NPS gets less taxing

The Cabinet has approved a series of measures to improve the flexibility of the National Pension Scheme

The appeal of the National Pension System (NPS) as a retirement vehicle has improved after changes announced the past week. Apart from the fact that the maturity amount will be fully exempt from tax, the Cabinet approved a series of measures to improve the flexibility of NPS, including increasing the Centre’s contribution to government employees’ pensions. All these changes are likely to be effective from the start of the next financial year.

Tax-free status

NPS investors are allowed to withdraw 60 per cent of their accumulated corpus as a lump sum when they turn 60. Now, this entire 60 per cent will be tax-free, which will be a big relief for investors as they can channelise a larger amount into suitable avenues for regular income. Earlier, only 40 per cent of the corpus was tax-free, while 20 per cent was taxable at the investor’s slab.

For example, let us say you accumulate ₹1 crore in your NPS account. You can now withdraw ₹60 lakh as tax-free corpus.

Earlier, of the ₹60 lakh, only ₹40 lakh was tax-free. The remaining ₹20 lakh was taxed at your slab. If you were in the 30 per cent category, you would have paid ₹6 lakh (plus cess) in taxes, thus leaving you with a net lump sum of only ₹54 lakh.

There is no change in the treatment for the remaining ₹40 lakh (out of the ₹1-crore accumulation). This ₹40 lakh has to be annuitised — you need to take an immediate annuity policy with an insurance company for this amount. The income earned from the annuity policy will be fully taxable at your slab.

Although NPS’ tax treatment has been made attractive, other avenues such as the Public Provident Fund (PPF) and the Employees’ Provident Fund (EPF) are still attractive on this front, as the entire accumulated corpus in these avenues is tax-free. In case of NPS, the entire accumulation is theoretically tax-free, but the income from the compulsory investment in annuities is taxable.

This rule on annuitising 40 per cent of the accumulated amount has not been done away with, which is a bit of a dampener. Annuity rates may not be attractive, and knowledgeable investors may be able to deploy the sum elsewhere for a regular income stream with higher returns.

For example, the Pradhan Mantri Vaya Vandana Yojana (PMVVY) and post-office Senior Citizen Savings Scheme (SCSS) offer higher rates than immediate annuity schemes offered by insurance companies.

Other key changes

Contributions to the NPS tier-II scheme, which has more flexibility in withdrawal, will now enjoy tax deduction benefits under Section 80C. But, this deduction is applicable only for government employees. To enjoy the tax benefits, the lock-in period is three years.

The government will also increase its contribution from 10 per cent of an employee’s salary to 14 per cent. This move will ensure that government employees, especially relatively young ones who joined recently, will receive a much larger pension.

Other proposals approved by the Cabinet include allowing government NPS subscribers to choose private sector fund managers and increasing the proportion of investment in equity to the extent of 50 per cent of the contribution amount (it was capped at 15 per cent earlier).

At just 0.01 per cent, the fund manager charges of the NPS are among the lowest in long-term investments. Even if other minor charges related to point-of-presence, asset reallocation request, etc, are included, the charges are a fraction what unit-linked insurance plans (ULIPs) or even mutual funds charge. At the accumulation stage, NPS can make for a fairly balanced retirement-focussed portfolio.

But, it is at the maturity stage that the NPS’ attractiveness wanes off a bit, given that only partial withdrawal is allowed.

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