NPS vs PPF is not an easy question to answer, but why should you face such a question?
Because no one has an unlimited amount of money to invest. Therefore, when we must make an investment choice, “This or That” or “X vs Y” or “Which is better” questions invariably pop up. Whether we talk about tax-saving or retirement or creating wealth, you will face such dilemmas.
What do you do in such cases?
The most obvious approach is to compare products and pick up the one that is the best match with your requirements. And this does not have to be an either-or decision. You can use a mix.
In this post, let’s look at two very familiar products for retirement and tax-saving. NPS and PPF.
What are NPS and PPF?
NPS is a proper retirement product. NPS has been specifically designed to provide pension in your retirement years. It is a defined contribution pension plan i.e. your contribution is defined or under your control. The pension (or annuity) that you get in your retirement is not fixed. It will depend on the accumulated corpus, the amount converted to annuity and the prevailing annuity rate.
NPS (National Pension Scheme) has been getting a lot of attention lately due to exclusive tax benefits on investment and the relaxation of the tax treatment of NPS corpus at maturity.
PPF (Public Provident Fund) has been a traditional favourite for retirement savings. Backed by the Government, it carries no risk. The Government announces the interest rate every quarter.
Which one do you think is a better product for your retirement savings or tax-saving?
To be honest, people are more worried about tax-saving than they are about retirement planning. Saving for retirement happens as a byproduct. It is unfortunate but that’s the way it is. However, it does not do away from the fact that NPS has become quite popular and likely to challenge many investment products in the future.
In this post, I shall compare PPF and NPS on various parameters and assess which product is better.
A point to note: Personal Finance is personal. I have an opinion. You must not let my opinion weigh too much on your decisions.
1. Tax Treatment of NPS vs. PPF
PPF is an EEE product. You get tax benefit for investment, interest earned is exempt from tax and the maturity amount is also tax-free. You get tax-benefit of up to Rs 1.5 lacs under Section 80C of the Income Tax Act.
NPS comes under EET (almost EEE now) product basket. You get a tax benefit for investment and returns are exempt. You get tax benefit up to Rs 1.5 lacs (with limitations) under Section 80CCD(1) of the Income Tax Act. The tax benefit under Section 80CCD(1) is subsumed under Section 80C of the Income Tax Act. (Read: Section 80CCE of the Income Tax Act).
Additionally, you get an exclusive tax benefit of Rs 50,000 under Section 80CCD(1B). Hence, the total tax benefit on investment in NPS can go up to Rs 2 lacs.
If your employer offers you NPS, you get even more exclusive tax benefits under Section 80CCD(2).
At maturity, you have to use at least 40% of the accumulated corpus to purchase an annuity plan. Up to 60% can be taken out lump sum. The amount that is used to purchase the annuity plan is not taxed. However, annuity income is taxed in the year of receipt. The entire lump sum withdrawal (up to 60% of the accumulated corpus) at the time of maturity shall be exempt from tax. This change was brought about in December 2018. Earlier, only 40% was exempt from tax.
Tax regime for NPS has gotten friendlier over the last few years.
Read: Common Doubts about NPS
2. Liquidity (Withdrawal and Exit options)
PPF scores over NPS on this front. PPF provides the option of loans from the 3rd year and partial withdrawals from the 7th year. PPF is a very flexible product after the initial maturity of 15 years.
NPS has very rigid exit and partial withdrawal rules. NPS is meant to be run till retirement. If you exit before retirement, there is a mandatory purchase of an annuity for 80% of the accumulated corpus. Limited partial withdrawals are permitted after a few years.
3. Mandatory Purchase of Annuity
PPF does better again. Under PPF, there is no such restriction.
With NPS, at least 40% of the accumulated amount must be used to purchase an annuity plan. If you exit before retirement, at least 80% must be used to purchase an annuity plan.
By the way, you can even use PPF as a pension tool.
A number of finance experts have been asking that the purchase of annuity should not be made mandatory. The subscribers should be allowed to use the accumulated corpus as they wish. I do not fully agree with such an argument.
NPS is a pension product. You cannot take out pension from a pension product. If you are not comfortable with pension (or the way pension products are structured), don’t invest in NPS. Forgo the exclusive tax benefit too. Unfortunately, this is not an option available to mandatory subscribers (Central and state Government employees) or those whose employers offer NPS.
I concede annuity rates are not competitive at a young age and will perhaps be lower than a bank fixed deposit. Moreover, annuity rates go up with age. In my opinion, annuities, if you purchase the right variant at the right age, can add a lot of value to a retirement portfolio.
4. Maximum Investment Amount (PPF vs. NPS)
You cannot invest more than Rs 1.5 lacs in PPF per financial year. This cap includes your own PPF account and all those PPF accounts where you are the guardian.
There is no cap on investment in NPS.
So, NPS scores over PPF on this front.
5. Returns (NPS vs PPF)
PPF is a pure debt product. The interest rate is announced by the Ministry of Finance every quarter.
On the other hand, NPS is a hybrid product. You can even make it a pure debt product. However, equity exposure is capped at
50% 75%. Returns are market-linked.
With equity exposure, I would expect NPS to provide better returns than PPF over the long term (pre-tax returns). For post-tax returns, it depends on how well you are able to reduce your tax outgo in the case of NPS.
Which is better? PPF or NPS
I like PPF more than NPS.
It should not be very difficult to replicate NPS performance using PPF and mutual funds (debt and equity). Hence, you can get similar performance without many restrictions of NPS.
With the combination of PPF and equity funds, there is no compulsion to purchase an annuity plan either. If you think you need an annuity plan, you can even use your PPF balance and mutual fund corpus to purchase an annuity plan. Annuity plans are not exclusive to NPS. You can purchase annuity plans even without NPS.
NPS offers an exclusive tax benefit of Rs 50,000 under Section 80CCD(1B). And somehow, most of us will lose sleep if we don’t maximize tax benefits. So, if you are investing in NPS for the tax benefits, Rs 50,000 is the maximum you should invest. Invest no more than Rs 50,000 per year in NPS. If you are a mandatory subscriber, don’t invest more than what you are already doing.
In this post, I have focussed more on comparing NPS and PPF. If you simply want to understand whether you should invest in NPS, please refer to this post.
With NPS, your investment is locked-in till retirement. Hence, NPS will be very useful for those who lack investment discipline. And in my experience, many investors do. You must take this call yourself. If you think you won’t be able to maintain that discipline, NPS is just the right product for you.
You don’t want to invest more than Rs 50,000 in NPS and you cannot invest more than Rs 1.5 lacs in PPF account.
What does this tell you?
If you need to invest more to build the required retirement corpus, you need to look beyond PPF and NPS. Don’t get fixated with tax benefits. Your retirement planning does not begin and end with tax benefits.
Look beyond tax benefits. In fact, were it not for the excess tax benefits, most of us wouldn’t even be discussing NPS.
Keep it simple. Retirement planning is primary and tax saving is secondary. Find out the amount needed for a comfortable retirement and choose investment products that are most likely to help you reach the amount.
PFRDA Website (PFRDA regulates NPS)
The post was first published in March 2016 and has been modified since.
Image Credit: OpenClipArtVectors,2013. Modified. The original image and information about usage rights can be downloaded from Pixabay.