Between NPS and PPF, which investment would you pick up for your retirement savings?
NPS? PPF? Both? Neither?
You may ask, why only NPS and PPF? That is a fair question. After all, PPF and NPS are not the only retirement products available. For your retirement, you can invest in stocks, mutual funds, EPF, NPS, PPF, Fixed deposits, pension plans, insurance plans, and many more products.
However, if PPF and NPS were the only two options available to you, which would you pick up?
If such a case, you would want to compare these products on various aspects: Returns, volatility, tax benefits, tax treatment on maturity, flexibility etc. And then you choose from various investment options based on your preferences and suitability.
Remember it is NOT an either-or decision. If you believe both products fit with your financial planning needs, you can use both.
In this post, let us compare NPS and PPF on various parameters.
What are NPS and PPF?
NPS is a proper retirement product. NPS has been specifically designed to provide pension in your retirement years. You contribute to NPS while you are working. Your investment earns returns until you exit NPS at time of retirement (superannuation) or after turning 60 (or later).
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.
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.
In this post, I shall compare PPF and NPS on various parameters. You must decide which is a better product for you.
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 per annum for investment under Section 80C of the Income Tax Act.
Note: The benefit on investment in PPF is available only under the old tax regime. If you file returns under the NEW tax regime, you do not get tax benefit on investment in PPF.
On the tax front, NPS is not too far behind PPF now. It is almost EEE. Well, almost.
You get tax benefits for investment.
- Own Contribution: Under Section 80CCD(1B). Up to 10% of salary. 20% of income for self-employed. Capped at Rs 1.5 lacs per annum. Subsumed under Section 80C.
- Own Contribution: Up to Rs 50,000 per annum under Section 80CCD(1B).
- Employer contribution: Up to 10% of Salary (14% for Government employees) under Section 80CCD(2). This is capped at Rs 7.5 lacs per annum. This is the cumulative cap for employer contribution to EPF, NPS, and superannuation accounts.
Benefits (1) and (2) are available only under the Old tax regime. Not under the New tax regime. Benefit (3) for employer contribution is available under both Old and New tax regimes.
Returns are exempt from tax. There is no liability until you exit from NPS.
At maturity (exit from NPS), you can withdraw up to 60% of accumulated amount as lumpsum and must use the remaining (at least 40%) to purchase an annuity plan. The entire lumpsum withdrawal is exempt from tax. The amount that is used to purchase the annuity plan is also not taxed. However, annuity income from such an annuity plan is taxed in the year of receipt.
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 becomes very flexible once you complete 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
With NPS, at least 40% of the accumulated amount must be used to purchase an annuity plan. If you exit before superannuation or the age of 60, at least 80% must be used to purchase an annuity plan.
Under PPF, there is no such restriction.
Clearly, PPF is a winner on the flexibility front.
However, is mandatory purchase of annuity such a bad thing? Many finance experts argue that the subscribers should be allowed to use the accumulated NPS corpus as they wish. I do not fully agree with such an argument.
Yes, greater flexibility is always desirable. However, NPS is a pension product. You cannot take out pension from a pension product. Mandatory annuity provision ensures that at least a portion of the accumulated corpus is utilized towards providing steady income to the investor. Annuities can add a lot of value to a retirement portfolio, if you buy the right variant at the right age.
By the way, do you know that you can even use PPF as a pension tool? Not through the customary way of buying an annuity plan, but you can smartly use your PPF account to generate tax-free income during retirement.
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.
With this cap on annual investment, if you want to accumulate a big corpus in PPF for retirement, you must keep investing patiently for years. You cannot suddenly discover the merits of PPF and build a big portfolio there.
There is no cap on investment in NPS.
NPS scores over PPF on this front.
Read: How you and your spouse can contribute more than Rs 1.5 lacs in PPF accounts?
5. Returns (NPS vs PPF)
PPF is a pure debt product. The interest rate is announced by the Ministry of Finance every quarter. The Govt. can announce a different return every quarter. PPF provides a good rate of return for a fixed income product. And that too tax-free returns.
Currently, PPF is the only EEE debt investment. Even EPF returns have become taxable under certain conditions.
On the other hand, NPS is a hybrid product, where your money is split between equity (E) and debt funds (C and G). If you opt for Active choice, you decide the split across the 3 funds.
If you opt for Auto-choice, the allocation is decide based on a pre-set asset allocation table. You can even make it a pure debt product. However, equity exposure is capped at 50% 75%. Returns are market-linked.
With equity exposure, if the Indian economy were to do well over the long term, I would expect NPS to provide better returns than PPF over the long term (on pre-tax basis). No guarantees though.
For post-tax returns, it depends on if and how well you can reduce your tax outgo in the case of NPS.
Which is better? PPF or NPS
I like PPF more than NPS.
Am I biased? Yes. I do not deny my bias.
But I invest in both NPS and PPF. Until now, I have kept my investments in NPS to a bare minimum. However, it is possible that I may start routing more in the future.
Let us digress a bit to understand why I may do that.
Over the past decade, the tax treatment of many popular investment products has become adverse. Or rather it has become less benign. Examples include:
EPF
Traditional Insurance plans
Unit Linked Insurance Plans (ULIPs)
Equity Mutual Funds
Debt Mutual Funds
PPF is the only debt investment that has retained its benign tax-free status.
NPS is the only investment for which tax incentives have improved over the last decade. The only investment product.
It is difficult to find a reason for NOT investing in PPF. It is the best fixed income investment for retirement. Hence, unless you decide to shun debt investments completely for your retirement portfolio, there is little reason why you should not invest in PPF.
The decision to invest in NPS is a more nuanced one.
In absence of tax benefits, NPS is no special product. We could have easily replicated the product by using mutual funds. Even in NPS, your money gets invested in diversified funds only. Mutual funds also do not have restrictions of NPS. No compulsion to buy an annuity plan either. In any case, if you must buy one, you can buy an annuity plan from the sale proceeds of your mutual fund corpus too.
However, with adverse developments in the taxation of mutual funds, portfolio rebalancing has now become quite an expensive affair with mutual funds. NPS provides tax-free rebalancing. And that I think is the greatest advantage of NPS, especially for big portfolios.
I compared NPS and mutual funds on various aspects in a post recently. While mutual funds score heavily in terms of flexibility and choice of funds, NPS stole the march on the taxation front.
Between PPF and NPS, it is not an either-or decision. You can invest in both. In fact, you do not have to limit yourself to just these two products. You can consider mutual funds as well.
PPF for tax-free debt returns.
NPS for tax benefits and tax-free portfolio rebalancing.
Mutual funds for flexibility and wider choice in investments.
You will have to decide the allocation to each for your portfolio.
Additional Read
PFRDA Website (PFRDA regulates NPS)
The post was first published in March 2016 and has been regularly updated since.
Image Credit: Unsplash
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This post is for education purpose alone and is NOT investment advice. This is not a recommendation to invest or NOT invest in any product. The securities, instruments, or indices quoted are for illustration only and are not recommendatory. My views may be biased, and I may choose not to focus on aspects that you consider important. Your financial goals may be different. You may have a different risk profile. You may be in a different life stage than I am in. Hence, you must NOT base your investment decisions based on my writings. There is no one-size-fits-all solution in investments. What may be a good investment for certain investors may NOT be good for others. And vice versa. Therefore, read and understand the product terms and conditions and consider your risk profile, requirements, and suitability before investing in any investment product or following an investment approach.
