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Individuals up to 70 years can now join the National Pension System (NPS), with the pension regulator raising the ceiling from the previous 65. The maximum age at the time of maturity will be 75. Should senior citizens seize the opportunity? Mint explains:

How much pension does NPS give?

The pension is determined by your NPS corpus. Assume your NPS corpus is 50 lakh on maturity. You can use 50 lakh to buy an annuity—essentially, a pension plan. At current annuity rates of 9-10%, this means you will get an annual pension of about 5 lakh on this corpus. This pension stops when you die. However, there is a variant in which your heirs get back the purchase price ( 50 lakh in the example). The annuity rate for this type of pension variant is lower at 5-6% (annual pension of 2.5 to 3 lakh). Hence the key to getting a higher pension is to grow your corpus as much as possible.

What if you don’t want an annuity?

The annuity is a pain point for many, especially since annuity rates seem low. But note that you only need to use 40% of the corpus to buy the annuity. You can let the balance 60% grow till age 75 and withdraw it free of tax on maturity. As shown in the chart, if you use  12 lakh to buy an annuity at age 63, the balance 18 lakh grows to 43 lakh at age 75. This you can withdraw tax-free in lump sum or in 10 instalments, called phased withdrawal. Each such withdrawal is tax-free. The regulator may shift out the annuity purchase rule from three years to the maturity (which can  be  as late as 75 years), allowing your corpus to grow more.

The pay off
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The pay off

How are NPS contributions, withdrawals taxed?

You can get a tax deduction of up to 2 lakh each year on contributions to the NPS. Before maturity, there is no tax on NPS. On maturity, the NPS is partly taxed. In the above example, you can withdraw 43 lakh free of tax at the age of 75. You can use 12 lakh to get pension of 60,000 per year on which you pay annual tax of just 18,720, assuming that you are in the 30% bracket.

What are the alternatives?

In terms of cost and taxation, mutual funds are the closest competitors to the NPS. Equity mutual funds held for more than one year are taxed at 10% for gains above 1 lakh. Debt mutual funds held for more than three years are taxed at 20% and given the benefit of indexation. If you factor in indexation, the effective tax rate moves close to 10%, which is similar to the blended rate you pay on NPS corpus at maturity. But there is a hidden benefit to the NPS—it is tax-free to your heirs on death.

What are the drawbacks?

Under the current NPS rules, you cannot defer the annuity by more than three years, even though you can defer the non-annuity part (60% of corpus) till the age of 75. This means, if you enter the NPS at the age of 60, you have to buy the annuity at the age of 63. This stops about 40% of your income from compounding in a tax-free manner to a sizeable amount, even as the remaining 60% can compound. In addition, the annuity is taxable, so you end up getting taxable income which you may not need.

 

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