Why Should You Choose NPS Ahead of PPF?

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Overview

Investments are intrinsic to your financial planning for two reasons – to create wealth with long and short term perspectives and secondly, to save tax with the help of investments. Many of the investment options that you look up to for achieving your goals are also efficient tax savers. As the dictum goes, money saved is money earned; your tax-saving investments also cater eminently to this principle. Since we are comparing the two important tax-saving instruments - NPS and PPF, that have the greatest impact on the Indian salaried taxpayers, we need to analyze threadbare as to which is preferable. To truly rationalize an informed choice, you must learn about them both in greater detail.

What is the National Pension System (NPS)?

It is a unique retirement vehicle created by the Government of India through an Act in the parliament to be regulated by the Pension Fund Regulatory and Development Authority (PFRDA). Though it is voluntary, it has been adopted by most employers for their employees as a tool to secure their retirement with pension drawn from it. The returns for the NPS investment are theoretically higher as funds are invested in market-linked instruments. There are dedicated fund managers to manage the funds, and you can also access your account digitally to gauge the performance.

What is the Public Provident Fund (PPF)?

It was established in 1968 by the National Savings Institute under the aegis of The Ministry of Finance, Government of India. It is a voluntary tax saving investment vehicle that provides fixed income in the form of interest declared by the government quarterly. While you can also plan to grow your wealth through this investment vehicle, it has an initial term of 15 years. You can extend this term further through an application in blocks of 5 years each.

Which is better NPS or PPF?

It is a question many ask as there is not enough clarity about the NPS as compared to PPF, which has been a popular vehicle for tax savers since its inception. Though the focus of NPS is retirement, PPF is not designed to serve your retirement plans exclusively. There is also a horde of other differences, which can be best assessed after learning about NPS in greater detail.

Benefits of NPS

The NPS is a perfect retirement vehicle promising to provide reasonable market generated returns. It is based on a unique Permanent Retirement Account Number (PRAN) allotted to you. Among the several benefits, the primary ones are:

  • Exclusive Tax Savings:Apart from the usual rebate under Section 80C for Rs.1.5L, for NPS there is an additional exemption for another Rs.50000 under Section 80CCD (B).
  • Well Regulated:It is governed by PFRDA under the control of the GOI.
  • Fully Transparent: You can access your NPS account online, make payments and track your investments.

NPS Account Eligibility:

The account has been designed with broad eligibility norms as it is voluntary.

  • Any citizen of India can open an NPS account.
  • Age has to be between 18 and 65 years.
  • You have to comply with KYC norms.
  • You can open only one NPS account.

Types of NPS Accounts:

This is the area that creates a lot of confusion in the mind of NPS account holders. It is important to understand the intricacies so that you do not have any doubts about the efficacy of the system. Since the focus is primarily based on your retirement, you must be clear in your mind as to the outcome of the maturity fund. On maturity, you are allowed to withdraw 60% of the amount free from the Income-tax. The remaining 40% is invested in pension annuities to fund monthly payment of pension. This component is fully taxable and deemed to be income from other sources. To accumulate the maturity amount in NPS, you have to open two accounts.

  • Tier I:You have to deposit a minimum of Rs.1000 into this account to keep it active. The other huge tax benefit is a contribution to this account is additionally exempt up to Rs.50000 under Section 80CCD (1B), over and above Rs.1.5L in Section 80C. On the flip side, there are restrictions for withdrawals from this account subject to terms and conditions.
  • Tier II:You have the option to deposit additional amounts in this account, which does not offer any tax benefits. You can also freely withdraw money from this account, without any hindrance. However, your failure to deposit the initial amount in this account will deactivate it by default.

Minimum amounts in NPS Accounts

Details

Tier I

Tier II

Minimum Account Opening Contribution

Rs.500

Rs.1000

Minimum Subsequent Contribution

Rs.500

Rs.250

Minimum contribution per year

Rs.1000

NIL

Minimum number of contribution in a year

 1

NIL

Investment choice in NPS

As a subscriber, you can decide the investment horizon you intend to explore. The fund managers will accordingly manage the funds on your behalf. This is one of the positive features of NPS. On the flip side, it requires a certain amount of acumen to make informed choices, which is hard to come by. Take a look at the provisions.

