The National Pension System was tweaked for flexibility but awaits tax clarity

Two, remove ambiguity on the taxability of the funds that remain in the NPS after the mandatory lump-sum to buy an annuity is taken out. The government introduced the NPS as a proactive measure to spare itself a pension burden that it would find hard to bear once the population has aged, reducing the proportion of those who work and pay taxes.

Paying the pensions of past employees from the taxes paid by current earners was clearly not sustainable. Under the NPS, pension is sought to be paid out of a saving corpus accumulated over the employee’s work life, with both the employer and employee contributing to it.

The British government has such a system of funded pensions even for its armed forces personnel, with an added guarantee of a top-up from the exchequer, should the pay-out fail to keep pace with inflation.

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India’s scheme is open to employees in the private sector and to self-employed individuals as well. All accounts are kept by a central record-keeping agency on a uniform platform. This brings down costs. An employee’s retirement saving account remains the same, with a permanent retirement account number (PRAN), even if jobs are switched.

Savers can invest in four different asset classes: equity, government bonds, corporate bonds and alternate investments. Savers can also choose their fund manager for each asset class. The NPS has one of the world’s lowest charges for fund management—about 0.06% of the assets managed, a sharp contrast with the 2% that mutual funds typically charge.

The scheme allowed savers to exit with the exit-funds falling in two baskets. One comprised 40% of the corpus, which must be used to buy an annuity designed to deliver a steady stream of income for the remainder of one’s life.

The remaining 60% had to be withdrawn as a lump-sum, anytime before reaching the age of 75. Recently, an NPS norm was tweaked to permit staggered withdrawals of the 60% portion, while the funds that remain in the account continue to earn a return.

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This grants the retiree a welcome degree of flexibility in how her savings are invested, with a chance to avail of the lowest fund management charges on the table. This fits in with the demographic and sociological changes underway in society.

Parents do not need to provide for their children in today’s world, nor are children often available to render care during old age, making an income stream with which to pay for such services more than desirable. How should systematic withdrawals be taxed?

Populist pressure made the government extend to NPS the same tax treatment that had been bestowed on the Employees’ Provident Fund: Exempt at the time of contribution (subject to a cap), exempt during accumulation and exempt at the time of withdrawal (EEE).

Since the lump-sum was tax-exempt, its withdrawal in stages should make no difference to its tax treatment. In fact, the government could go further.

It could give tax breaks to the portion that’s kept invested in the NPS for allocation to alternate investments, since an important chunk of these go into funding startups in sectors of strategic technological capability essential to the cause of India’s strategic autonomy.

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