Soon after this year's Union Budget, I wrote in a number of places, including this newspaper and on Value Research Online, about the fillip that Mr. Jaitley had given to the National Pension System (NPS).
In fact, I wouldn't be surprised if Budget 2015 turns out to be the turning point for the NPS. This change will be driven by two measures in the budget. One, at long last, there is a tax-break for the NPS that is not shared with any other type of investment. Since a great deal of the investing behaviour is driven by tax-breaks, this new Rs 50,000 deduction will mean that for a lot of people, Rs 50,000 a year is now going to flow into the NPS.
The potentially much bigger change is that of allowing the NPS as an option to the EPF. It's possible that in the beginning, relatively fewer people will opt for NPS. However, as the years go by, the differential of returns between the NPS (with its equity component) and the EPF will become clearer and clearer. In five to seven years, it will become self-evident that NPS returns are much higher than the EPF, and the service standard and the convenience is much higher. Of course, the second measure has actually not been enacted in the finance bill. It will need a separate action which will hopefully come later in the year.
Because of these two changes, more and more people will try the NPS as time goes by. They will get to like the returns it generates along with relative safety and low cost. I believe that gradually, more and more people will also shift their discretionary savings to NPS. Yet another reason that I feel the NPS will become popular is, paradoxically, it's locked-in nature. Because investors will be forced to have a long-term view, they will get better returns.
However, having expressed this view a few times, I got emails and comments with a lot of pushback. It seems that a lot of savers think that NPS is a bad option, when compared to EPF, PPF and similar fixed return options that can be used for retirement savings. Some savers (and a lot of investment advisors) think that the taxability of returns and the compulsory investment of 40 per cent of the corpus into a pension-bearing annuity makes the NPS an inferior choice to EPF. I've read any number of people state that despite higher returns, this makes the NPS the inferior choice.
However, I'm afraid these people are making a most basic mistake in investing--that of dismissing the effects of compounding returns without actually doing the maths. So let's see what the numbers tell us. I compared two hypothetical cases comparing the 30-year course of an EPF account with an NPS one. In the beginning, Rs 5,000 is put into each every month. To simulate rising income, this amount goes up seven per cent every year. The EPF case earns at 8.75 per cent a year and the NPS at 13.5 per cent, (which is not an aggressive estimate).
After 30 years,Rs 67.5 lakh have been invested and the EPF account has Rs 2.05 crore in it. However, with the same investment, the NPS account will have Rs 4.7 crore in it. With 40 per cent of this amount, the saver will have to compulsorily buy an annuity which will yield a lifelong pension. That leaves Rs 2.8 crore for a lump sum withdrawal. The tax outgo on the returns will be indexed but even if we assume that it will be ten per cent, we are left with Rs 2.16 crore!
You see, the magic of even conservative equity returns over a long period means that even after paying for a lifelong pension-bearing annuity, and even after paying taxes, the saver will be left with a higher lump sum amount than EPF.
Clearly, this passion for the false safety of fixed income returns, and the fear of the false dangers of equity are a prime cause of old-age financial stress among retirees in India. So, don't fall for conventional (un)wisdom, and embrace the NPS for your retirement savings. Of course, that doesn't change the fact that it's truly unpardonable for the government to give EPF and PPF a free pass on taxes and yet tax NPS.