National Pension Scheme – NPS vs PF, Which One Is Better?
Provident Fund and NPS are two retirement instruments that take care of post retirement life of a salaried employee, be it from public or private sector. It has two components to it, one is the contribution of the employee and the other a matching amount contributed by the employer. Currently in India, PF, EPF and PPF are the instruments which have been on a fixed returns yielding mode. NPS is market linked and gives returns based on the portfolio we select based on our risk taking ability.
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However, the government changed two things related to PF that pinched the salaried employees in this budget. One was the slashing of the interest from 8.8% to 8.1%. Second was the tax levied on withdrawal of PF amount of the employer contribution before retirement. This has been withdrawn already, much to the relief of the employees.
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If we look at developed nations across the world, they typically invest this corpus into government bonds which is made payable in the future to the trust fund from which it is borrowed. In other words, the government borrows from itself and invests into the markets. The investment horizon is always long term. In other words, there is nothing like a fixed returns tab attached to the investment. The returns are based on the actual performance of the government bond funds over the years. This is a mature way of investing the corpus as any government would not want to be burdened with a fixed returns model of investing, as returns from investments are dependent on market driven factors.
However, till now in India we have been following a fixed returns model when it comes to PF. This is not sustainable as it adds a lot of burden on the government, which has to dig deep into other sources of revenue to supplement losses arising out of investments of PF. This is precisely why the government wants to reduce the interest rate on PF. Financially, it would be a better model to move away from fixed returns model for PF as a retirement tool.
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Also, the government wants to drive people towards National Pension Scheme (NPS) by imposing tax on withdrawal on the employer’s contribution before 58 years of age. It is a welcome move because often times, employees withdraw their PF amount when they shift their employment from one company to another. This reduces their ability to meet their retirement goal. The mantra is not to touch the retirement instrument, no matter what the emergency is. This is the standard practice across the world. Why should it be any different in India? In imposing a tax on withdrawal, the government wants the employee to be ready for retirement, which is a good thing.
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NPS is a better retirement instrument compared to PF because it allows the employee to choose their risk profile and make a diversified portfolio. This ensures better returns on investments. The two measures which did not go well with the salaried class are in fact efforts on the part of the government to drive reforms in this sector and make people choose NPS as their retirement instrument.
Conclusion: The best way to achieve any financial goal, including but not limited to retirement is to create a diversified portfolio and invest with discipline and not get tempted on short term gains. A long term vision and ability to desist from temptation of short term gains will ensure that the corpus accumulated for retirement is sufficient and at the same time is not a burden on the economy of the country.