Budget 2015 brought the National Pension System (NPS) back into the limelight by announcing an additional deduction of Rs. 50,000 for the same. But before going into those details, let us first understand what NPS is all about.
For starters, the NPS is a defined contribution pension scheme. Originally, only Central Government Employees joining service on or after 1.1.04 were eligible to avail of this scheme. Later, it was extended to employees of any other employer and also to any citizen of India (including an NRI but not a PIO having bank account in India) between the age of 18 and 55. They have to contribute annually 10% of their salary to NPS. A matching contribution would be made by the employer.
In order to give a fillip to this scheme, the FM has proposed a separate deduction of Rs. 50,000 over and above the current deduction of Rs. 1,50,000 available u/s 80CCE for contributions to NPS. Consequently, now it is possible for a taxpayer in the 30% tax bracket to save up to Rs. 15,450 in tax every year over and above what he could do so far.
Salient Features
There are two types of accounts –– Tier-I and Tier-II. Tier-I is geared towards retirement and has restricted liquidity. Withdrawal is possible only between the age of 60 and 70 years except for critical illnesses and for buying or constructing a house. On attaining 60 years of age and up to 70 years, the investor has an option of withdrawing a minimum of 40% of the pension wealth in order to purchase a life annuity. If withdrawal is sought earlier than age 60, say, when the person opts for early VRS or retires at the designated age, 80% of the accumulated capital is to be used to buy a life annuity. At the age of 70, the entire amount may be withdrawn.
Tier-II accounts are add-ons having all the parameters identical with the Tier-I, but there is no restriction on any amount of withdrawals any number of times, provided a minimum balance of Rs. 2,000 is maintained at the end of the FY.
Any individual can opt for such add-on only after he has contributed at least the minimum contribution to Tier-I. This Tier-II is comparable with say a tax saving mutual fund or even a savings bank account.
Low Cost — The investment management fee is as low as 0.0009% p.a., irrespective of the type of portfolio the account holder desires. Yes, there are some small fees charged for various purposes, but it is claimed that all these put together makes NPS having a very low cost for its management.
The corpus will be invested in three asset classes –– Equity (E), Government Securities (G) and Corporate Bonds and Fixed Deposits (C).
The account holder can opt for an active choice (change any time) of the asset mix he desires to have or a default option called Life Stage Fund where the asset mix gets changed automatically depending upon the age of the subscriber. At the age of 18 years, the asset allocation would be 50% in E, 30% in C and 20% in G till the investor turns 35 when the ratio of investment in E and C will then decrease annually, while the proportion of G will rise. At 55 years, G will account for 80% while the share of E and C will fall to 10% each.
Because of the link of NPS with equities, you may stagger your investments in some installments like the SIP of a mutual fund. However, take account of the fact that there is a transaction charge of 0.25% or Rs. 20 (whichever is higher) on every contribution.
Minimum annual contribution is Rs. 6,000 per FY payable in one or more installments of minimum Rs. 500 to Tier-I. For Tier-II the minimum amount is Rs. 250 per contribution and also per FY.
Transparency could be improved. Whereas Mutual Funds have to announce their NAVs on a daily basis NPS would announce NAV on yearly basis.
Tax Treatment
The Finance Act 2011 has clarified that the contribution of the employer to the extent it does not exceed 10% of the employee’s salary is not a part of the limit on contribution of Rs. 1,50,000.
Contributions made by an individual to his NPS account are deductible u/s 80CCD. The ceiling on contribution in the case of an employee is 10% of his salary and in any other case, 10% of his gross total income. Salary includes dearness allowance if the terms of employment so provide, but excludes all other allowances and perquisites.
Unfortunately, NPS withdrawals (including employer’s contributions) are governed by Sec. 80CCD (3) which taxes any amount received by the assessee, including the annuity. It is also taxable in the hands of the nominee who has the option to own the scheme and continue the contributions, if he is eligible to do so.
Consequently, the entire income stream from NPS (the lump sum and the pension) is fully taxable. This essentially makes NPS the first among the EET (Exempt-Exempt-Taxed) kind of instruments. This is the greatest drawback. The other drawback is the compulsion of buying an annuity with 40% of the corpus if withdrawals are effected when the assessee’s age is between 60 and 70 years.
On the plus side, NPS is slated to provide higher returns because a part of its corpus can be parked in equities and moreover, the cost of managing the NPS is very low.
For clarity, assume that you have invested Rs. 50,000 in NPS for 20 years and the returns are 12% p.a., resulting in the corpus rising to Rs. 36.03 lakh. If it is taxed @30.9%, the value will be fall to Rs. 24.89 lakh. The same amount invested in EPF @8.5% will grow to Rs. 25.58 lakh and it is tax-free. Realise that NPS invests maximum 50% of your contributions in equities and that too in Nifty Index whereas the MFs have no such restrictions.
Fortunately, this extra contribution up to Rs. 50,000 under Tier-II is not taxable at its withdrawal. But you need to possess a Tier-I account and contribute minimum of Rs. 6,000 before you go for Tier-II.
To Sum
At the end of the day, NPS has both positives as well as some negatives. On the one hand is the taxability factor at withdrawals (even in the hands of a nominee) and also of annuity receipts but on the other hand is the extremely low cost as compared to any other saving product. Only time will tell which factor would prove to be more decisive.
