For or Against NPS?

I had posted a few days ago, facts on NPS - it is available here.

Once in a few days, we would have got mail from NSDL saying to avail the additional tax benefit of Rs 50,000 per year under section 80CCD(1B).  So, if you are in 30% tax slab, it works out to a direct tax saving of Rs 15000 per year. So, it looks like Rs 15000 easy money.

But, just look at the the exit opportunity of Rs 50000 invested.

You can take out only after attaining age 60. And a mininum of 40% has to be invested in annuity. So, you can take out the lumpsum of a maximum of only 60%.  Out of 100%, 40% is tax free and the remaining is taxable at the appropriate income tax slab.

Let us say we take an annuity of only the minimum mandatory amount of 40%.

The split will be 40% taxfree lumpsum + 20% taxable lumpsum + 40% taxable annuity.

Two possible decisions:
1. Take the tax incentive and invest Rs 50000 in NPS
2. Do not take the tax incentive, pay Rs 15000 (@ 30% tax slab for the current year) and invest Rs 35000 in non NPS equity instruments (Long term capital gains being tax free).

For the ease of calculation, let us assume NPS and non-NPS investments generate the same CAGR over the years till the person reaches 60 years of age.  Assume the current investment becomes 10 times in about 30 years of time.

35,000 Non-NPS would have become 350,000 and this entire sum will be taxfree (assuming the current tax structure prevails after 30 years - big condition!)
50,000 NPS would have become 500,000
200,000 tax free
100,000 taxed at 30% = 70,000
200,000 annuity take which will generate just an inflation matching return beyond age 60

Current annuity table from LIC: https://www.licindia.in/Products/Pension-Plans/jeevan_akshay

@60 years of age, with return of capital, Rs 6600 is the annuity for Rs 1 Lakh purchase.  @15% service tax, for Rs 1.15 Lakh, annuity works out to be 5.74% - effectively just matching the inflation (and there is a possibility it might miss the inflation too in some years!)

And this will also be taxable.  Let us say, the annuity holder is still only at 10% tax bracket - then, net return is 5.74 * 0.9 = 5.17%  If the persion is in higher tax brackets beyond 60 years of age, the return further reduces.

@60 years of age:
Non-NPS is 350,000
NPS is 270,000 + 200,000 annuity

Effectively, the difference is :
Non-NPS is 80,000
NPS is 200,000 annuity with 5.17% return

Assume Non-NPS investment generates 3% higher CAGR - which is 8.74% and non-taxable.  At some point, the non-NPS will start accumulating more capital than the NPS one because of the higher compunding rate.
80000 * (1.0874) ^ (years) = 200000 * (1.0517) ^ (years)

It works out to be 27 years @ 3 percent better CAGR
It works out to be 18 years @ 5 percent better CAGR

NPS works out better if someone has an expectancy of around 80 years and do not foresee more than 5 percent better CAGR in non NPS investments (assuming LTCG in non NPS investments will be tax free)

All our analysis are based on our key assumption that till 60 years of age, NPS and non-NPS generate equal returns.  But, if the non NPS has compouneded at a better rate over the accumulation period till 60 years, then the scenario will be completely different with a tilt towards avoiding investing the tax incentivised NPS.