Advantages and disadvantages of NPS

Every investment option has its benefits and drawbacks. It is only after knowing both that an investor can take the right investment decision. If you are planning to invest in National Pension System (NPS), the advantages and disadvantages of the scheme discussed in this post can help you make an informed decision.

The government-backed NPS is one of the top options for investors aiming to build a retirement corpus. The money invested in this voluntary scheme is managed by Pension Fund Regulatory and Development Authority (PFRDA) regulated fund managers to help investors build a well-structured investment portfolio.

While NPS benefits are well-known, one should take an investment decision only after considering the benefits as well as the drawbacks. If you are planning to invest in NPS, here are some of the most important advantages and disadvantages of the scheme you should know about:

Advantages of NPS (National Pension system)

The National Pension Scheme (NPS) provides several benefits for those looking for options to have a secure retirement with a strategic planning.

Investment Choices Flexibility

Two major options for investment management come with NPS: Auto Choice and Active Choice. Your investments are handled by fund managers who diversify them across equity, corporate bonds and government securities as per their competency under the Auto Choice option. Conversely, Active choice gives you power to do asset allocation on your own thus guidelines to allow 75% of the total amount invested in equities till the age of 50 years, among other investment decisions.

Partial Withdrawals

One of its interesting features is that NPS allows partial withdrawals from Tier I accounts. Partial withdrawals from Tier I accounts are allowed after three years of subscription, with up to 25% of contributions allowed for specific purposes such as higher education, marriage, or medical treatment. Maximum three such withdrawals can be made with a gap of at least five years between each withdrawal. The condition of withdrawal after 5 years gap is waived for medical treatment and for those who subscribe after 60 years of age.

Tax Benefits

Large tax reliefs are given by the NPS scheme. Section 80CCD(1) grants tax deduction till Rs. 1,50,000 for contribution made towards the scheme annually. Besides Section 80CCD(2) provides tax benefits for employer contributions up to 10% of the employee's salary (basic + DA). There is a further provision for voluntary contributions up to Rs. 50,000 exempted from tax purposes in this regard when he pays employees’ statutory retirement benefits like pension contributions etc.

Diversification and Market-Linked Returns

The combination of equity and debt investments by NPS offers a significant diversification. This balance helps to achieve favourable returns which are linked to the market, thereby helping in growing your retirement corpus over time.

Flexible Contributions and Fund Manager Options

Contributions can be made any number of times in a financial year subject to a minimum contribution of Rs. 1,000 per year for Tier I accounts. Subscribers can change fund managers once a year if they are not satisfied with their performance.

Disadvantages of NPS (National Pension System)

Advantages & Disadvantages of NPS should be understood before investing. Several benefits have been offered under the National Pension Scheme (NPS) but at the same time certain drawbacks also exist that any potential investors should consider.

Tax Liability at Maturity

Despite its initial tax benefits, there is a major tax disadvantage associated with NPS at maturity stage. It may increase your taxes due during retirement as 60% of the corpus is added to your taxable income at maturity. This element can dilute some financial benefits accumulated over years.

Limited Withdrawal Options

Primarily meant as a scheme for retirement savings, NPS has limitations on withdrawals prior to maturity stage.

Reducing Equity Exposure

NPS gradually reduces the proportion of equities with ageing. The program shrinks your equity investment by 2.5% every year after you have attained 50 years aimed at reducing risk as one is near retirement stage. However, this automatic reduction may be known to people who prefer a higher exposure to stocks, expecting a higher return.

Annuity Requirement

At maturity, NPS requires that at least 40% of the amount should be utilised for the purchase of annuity. This ensures regular income in retirement however the annuity terms and payouts are determined by the annuity service provider. It is possible to withdraw the balance of 60% as a lump sum which seems limiting to some people.

Complexity for New Investors

Despite NPS being designed with simplicity in mind, its asset allocation and fund management concepts can confuse new investors. Without background in finance, it could be difficult comprehending Auto and Active Choices details and withdrawal rules.

To invest or not to invest in NPS?

Now that you know some of the most important advantages and drawbacks of NPS funds, you can decide whether or not it is the right option for you. Just like every other investment, NPS also has a few drawbacks. However, most of them have been intentionally put in place to meet the retirement objective of the scheme. If you are still finding it difficult to make a decision, get in touch with an investment advisor or PFRDA-authorised bank to know more.