NPS has a tax edge, but watch out for annuities

   The New Pension Scheme (NPS) is  likely to get a makeover if the revised Direct Tax Code is
implemented. However, the government is doing its bit to lure  investors to take a close look at the NPS. Recently, the  government announced the ‘Swavalamban’ scheme through which it  would add Rs 1,000 co-contribution every year for the next three  years for everyone who joins the New Pension Scheme in this  financial year.

   Any NPS subscriber who invests Rs 1,000-12,000  per annum between April 1, 2010 and March 31, 2011, will get Rs  3,000 free from the government.

The likely DTC impact The revised DTC, if implemented  without any changes, will keep the NPS out of the tax net. This  new change will make the NPS an attractive investment  opportunity. The government has proposed EEE  (exempt-exempt-exempt) method of taxation for NPS, which implies  the NPS will be exempt from taxes at all the three stages of  deposit, appreciation and withdrawal. Earlier, the NPS proceeds
were taxable at maturity. 

    Advantages One of the major advantages is  also the lowest fund management charge, which is Rs 99 per lakh  (0.0009%) compared to charges of a pension plan offered by an  insurance company, which is around 0.75-1.75% per year. This  low-cost structure makes it more attractive than most  annuity/pension plans offered by insurance companies, financial  advisors say. The custodian charges are in the range of 0.0075%  to 0.05%. Despite all charges, the cost of investment is cheaper  than charges of mutual find and ULIPs.

   How does it work? Investors have an option to  choose their investment mix among three categories. The first  one (E) refers to high investment exposure in equity, which  targets investors with a high risk appetite. Equity investment,  however, is capped at 50%, which mainly comprises index funds.  The second option (C) is high exposure in fixed income  instruments, which targets investors of a moderate risk profile.  These instruments include liquid funds, corporate debt  instruments, fixed deposits and infrastructure bonds. The last  option is pure fixed investment products (G) which offer low  returns.

   Ideally, you should start investing for your retirement  in your early thirties. If you have the advantage of longer  investment horizon (20 years plus), equity is the best option to  start with. But in the case of the NPS, you have to buy a life  annuity offered by life insurance companies. The NPS requires  the investor to use the retirement corpus to buy annuities to  avoid taxation. As per the existing stipulations, you have to
invest 40% of the corpus in annuities. 

   Other alternatives Annuity plans which don’t return  the purchase price offer 8-9% and the ones that return the  purchase price offer 50% a year are other options. Any bank  deposits over five years, which offered 10% a couple years ago,  offer around 8-8.5% today because of a decline in interest  rates. There are other assured monthly income options like the  Senior Citizens’ Savings Scheme (SCSS) which offer 9%, PPF at  15% and the post office monthly income scheme at 8%.

source-economictimes