Rationalised taxes for pension plans

This budget could have embarked on the move towards comprehensive pension reform


Consider the pension scenario in India. Within the public sector, we have a traditional, defined benefit (DB) system for civilian employees, a defined contribution (DC) National Pension System (NPS) for recruits since 2004, and a wage-indexed DB pension for the armed forces.

Private sector employees in large firms get covered by the Employees’ Provident Fund (EPF) and the Employees’ Pension Scheme (EPS), or run their own exempt funds. Then there is the rest of India, of which some voluntarily open NPS accounts, or purchase mutual funds or insurance pension plans. Some in the informal sector contribute to the hybrid DB-DC Atal Pension Yojana (APY) launched in the budget last year. Some get a social pension in the form of the Indira Gandhi National Old Age Pension Scheme (IGNOAPS).

What is striking about the description is the complete inconsistency in the pension landscape. We have just promised expensive wage-indexed pensions to the armed forces but offer the poorly designed APY to the informal sector. We began giving the option to switch from the EPF to NPS but taxed these products differently. We offer different variants of the NPS depending on whether the contributor is a government employee or an ordinary citizen. We have been diluting the core design elements of the NPS without adequately arguing for the case for change. We run large deficits on the EPS.

We have little idea about the funding status of exempt funds. Problems in delivery of social pensions persist. Most of India remains uncovered.

This budget could have embarked on the move towards comprehensive pension reform. For this scale of possibility, it had three tangible things to offer:

8.33% of contributions to the EPS for first-time employees with salaries up to Rs.15,000 a month will now come from the government for three years.

That the EPS is in financial trouble has been known for long. Instead of reforming the EPS, and bringing out more transparency in its accounting, the government has decided to make the contribution of 8.33%.

The finance minister had promised to bring about portability between the EPFO and the NPS in the last budget. This year, he has walked in the opposite direction by making this choice difficult, and also diverting more taxpayer money into a scheme that covers less than 10% of the workforce.

 40% of the lump-sum withdrawal at retirement from the NPS, the EPF and other superannuation and provident funds will become tax exempt. Service tax on annuity purchase using 60% of NPS accumulations will be removed. Monetary limit for taxation of employers’ contribution to provident funds will become Rs.1.5 lakh.

There seems to have been rationalization in taxation of various pension products. The exemption of tax on 40% of withdrawals from the NPS, EPF and other superannuation and provident funds implies that the other schemes which were entirely EEE, will now be EET, for the remaining 60% of the withdrawals.

The service tax from the purchase of an annuity also seems to have been removed. The exemption on employer contributions to all of the funds have also been equalized. Such parity is a welcome move.

 Promises of foreign direct investment (FDI) in pensions and a social security platform linked to Aadhaar.

The promise of FDI in pensions and a social security platform linked with Aadhaar sound promising in theory. Similar promises have been made by previous governments; so much rests on the ability of this government to translate these promises into concrete action.

The budget has come through on one aspect of pension reform: rationalizing tax treatment across various existing pension products. It has, however, regressed on the issue of funneling money into EPS.

More importantly, it has failed on taking a holistic view of the pension system. By focusing on parametric changes, it has let go of the opportunity of systematic reform.

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