On Monday, finance minister Arun Jaitley announced changes to the National Pension System (NPS), increasing the total tax-exempt cover to 100% of the NPS maturity value from 80% earlier.
Prior to this change, 40% of the total was annuitized without paying tax, 40% could be withdrawn tax-free and only the balance 20% was taxable. By the way, it is not clear why even the taxable portion was treated as income and taxed at the slab rate and not as long-term capital gains.
Even though the taxable component was only 20% of the NPS corpus at retirement, the quantum was high enough to push the taxable amount in the highest tax slab. This is one reason why the finance minister decided to allow exemption on the balance 20% portion as well.
How much more attractive has NPS become after this 20% has been made tax-free? According to our previous analysis
, we did not find NPS good enough, even after considering the various additional tax-deductions offered on the salary contribution.
There are two problems with NPS. One, the return of NPS could be lower than actively-managed mutual fund schemes. Over a very long time, even a 2% difference in return amounts to a very substantial amount of money.
Two, the saver is forced to put 40% of the NPS corpus at maturity in an annuity. This is a substantial amount which will earn low returns. And it is mandatory. Suppose your NPS corpus is Rs1 crore at retirement, Rs40 lakh would directly go toward purchasing an annuity product.
Currently, returns on annuities fetch pre-tax 6%, whereas, returns on government-sponsored products like Senior Citizen Savings Scheme and LIC’s Pradhan Mantri Vaya Vandana Yojana offer 8%+ returns to their investors.
We decided to quantify the effect of the recent changes in NPS vis-à-vis the older NPS rules for those in the 30% income-tax slab and, simultaneously, even compare it with the performance of investing in equity-linked saving schemes (ELSS) of MFs. This is what we found.
The above example shows that allowing total exemption on the NPS corpus will increase the post-tax retirement amount marginally. Importantly, it will do away with the hassles of calculating and paying tax on the withdrawn sum. However, equity MF schemes are more competitive in terms of performance, flexibility and taxation than NPS.
Also, the withdrawal process of NPS is a nightmare. After enquiring with a couple call centre executives of CRA-NSDL, the record-keeping agency of NPS, about the (now) tax-free status of withdrawals, we were dumbfounded with the responses received. One of the call centre executives herself was unaware that NPS was now tax-free; another executive told us that 60% of the maturity value was taxable (correct answer is 20%).
Other than being up-to-date with the latest changes, we found that our main query – whether the 20% taxable portion of withdrawal is taxed at the slab-rate or as capital gains–also took the executives by surprise. We were told to consult a chartered accountant for the taxation aspect. On the other hand, the same executives are fluent in the various tax-benefits and the Sections of the Income-tax Act under which the tax-exemptions can be availed.
Senior journalist R Jagannathan has described his own journey of withdrawing from NPS in this article
. He described the whole withdrawal process as “unnecessarily complicated and tiresome to the subscriber.”At retirement, when you want to spend a peaceful life, if you have to go through hassles of getting back your own money after savings for decades, it is not worth it.