Read the offer documents carefully

There is a reason why ads for financial products come with the disclaimer that you should read the offer documents carefully before investing. One product that many people invest in without giving proper thought is the National Pension System (NPS). The tax savings offered by the scheme seem so attractive that people ignore all other aspects.

Long lock-in

People are drawn to the NPS by the additional Rs 50,000 deduction offered under Section 80CCD(1b). But what they don't realise is that once they invest, the money cannot be withdrawn before the age of 60 (a provision for emergency withdrawals is available only for special circumstances). This may be fine for government employees and those who want to work till they are 60.

You have to contribute a minimum amount every year. Yes, this is a great way to save and you are saving 20-30% tax on that amount, but keep in mind that NPS only defers the tax. You have to pay the tax later, at the time of withdrawal.

Taxation: the big negative

At the time of withdrawal, only 40% of the NPS corpus can be withdrawn tax-free. Another 20% of the corpus, when withdrawn, will be taxable at the marginal tax rate applicable to the investor. The remaining 40% has to compulsorily be invested in an annuity to earn a monthly pension. The annuity is fully taxable and does not get any benefit of indexation or long-term capital gains.

Interest rate

The interest rate is fixed rate, irrespective of the rate of inflation. Further, you will not have any control over the investment portfolio. NPS forces the individual to pour at least 40% of his corpus into an annuity. Added to that he has to opt for an annuity only with one of its enrolled service providers.