New Pension Scheme

TAXTALK

A. N. Shanbhag

New

PENSION SYSTEM T As per most media reports, contributions made to NPS are said to be deductible under Sec. 80C. Note that it is not Sec. 80C but in fact Sec. 80CCD that extends the deduction.

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he New Pension System (NPS) has been made applicable to all the citizens of India from the 1st of May 2009. This article discusses the taxes as well as other features of NPS. Taxes are indeed important, since, like expenses, they too tend to eat into the eventual returns. The NPS offer document is remarkably reticent on this issue by simply mentioning “tax benefits would be applicable as per the Income Tax, 1961 as amended from time to time”. Therefore, let us examine what the Income Tax Act (ITA) has to say about tax benefits as they stand now. First, let us take contributions or payments that an investor will make into his NPS account. As per most media reports,

contributions made to NPS are said to be deductible under Sec. 80C. Note that it is not Sec. 80C, but in fact Sec. 80CCD that extends the deduction. The aggregate limit on deductions under Sec. 80C, 80CCC (pension fund of life insurers) and 80CCD is Rs. 1 lakh. Possibly the confusion is caused by Sec. 80C(2)(ii) that offers deduction to effect or keep in force a contract for a deferred annuity…on the life of a person. Since NPS is not related with the life of a person, it is clear that this section does not cover NPS. It is interesting to find out why NPS was slapped on the employees of the Central Government, who have joined the service on or after 01.01.04. The previous pension scheme was not based on the contributions of the employee and benefited even those whose contribution was little, specially the ones who opted for VRS. The new employees had and have no choice. He has to contribute 10 per cent of his salary and a matching contribution would be made by the employer. FA07 extended the scheme w.e.f. 01.04.04 to the employees of any other employer. Moreover, now, w.e.f. 01.04.09, the NPS has been made available to any citizen of India (including an NRI with an Indian passport), between the ages of 18 to 55 years. This would mean that selfemployed persons or anyone who is not employed as such, will be able to take shelter under Sec. 80CCD

TAXTALK

as it stands today. In their case, while the minimum contribution to NPS is Rs. 6,000 per annum, there is no limit on the maximum that one can invest. Next, let’s examine the tax treatment of the maturity amount. As per NPS rules, no withdrawal is possible until the age of 60 years, except for critical illnesses and for buying or constructing a house. Thereafter, a minimum of 40 per cent of the pension wealth is to be used to purchase the annuity and the balance may be withdrawn as a lump sum. If withdrawal is sought earlier than the age of 60, say, when the person opts for an early Voluntary Retirement Plan or retires at the designated age of 56 or 58 as per the rules of the organisation, 80 per cent of the accumulated capital is to be used to buy a life annuity and the balance 20 per cent may be withdrawn as lump sum between the ages of 60 to 70 years. Therefore, basically, at maturity, tax incidence will have to be examined on both the lump sum as well as the annuity. As per the existing provisions, as laid out under Sec. 10(10A) of the ITA, any commutation of pension received under a pension scheme received from an insurance company is fully exempt. Commutation of pension is jargon for what essentially is receiving a lump sum within the permissible limits. Therefore, simply put, any lump sum received under a pension scheme of an insurance company is fully tax-free. NPS lump sums are governed by Sec. 80CCD(3), which taxes any amount received by the assessee or his nominee, along with the amount accrued thereon, if any, on account of closure or his opting out of the scheme or as pension received from the annuity plan. This means that the entire income stream from NPS (the lump sum as well as the annuity) would be fully taxable for the pensioner. This essentially makes NPS the first among the EET (Exempt-Exempt-Taxed) kind of instruments. It has been the stated intention of the government to gradually move to an EET type of taxation system from the current EEE (Exempt-ExemptExempt) architecture. Case in point-PPF.

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The upfront investment in PPF is tax deductible (the first E), the interest is tax-free (the second E) and the maturity amount is also fully exempted (the last E), thereby making it EEE. However, under the EET system, while the upfront investment will be reduced from your income thereby lowering the tax liability, and the accruals by way of interest or capital gains are also exempt, when the amount matures, the amount withdrawn, as per the rules as well as the annuity received as pension, is fully

You do not have to be an expert in financial analysis to realise that all other schemes, which are EEE in nature, are much more beneficial than this singular EET NPS. exigible to tax in the year of its receipt. You do not have to be an expert in financial analysis to realise that all other schemes, which are EEE in nature, are much more beneficial than this singular EET NPS. Compare this NPS with PPF, NSC, post office time deposits, Senior Citizen Savings Scheme, all life insurance plans, ELSS etc, which provide different courses for different horses. Any new scheme introduced, should have at least a small advantage over the existing schemes. Now, let us turn to other features: 1. Low cost. There are no agents or brokers for pushing the scheme. The annual cost of record keeping is Rs. 350. Each transaction will attract a cost of Rs. 20. Most importantly, the investment management fee is 0.009 per cent per annum, irrespective of the type of portfolio the account holder desires. Compare this with around 2 per cent charged by a mutual fund for equitybased portfolio. 2. The account holder can choose fund

manager, out of the 6 chosen by the authorities and also the type of portfolio (6 different mixes between corporate bonds, government securities and equity). He may also go in for a default option where the asset mix is changed automatically depending upon the age of the subscriber. The equity allocation will be maximum at 65 per cent when the age is below 35 years. From the 36th year onwards, the allocation to equity will be brought down steadily until it becomes only 10 per cent at an age of 60 years. The subscriber can change his fund manager once a year. 3. The transparency is poor. While the authorities force mutual funds to announce their NAVs on a daily basis, NPS would announce NAV on yearly basis. 4. As observed earlier, the liquidity is poor. However, there are plans to introduce Tier-II account, in which all the parameters would be identical with the normal Tier-I account but the withdrawals can be made anytime. This Tier-II will be comparable with any MF scheme and will behave like a savings bank account.

Summary The disadvantage of taxability of withdrawals and annuity receipts is so overwhelmingly large that it is difficult to accept that the advantage of low cost will counterbalance this. Obviously, anyone who makes his investments after careful appraisal would not opt for NPS, unless he is compelled to do so as is the case of those who joined government service after 01.04.04. There is no gain saying the fact that the sooner this NPS is changed from EET to EEE, the better it would be. I am tempted to quote here Benjamin Franklin who observed, “Taxes are indeed very heavy – We are taxed twice as much by our idleness. Three times as much by our pride. And four times as much by our folly.” (The author contributes to Investime regularly on matters of current interest) R