The government has decided to make the National Pension System (NPS) withdrawal entirely tax-free. In a significant decision by the union cabinet last week, which was announced on Monday, the government has enhanced the tax exemption limit for lump sum withdrawal to 60%. With this, the entire withdrawal will now be exempt from income tax.
Currently, out of 60% of the accumulated corpus withdrawn by the NPS subscriber at the time of retirement, 40% is tax exempt and balance 20% is taxable. The Union cabinet which met last week has made this remaining 20% portion also tax-free. However, note that there is no change in the status of the 40% of the total accumulated corpus utilised for the purchase of annuity, which is tax-exempted at the time of purchase while it’s taxed at the time of payout.
The government has also made contribution by the government employees under Tier-II of NPS to be covered under Section 80 C for deduction up to Rs. 1.50 lakh for the purpose of income tax at par with the other schemes such as General Provident Fund, Contributory Provident Fund, Employees Provident Fund and Public Provident Fund. There will be a lock-in period of three years to be eligible for this. NPS is also eligible for an additional deduction of up to ₹50,000 under Section 80CCD (1b).
In another significant step, the government has also allowed central government employees to choose savings schemes offering equity exposure up to 50% of their corpus. Till now, central government subscribers of NPS can invest only 15% of their corpus in equity, while others (private sector) could invest upto 75%.
Here are the key reforms announced in the National Pension System (NPS) at a press conference on 10th December 2018 by Finance Minister Arun Jaitley.
- The NPS tax-free withdrawal will be hiked from 40% of the subscriber’s corpus to 60%. Since the balance 40% used for annuity purchase is also tax free, the NPS in effect becomes a 100% tax free instrument. However, note that the annuity (monthly pension) you purchase from the balance 40% NPS corpus is taxable. This reform is applicable to both government and private subscribers.
- Tax deduction under Section 80C will be extended to Tier II of NPS with a lock-in for 3 years for government employees. Currently it is only available under NPS Tier I and the lock-in is till the age of 60. However, this reform does not extend to private sector subscribers who will only get a tax-break in Tier I.
- Central Government employees will get to choose one of four NPS plans. They will be 0% equity, 15% equity (current default plan), 25% equity and 50% equity. At present, equity is capped at 15% for Central Government employees.
- Central Government employees will be able to select from amongst the eight pension fund managers in the NPS. Currently their money is split equally between the three public sector fund managers.
- Government contribution for the Central Government NPS subscribers will be hiked from 10% to 14%. However, employee contribution will remain the same (at 10%).
- If the employee chooses to convert his entire NPS corpus into an annuity (monthly pension), he will be guaranteed a minimum pension equal to 50% of last drawn salary.
- State Governments have to adopt these reforms for them to apply to State Government NPS systems. Currently all of the states in India have adopted NPS, except West Bengal.
When asked about the additional fiscal burden on the government due to these reforms, finance minister gave out a figure of Rs 2,800 crore for FY 2018-19. However, the burden is likely to grow significantly higher in future years. This is because NPS only applies to government servants who joined service after 2004. Most of these employees are still working. They are likely to start retiring in the 2030s which is when the pension guarantee of 50% of last drawn salary will kick in.
The reforms are a response to protests by government servants over poor NPS returns and low pensions. You can read our article highlighting this here. Although they address the concerns of government employees, private sector subscribers have been left out in the cold over most of these reforms.
More NPS stories here.