Making NPS more attractive for investors

Come Budget time and the buzz on expectations from the common man intensifies. This year is no different. Given the focus of the government in the past on pension for all through the National Pension Scheme (NPS), there is much expectation that the government would make this initiative more attractive. While NPS is being projected as an alternative to the provident fund scheme, it is yet not as popular. Let us understand more about this scheme.

NPS is open to all citizens of India in the age group of 18-60 years, can be an employer-driven scheme or be subscribed to in the individual capacity. The scheme is portable and gives the subscriber a choice of funds/investment options to choose from. It is also open to non-resident Indians and can be accessed online. NPS 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while partial withdrawal is permitted for specified purposes; significant portion of the contributions to NPS cannot be withdrawn until one reaches superannuation.

Upon withdrawal, 40% of the accumulated amount has to be utilised to purchase annuities and only the remaining 60% will be paid as lump-sum. Clearly, the NPS is focussed on providing pensions during the post-retirement sunset days, and is not comparable to the Provident Fund scheme, which ensures lump-sum savings.

Investors in NPS tend to compare the scheme’s architecture, which has mandated the purchase of annuity to provide for sustained regular income post retirement, with other options such as mutual funds, monthly income schemes and systematic investment plans etc. that may be perceived to be more attractive.

One of the concerns that investors in NPS have, is the tax impact. Favourable tax regimes still seem to be one of the major drivers that determine investment decisions. In the case of NPS, individuals’ contributions qualifies for deduction under Section 80C subject to the overall ceiling of ₹50,000 (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 ₹50,000 under section 80CCD (1B). Further, contributions made by the employer under the corporate model are also eligible for deduction up to 10% of defined salary.

So how is this very different from the tax treatment of PF? The answer lies in the structure and taxation of withdrawals. We have already seen that NPS does not permit 100% withdrawal unlike PF. While the mandatory transfer of 40% to annuity is tax exempt, out of the 60% that can be withdrawn as lump-sum, only 40 percent is tax-free and the remaining 20% would be subject to tax. Add to this taxation of annuity on receipt and the taxation scale seems to shift against NPS. As we know, PF continues to enjoy the “EEE” regime, which translates as “zero” tax on contribution, accrual and withdrawal. 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.

The government has recognised this and has taken steps for enhancing the lumpsum withdrawal limit to 60%. The Union Cabinet had approved the change in 2018 itself and it was expected to find a place in the interim Budget. Hence, this ranks high on the expectation list. The government could also exclude annuity from the tax net in the Budget proposals. Another area that could help in bringing investors back to NPS would be the option to change investment patterns/funds at any given time. While subscribers under the active choice mode do have the option to change the investment pattern, this can be done twice a year, which could be viewed as restrictive. By relaxing this provision and thereby permitting subscribers to change the investment pattern freely, anyone willing to take a higher risk could get better returns while those who want to take the safe route would also be protected.

It is also worth mentioning that currently, Tier II contributions are not eligible for deductions and it is available only for Tier I contributions. While there were reports that the government is exploring the possibility of removing this differentiation, it has not yet seen the light of the day. Extending the benefit of deduction to Tier II contributions would be a welcome change that can alter the dynamics for NPS.

Though the list of expectations from the Budget can be endless, it remains to be seen if and what would be fulfilled. With employment levels at a record low and a slowdown in GDP, the government has its task cut out in the Budget. It may be a challenge to provide tax sops that could further dent the exchequer.

The impact on the exchequer in respect of the above proposals would not be immediate and if implemented in the current Budget, could go a long way in making NPS an attractive pension scheme inviting more investments.

Saraswathi Kasturirangan is partner, Deloitte India, and Radhika Viswanathan is director, Haskins and Sells LLP.