Let me begin this article by citing a Jewish proverb - 'Taxes grow without rain!'. Income Tax is the most dreaded and probably the most hated word even for those who are patriotic. Especially in countries like India, there is often a social dilemma, whether, the tax money collected is efficiently utilised? That's a separate discussion. Remaining within the Legal boundaries, can you reduce the impact of Income Tax?
Yes. Thankfully yes. To make this sound more interesting, let's crunch some numbers:
Let's say, Sandeep starts working at the age of 25. The organisation he joins offers him NPS as one of the Compensation item, where he could opt to contribute INR 100,000 per annum through Employer. But, he chooses not to. His Employer deducts, INR 30,000 as tax (assuming at 30% tax).
So Sandeep receives INR 70,000 post tax and this money he has to invest in certain other products (Gold, FD, Real estate etc.,) to create wealth.
In Economics, there is always a trade-off to your decisions. Is there something which Sandeep is foregoing, with this decision of taking a 30% cut.
With three assumptions let's looks at what these 30,000 per annum chunks would have turned into
- Sandeep would have retired at 60
- Yearly contribution through Employer for the remaining 35 yrs kept at INR 100,000
- Assuming 8% return on INR 30,000 chunks
Amazing isn't it! The amount saved if otherwise would have been paid as taxes would have grown to INR 52 Lakhs! The corpus which Sandeep could have built is INR 41 Lakhs!
Let us also look at, what % of return is needed to match NPS returns, if Sandeep would have invested in Equity Mutual Funds. Post Tax, Sandeep is left with INR 70,000. Let us compare this with an Annual investment of INR 100,000 over a period of 35 years.
Above picture shows an investment of INR 70,000 made every year over a period of 35 years in a Mutual Fund. Gains on Equity mutual funds, currently are taxed at 10% on profit above INR 1 Lakh.
Now let's compare this with investment made in NPS. Remember in NPS, subscriber has an option to allocate up to 75% of their contribution towards Equity. Remaining 25% of the contribution let's say is invested in Corporate Bonds / Government Securities.
1. Assuming the Equity portion i.e 75% of the contribution mimics the gain of Equity mutual fund
2. Assuming the other 25% of the contribution grows at 8%
The above table depicts the returns which Sandeep will be able to generate - Tax free, if he opts for NPS. Even if your Equity Mutual Fund generates a return of 15% per annum, even then it won't be able to match NPS over a long period of time.
So, don't be in a hurry to invest your money. Think well before you make any investment.
Credits: https://www.rapidtables.com/calc/finance/compound-interest-calculator.html
Disclaimer: The income tax rates / assumptions are taken at current rates / ease of calculation purposes. Please treat this as an awareness post but not as any advise.
I have not considered inflation, expense ratios etc.,
So with that, I will try and write a few more posts on the advantages of NPS
Until my next post!
