In India, we have retirement and tax-saving investments. It's time that instead of investments, we had retirement and tax-saving accounts. This will help savers switch between investments according to their changing needs and without paying an unfair tax. While it would seem pointless to suggest something to the government that would reduce taxation, the provision for such accounts was there in the draft of the now-forgotten Direct Tax Code, so it's not some radical new concept. It exists in countries like USA, UK, Australia and many others and was actually codified by the Government of India years ago into the statute that was supposed to be the replacement for the antiquated Income Tax Act.
The idea is quite simple. Each person who's saving for retirement would have a 'Retirement Benefit Account' (RBA), which was the exact term used in the Direct Tax Code. Any investment that you put into this account would be part of your pool of retirement savings and would have whatever tax breaks that the government gives to retirement savings. In the current system, such an investment gets locked-in till you retire or die. In the account system, this lock in would apply only to the account as a whole. As your needs and understanding grow, and the alternatives available evolve, you could switch from one option to another. Since the lock-in would apply to the account as a whole, and not to individual investments in it, selling such investments would not attract capital gains as long as the money was redeployed in investments that would also be kept in the account. Essentially, the RBA would be a one-way account into which money can only be put till retirement or death, but cannot be taken out.
The main advantage of an RBA is flexibility and a closer match to the saver's needs. Retirement savings are something that commence in a saver's mid-20s and continue accumulating till 60 or 65. That's 40 years. Then, they have to be managed and spent over another 20 or 30 years. That comes to a total of up to 70 years. Having a rigid structure that doesn't easily allow for changing options and needs may satisfy the government's desire to be able to extract tax easily, but gives a raw deal to citizens.
How hard would be the RBA to implement operationally? Well, the RBA proposal that was there in the Direct Tax Code draft of 2009 was dropped later in a revised draft. The reason given was that it would be too difficult to implement technically. Here's what the June 2010 revision of the DTC said. "Maintaining individual Retirement Benefits Account by permitted savings intermediaries on behalf of all employees would require a centralised nationwide authority to regulate and manage crores of retirement benefits accounts of employees and to deduct tax on withdrawal which entails creation of a separate institutional mechanism, complex logistics and substantial costs."
However, given the kind of nationwide information systems that are running now, this does not sound like a tenable reason. In fact, such a system would be almost identical in concept to the demat system, which has now worked well for more than a decade. Everything costs something, and the above objection was clearly made without thinking through the real trade-offs between the pros and the cons. If retirement savings are made flexible, then it would actually give impetus to the quantum of savings that people manage to do.
There could also be an additional benefit if the annual tax-saving investments are also part of the same system, along with a clear path for converting these to retirement savings. Like many other parts of our tax system, the retirement and tax-saving investment structure is based on an outdated set of assumptions on to which half a century of ad hoc modifications have been layered. They are a poor fit to the way people actually save and use their savings. It's time to revive this fundamental change that was abandoned with the DTC.
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