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Making a choice between provident funds and NPS

The National Pension Scheme (NPS) that was recently launched by the Indian government has attracted a lot of attention, although there are still worries over the tax treatment of NPS. What is the difference between provident fund and NPS? After all, both provident fund and NPS are a means for planning for your retirement. Let us understand how to make a choice: EPF or NPS, which is better.


Freedom to choose where to invest the corpus..

This is where the NPS scores over the EPF. The EPF currently invests predominantly in central and state government securities. In the last 2 years, they have also been permitted to invest in equities via the ETF route but that is still very small. So the pension under the EPF is independent of the conditions in the market as these are mostly invested in blue chip government bonds with committed interest payments. The NPS on the other hand offers two modes of investing viz. Active Investment Mode and Auto Investment Mode. Under the active choice mode, NPS investors can go up to 50% in equity. Under the auto mode, the mix of equity and debt will be automatically tweaked based on the age of the individual. NPS offers greater investment flexibility compared to EPF.


Returns on EPF versus NPS..

The average return on an EPF is in the range of 8-8.5% and has been on a continuous downtrend since the last couple of years when the rates have been falling. The NPS is a market driven scheme and therefore we will have to look at actual returns in the last 4-5 years to get a clear picture. A typical NPS scheme with 85% exposure to fixed income securities and a 15% exposure to equities has given 10.35% returns in the last 5 years. That is more attractive than an EPF by nearly 200 basis points. Of course, over longer periods of time, the returns on NPS will be higher if the exposure to equities is increased.


Withdrawal of funds or redemption..
EPF funds can be withdrawn if you have continuous contribution under the same account for a period of 5 years. EPF is retirement money but it permits conditional withdrawal. For example, 6 times a member’s salary can be withdrawn for medical purposes while 36 times the salary can be withdrawn in case of repayment of home loan. For purposes of marriage and education one is allowed to withdraw up to 50% of the corpus up to 3 times. In case of NPS no withdrawals are permitted until the member attains the age of 60. Even the withdrawals made after the age of 60 require 40% to be reinvested in annuities. Surely, in terms of withdrawals and liquidity, the EPF scores over NPS.
Income Tax exemptions on NPS versus EPF..
Both are tax efficient although the extent and the nature of tax breaks differ. In case of EPF, there are tax breaks at 3 levels. Firstly, when you invest in an EPF it is exempt under Section 80C of the Income Tax Act to the extent of the outer limit of Rs.150,000 per annum. The interest earned on the EPF account is entirely tax free in your hands. The amount is entirely tax-free on redemption. Additionally, the employer is also eligible to contribute 12% to your EPF Account and that is also tax free at all the three levels. Currently, EPF operates on the EEE (Exempt, Exempt, Exempt) model. However, there is a proposal to shift the EPF to EET (Exempt, Exempt, Taxed) model wherein the redemption will be taxable as income in the year of redemption.

How is the tax treatment in case of NPS? Only funds invested in annuities are eligible exemption. While the contribution is eligible under Section 80C, like EPF, there is an additional benefit of Rs.50,000 for NPS under Section 80CCD exclusively for NPS. In tax benefit terms, the NPS appears to score over the EPF.


Taking a call on EPF versus NPS..
The answer may not lie in choosing one but mixing the two in your retirement plan.  Compare both of them. Also, estimate your retirement benefits with gratuity calculator. Gratuity enables you with the power to invest amounts after retirement. For example, since most people require regular income flows after retirement, the NPS annuity model does it best for them. One can argue that EPF has more access points if you are looking at liquidity for your needs. However, remember that this criterion must be used only in an extreme emergency. Otherwise do not interrupt your retirement corpus. One can actually consider mixing the best components of these two products to create a safe and meaningful retirement plan.

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