By Saraswathi Kasturirangan, Radhika Viswanathan and Nidhi Jain
Pension for all and enhancing financial security of the aged has been on top of the government’s agenda. Despite being one of the flagship schemes in this direction, the National Pension System (NPS) is still not the first choice for individuals. Statistics show that total subscribers contributing to NPS till May 2019 are just over 55 lakh. Therefore, the government may bring in changes in the coming Budget to remove certain hurdles and make this scheme more attractive.
When we talk of changes, what could these be?
Each one of us may have a different set of demands, but two expectations that stand out are enhancement of the tax exemption limit for lump sum withdrawal and bringing Tier II NPS contributions under the list of investments eligible for section 80C tax benefit.
The Union Cabinet, had, in 2018 approved the proposal to make 60 percent of the accumulated corpus that can be withdrawn, as completely tax exempt. Besides, there were also discussions on making contributions by government employees to Tier II of NPS eligible for deduction under section 80C though with a 3-year lock-in period. There was much speculation that these would find a place in the interim Budget in February though that was not to be. As a result, these once again find a place in the wish list for Budget 2019.
Though accumulated balance in NPS can be withdrawn only on closure of the scheme, there is an option to withdraw partially prior to this. It may, however, be noted that partial withdrawal only by employee is exempt up to 25 percent of the total amount of contributions made by such employee. Extension of this benefit to investors other* than employees would be a welcome change.
Here’s a little insight into the scheme itself and its tax implications.
NPS is open to all citizens of India in the age group of 18-60 years. It can be an employer-driven scheme or be subscribed to in an individual capacity, or both. It is also open to non-resident Indians and can be accessed online. This scheme has a lock-in period, while partial withdrawal is permitted for specified purposes; significant portion of the contributions to NPS cannot be withdrawn until one reaches superannuation.
The scheme gives the subscriber a choice of funds / investment options to choose from.
Tax impact of contributions
Individuals’ contributions qualifies for deduction under Section 80CCD subject to the overall ceiling of Rs 1.5 lakh (which includes all other eligible investments such as PF, PPF, LIC premia etc.). An additional deduction, specifically for contribution to NPS is available up to a ceiling of Rs 50,000 under section 80CCD (1B). The tax laws also provide for deduction of employer contributions up to 10 percent of specified salary.
Withdrawal and Taxability
NPS does not permit 100 percent withdrawal even on maturity. Upon closure or opting out of the scheme, 40 percent of the accumulated amount has to be compulsorily utilised to purchase annuities and only the remaining 60 percent will be paid as lump sum. Though transfer of 40 percent to annuity is tax exempt, out of the 60 percent that can be withdrawn as lump-sum, currently only 40 percent is tax-free and the remaining 20 percent is subject to tax. Further, exemption for partial withdrawal up to 25 percent of the total amount of contributions made, is available only for employees and for other categories this is fully taxable.
Concerns around NPS
Key driving factors in investment decisions are tax benefits at the time of contribution, accrual of income, withdrawal and risk involved in such investments.
The NPS scheme’s architecture mandates the purchase of annuity to provide for sustained regular income post retirement. This, when compared with other options such as mutual funds, monthly income schemes and systematic investment plans could lead to NPS being perceived as less attractive.
Though taxation of annuity is seen negatively, it is actually in line with schemes such as the PF where the subsequent returns are taxed.
NPS is focussed on providing pension during the post-retirement sunset days, and is not comparable to the Provident Fund scheme, which ensures lump sum savings.
Also as we know, PF continues to enjoy the “EEE” regime, which translates as “zero” tax on contribution, accrual and withdrawal. Mutual funds too, provide for tax benefit on investment and dividends are tax-free. So, when NPS is compared with other alternatives that a taxpayer has, clearly there is a need to realign NPS to a more tax-friendly mode.
Considering this, one hopes and wishes that the expectations of the taxpayers finds a place in the Budget 2019 proposals.
Although these would have an impact on the exchequer in the long run, nevertheless, bringing in the amendments in the current Budget could be the game changer for NPS.