You can get a tax deduction of up to ₹2 lakh every year on contribution to NPS. There is no tax on NPS before maturity. On maturity, NPS is partially taxed. In the above example, you can withdraw ₹43 lakh tax free at the age of 75. you may use ₹12 lakh to get pension of ₹60,000 per annum on which you pay annual tax of the appropriate ₹18,720, assuming you are in the 30% bracket.

what are the options?

In terms of cost and taxation, mutual funds are the closest competitors to NPS. Equity mutual funds held for more than one year are taxed at 10% for gains above₹1 Lac. Debt mutual funds held for more than three years are taxed at 20% and are given the benefit of indexation. If you take indexation into account, the effective tax rate jumps to 10%, which is the same as the compounded rate you pay on the NPS corpus at maturity. But NPS has a hidden benefit- it is tax-free to your heirs on death.

What are the drawbacks?

Under the existing NPS rules, you cannot defer the annuity for more than three years, even though you can defer the non-annuity part (60% of the corpus) till the age of 75 years. This means, if you enter NPS at the age of 60, you will have to buy the annuity at the age of 63. This prevents about 40% of your income from compounding in a tax-free manner, up to a sizable amount, while the remaining 60% can be compounded. In addition, the annuity is taxable, so you receive taxable income that you may not need.