For starters, the NPS is a defined contribution pension scheme. Originally, only Central Government Employees joining service on or after 1.1.04 were eligible to avail of this scheme. Later, it was extended to employees of any other employer and also to any citizen of India (including an NRI but not a PIO having bank account in India) between the age of 18 and 55. They have to contribute annually 10% of their salary to NPS. A matching contribution would be made by the employer.
In order to give a fillip to this scheme, the FM has proposed a separate deduction of Rs. 50,000 over and above the current deduction of Rs. 1,50,000 available u/s 80CCE for contributions to NPS. Consequently, now it is possible for a taxpayer in the 30% tax bracket to save up to Rs. 15,450 in tax every year over and above what he could do so far.
Salient Features
There are two types of accounts –– Tier-I and Tier-II. Tier-I is geared towards retirement and has restricted liquidity. Withdrawal is possible only between the age of 60 and 70 years except for critical illnesses and for buying or constructing a house. On attaining 60 years of age and up to 70 years, the investor has an option of withdrawing a minimum of 40% of the pension wealth in order to purchase a life annuity. If withdrawal is sought earlier than age 60, say, when the person opts for early VRS or retires at the designated age, 80% of the accumulated capital is to be used to buy a life annuity. At the age of 70, the entire amount may be withdrawn.
Tier-II accounts are add-ons having all the parameters identical with the Tier-I, but there is no restriction on any amount of withdrawals any number of times, provided a minimum balance of Rs. 2,000 is maintained at the end of the FY.
Any individual can opt for such add-on only after he has contributed at least the minimum contribution to Tier-I. This Tier-II is comparable with say a tax saving mutual fund or even a savings bank account.
Low Cost — The investment management fee is as low as 0.0009% p.a., irrespective of the type of portfolio the account holder desires. Yes, there are some small fees charged for various purposes, but it is claimed that all these put together makes NPS having a very low cost for its management.
The corpus will be invested in three asset classes –– Equity (E), Government Securities (G) and Corporate Bonds and Fixed Deposits (C).
The account holder can opt for an active choice (change any time) of the asset mix he desires to have or a default option called Life Stage Fund where the asset mix gets changed automatically depending upon the age of the subscriber. At the age of 18 years, the asset allocation would be 50% in E, 30% in C and 20% in G till the investor turns 35 when the ratio of investment in E and C will then decrease annually, while the proportion of G will rise. At 55 years, G will account for 80% while the share of E and C will fall to 10% each.
Because of the link of NPS with equities, you may stagger your investments in some installments like the SIP of a mutual fund. However, take account of the fact that there is a transaction charge of 0.25% or Rs. 20 (whichever is higher) on every contribution.
Minimum annual contribution is Rs. 6,000 per FY payable in one or more installments of minimum Rs. 500 to Tier-I. For Tier-II the minimum amount is Rs. 250 per contribution and also per FY.
Transparency could be improved. Whereas Mutual Funds have to announce their NAVs on a daily basis NPS would announce NAV on yearly basis.
Tax Treatment
The Finance Act 2011 has clarified that the contribution of the employer to the extent it does not exceed 10% of the employee’s salary is not a part of the limit on contribution of Rs. 1,50,000.
Contributions made by an individual to his NPS account are deductible u/s 80CCD. The ceiling on contribution in the case of an employee is 10% of his salary and in any other case, 10% of his gross total income. Salary includes dearness allowance if the terms of employment so provide, but excludes all other allowances and perquisites.
Unfortunately, NPS withdrawals (including employer’s contributions) are governed by Sec. 80CCD (3) which taxes any amount received by the assessee, including the annuity. It is also taxable in the hands of the nominee who has the option to own the scheme and continue the contributions, if he is eligible to do so.
Consequently, the entire income stream from NPS (the lump sum and the pension) is fully taxable. This essentially makes NPS the first among the EET (Exempt-Exempt-Taxed) kind of instruments. This is the greatest drawback. The other drawback is the compulsion of buying an annuity with 40% of the corpus if withdrawals are effected when the assessee’s age is between 60 and 70 years.
On the plus side, NPS is slated to provide higher returns because a part of its corpus can be parked in equities and moreover, the cost of managing the NPS is very low.
For clarity, assume that you have invested Rs. 50,000 in NPS for 20 years and the returns are 12% p.a., resulting in the corpus rising to Rs. 36.03 lakh. If it is taxed @30.9%, the value will be fall to Rs. 24.89 lakh. The same amount invested in EPF @8.5% will grow to Rs. 25.58 lakh and it is tax-free. Realise that NPS invests maximum 50% of your contributions in equities and that too in Nifty Index whereas the MFs have no such restrictions.
Fortunately, this extra contribution up to Rs. 50,000 under Tier-II is not taxable at its withdrawal. But you need to possess a Tier-I account and contribute minimum of Rs. 6,000 before you go for Tier-II.
To Sum
At the end of the day, NPS has both positives as well as some negatives. On the one hand is the taxability factor at withdrawals (even in the hands of a nominee) and also of annuity receipts but on the other hand is the extremely low cost as compared to any other saving product. Only time will tell which factor would prove to be more decisive.
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