The tax squeeze of the New Pension Scheme
While the focus of the NPS has been its lower charges, relative to other pension schemes, the tax implications on your investment, which is pretty much locked in until you retire, can be dire.
The New Pension Scheme (NPS) is ostensibly a tax-friendly retirement scheme with nominal costs. This is what you’ll remember if you’ve just been skimming personal finance sections since 2009, when the scheme was launched. The fact that you can get a deduction under Section CCD (1), aside from the low fund management charges, has been reported regularly. But this is a narrow view of the NPS. A critical assessment of how returns are taxed under the NPS will reveal that the scheme may not deliver the great returns it promises.
Deduction under Section CCD
You can receive tax benefits on up to 10% of your total income under Section 80CCD (1). However, the total of your deductions under this section, coupled with Section 80C, can be no more than Rs1 lakh. So if you plan to keep investing in public provident fund or employees’ provident fund or have a life insurance policy, it’s possible that you will receive no tax benefit under the above-stated section. While you could reduce your taxable income by 10% of your basic salary under Section 80CCD (2), your company needs to be registered with the NPS for you to be eligible for this benefit. Currently, only a few large companies, such as Wipro and Crisil, are registered.
You can’t withdraw your investment in NPS until you retire. But even when you do retire, the money isn’t immediately all yours. It’s a retirement product, remember? So the scheme decides when and how much money you need even in retirement. In its current form, you may withdraw no more than 60% of the money. This money that you withdraw isn’t tax-free either. While a change has been proposed under the Direct Tax Code, NPS currently comes under exempt-exempt-tax system. So while contributions could be tax-free, withdrawals are always taxable. With the rest of the money (40% of the corpus), you must buy an annuity. Under an annuity, which typically earns returns of 5-6%, periodical payments will be made to you. Now this amount is also taxable. What’s worse is that you won’t just be paying taxes on the gains. If your income is taxable at 20%, the entire amount will be taxable.
If you find this to be a scary picture, consider the following situation. If you retire before you turn 60, you do have the option of withdrawing your funds from the NPS. However, under this scenario, a whopping 80% will be invested in the annuity, while just 20% will be given to you. Now imagine 80% of your so-called retirement corpus being fully taxable at the slab rate when you need it most. Unless the NPS is given exempt-exempt-exempt status, as promised under DTC, it may be best to stay away.