Retirement savings: Does NPS Tier-2 tax loophole make it better choice than MFs?

livemint.com:

Subscribe to enjoy similar stories. MUMBAI : People use mutual funds to plan for all sorts of things: buying a house, car, or even an iPhone. However, when it comes to retirement planning, some investors are choosing the National Pension System (NPS) Tier-2 over mutual funds for building their nest egg.

While NPS Tier-1 offers tax benefits but restricts withdrawals, Tier-2 offers flexible withdrawals without tax benefits. Mutual funds command an asset base of ₹67 trillion. The NPS Tier-1 account has an asset base of ₹2.28 trillion, excluding contributions by state and central government employees.

Meanwhile, the NPS Tier-2 accounts for just ₹6,510 crore. Mint spoke with Kurian Jose, chief executive of Tata Pension Fund, to understand what makes the NPS Tier-2 attractive. Edited excerpts: Investors have broadly three options when it comes to retirement planning.

The first is to invest in mutual funds, which invite capital gains tax at the time of redemption. The second option is to invest in NPS Tier-1 and get tax benefits. The NPS Tier-1 falls under the Exempt-Exempt-Exempt, or EEE, category from a taxation perspective.

It means that contributions, accumulations, and withdrawals are tax-free. However, it comes with the condition of being unable to withdraw funds before 60, except for some grounds defined by the Pension Fund Regulatory and Development Authority. Investors can withdraw 60% of the corpus when they retire at 60 without any tax incidence, and the remaining 40% has to be invested in an annuity scheme that provides regular cash flow.

The tax must be paid on the periodic pension (cash flow) they receive through this annuity purchase at their respective tax bracket. The third option is the NPS Tier-2. Let’s say