  • Active Choice:You are free to design your portfolio for which you have three asset classes.
  • Equity (E):This is a high risk and high yield option. You have to limit a 50% investment in this class.
  • Corporate Bonds (C):The investments are directed to fixed income bonds providing moderate yield.
  • Government Securities (G):It is a safe investment vehicle.
  • Auto-Choice – Life-Cycle Fund:In case you do not opt for Active Choice, then this option comes into play. Funds are invested in a pre-determined fashion.
  • Exposure is higher in equity, progressively moderated in high, medium, and low risk.
  • In the middle thirties, the ratio will be 50% in E, 30% in C, and 20% in G.
  • Over that age, the ratio will be gradually tempered until it is 10% in E, 10 % in C, and 80% in G.

Some Salient Features of PPF

The canvas designed for NPS is large as the scale is large, focusing on retirement plans. On the other hand, the scope of PPF is much lower in comparison. It is prudent to check out the salient features of PPF, which will be a fair measure of comparison between the two.

  • Tenure:The initial term of the PPF account is 15 years. After maturity, you can extend further in blocks of 5 years each, with facility for both continuing and discontinuing contribution.
  • Partial Withdrawal:You can withdraw only after the six years of the continued life of the account to the extent of 50% of the closing balance after six years.
  • Interest Rate:It is declared by the GOI quarterly, and the current rate (Jul-Sep) is 7.9% compounded annually.
  • Investment:The minimum contribution per year is Rs.500, while the maximum is Rs.1.5L.
  • Tax Break:It is the best as the EEE regime applies to it. At no point, any of its components is taxable.

Why Choose NPS Over PPF – A Comparison

Let us evaluate them as far as possible.

Comparison between NPS and PPF on Fundamental parameters

Parameter

NPS

PPF

Safety

Low

High

Returns

High

Moderate

Liquidity

Low

Low

Tax impact

Fully exempt

Low

 

From the above, it is quite evident that while PPF is highly safe, the return on NPS is high – for two reasons. One - because it is invested longer and two because the returns are linked to market forces.

Let us consider the parameters one by one in greater detail.

  • Safety: Unlike the PPF, NPS is regulated by PFRDA which obviates any malpractice. On the other hand, investment in market instruments always carries a high risk, and the yield is dependent heavily on the performance of fund managers. Though you can change your fund manager for underperformance, in the case of PPF, you get a fixed return under guarantee by the GOI, precluding and risk of default.
  • Returns:You are guaranteed returns in PPF based on the quarterly declaration of interest by GOI. Additionally, you get the benefit of annual compounding and are assured of growing wealth. In the case of NPS, the yields will depend on market instruments, and there is no guarantee for sustained good returns.
  • Liquidity:You can partially withdraw from your PPF account only after the end of the 6th  The amount is limited to 50% of the balance in your account at the start of the 7th year. You can, however, avail the loan between the 3rd and 6th year of your account. In the case of NPS, till the time of maturity at 60 years, extendable to 70, you can withdraw from Tier I account up to only 25% and on the grounds like education and marriage of children. Thus it is low for both.
  • Tax Break:This is one area where PPF scores heavily over NPS. In the PPF and NPS both, you get an exemption of Rs.1.5L under Section 80C. While the maturity amount is also tax-free in PPF, 40% of the maturity value in NPS is taxable. Additionally, the fund is locked up in annuities for your monthly pension. While you enjoy the EEE regime in PPF, your NPS investment is not so.

Bottom Line:

The primary reason for investment is to create wealth. You can fruitfully use this wealth to ensure that you can enjoy financial freedom in your twilight years. As the NPS is focused on your retirement benefits, it offers a good option. On the other hand, PPF offers a good option for a guaranteed growing of wealth. Since their primary focus is different, the best course is to invest in both of them in proportions matching your capacity.  However, the final choice is yours.  

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