National Pension Scheme: It’s getting a leg-up but will tax rules be a let-down?
With greater flexibility on equity exposure and a higher lump-sum withdrawal limit, India’s revamped National Pension Scheme will soon be more attractive to retirement investors. But unresolved tax wrinkles need to be ironed out.
Come 1 October, a reformed National Pension System (NPS) will be put in place to eliminate some of its current rigidity. For one, non-government-employee subscribers will now have an option to invest their money fully in equities; they can decide whether they prefer their hard-earned savings to be parked in debt instruments or equity, or a mix of both, rather than have stiff rules dictate their asset allocation.
Further, pension fund managers will now have the freedom to customize this nest egg for the needs of various segments of investors. Those near retirement, for instance, may be offered debt-heavy portfolio plans to keep their principal safe, while early-stage investors may opt for equity-heavy plans to maximize capital gains over longer spans. Such bespoke products work better than a one-size-fits-all NPS.
Another problem that has been addressed is its cap on lump-sum withdrawals, which is currently set at 60%. Once new rules take effect, contributors will be able to withdraw as much as 80% of their NPS corpus, with the rest retained for funding pension annuities.
While the idea of an annuity-pool is to assure subscribers regular payouts, a 40% hold-back for it deters those who either do not want such a big chunk of their money locked up or prefer to deploy it themselves. A lower fraction held back should enhance the NPS’s appeal. From a policy perspective, NPS coverage expansion is better than having fewer people assured of larger pension payments.
Broadly, the moves are in the right direction. With India’s economy forecast to grow rapidly, equity returns should match its nominal output expansion over long stretches and prove to be a more lucrative choice than other asset classes.
Social security provisions in India are anyway weak. So, we need more people to pick investment avenues that enrich them rather than merely stay a nose ahead of inflation.
As it is, with the relative price stability granted by the central bank’s inflation-targeting regime, returns on debt have fallen. That is not to say we mustn’t invest in safe debt instruments. But a greater portion for most nest-egg creators, especially those at the start of their working lives, should go into equities.
By letting NPS subscribers go all-in on the stock market, some of the money going into mutual funds could flow into this scheme. Since it is state-run, it charges a far lower fee, the savings from which would add up to significant amounts over long tenures. In addition, NPS investment of up to ₹50,000 annually gets income tax exemption.
All this makes the NPS attractive even to those for whom participation is optional, like private-sector employees. Moreover, ever since the Centre’s launch of the Unified Pension Scheme (UPS) this year with a special payout assurance as an option for its employees, the NPS has needed a recast for others not to feel left behind.
That said, the annual NPS tax exemption is available only under the old income tax regime, so it would be nullified if all taxpayers are moved to the new system at some point. So far, the government has not said that the old regime will be phased out, but broad taxation clarity demands that we do not persist with a dual system for too long.
Another complexity is that the tax exemption on an NPS lump-sum withdrawal will remain set at 60%. Since the latter’s limit has been raised, income-tax rules need to be aligned accordingly.
These tax wrinkles should be ironed out quickly. With UPS switchovers likely, the NPS must keep enlarging its base.
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