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A New Beginning for the NPS
The new zero-tax regime for the National Pension System is a very big deal for retirement savings
By Dhirendra Kumar | Dec 17, 2018
At long last, withdrawals made from the National Pension System after retirement have been made tax free. It was always clear that this would have to be done eventually, and before every Union Budget, some people have said so. I myself have written this every year since 2009. A couple of years ago, even a senior finance ministry bureaucrat said before the budget that this was a logical thing to do. However, this still had to wait till now to happen.
This finally brings NPS on par with EPF and PPF as far as taxation goes. In the provident fund schemes too, deposits are tax-free (up till the limit specified), the returns are tax-free when being earned, and withdrawals are tax-free too. In NPS, this third stage was not, till now, tax-free. In fact it had a split taxation structure, more complex than any other form of savings. 40 percent of the value has to be compulsorily used to purchase an annuity and this amount was tax-free. The remaining amount could be withdrawn and was taxable. Now, it's all tax-free.
While NPS is mandatory for government employees who have joined service after 2004, it's also available to private business' employees and to individuals acting on their own. Making NPS tax-free is a fundamental and far-reaching change in the retirement options available in our country. This is specially so now when long-term income from equity funds has been made taxable.
Now, a private individual can choose a high-equity option in NPS and save till the age of 60. At that point, the entire amount is tax-free, although 40 per cent must be put into an annuity. You could do the same with a mutual fund, but I suspect that in the new zero-tax situation, NPS may actually be a better choice. Compared to mutual funds (in fact, compared to anything else), NPS has extremely low cost. Over a long period of time, the benefit of low cost gets specially magnified due to compounding. Coupled with the new zero tax regime, this could well mean that NPS is a better retirement savings option than mutual funds.
Of course, one cannot be sure because precise forward-looking projections tend to be more fiction than fact, specially over the kind of long timeframes that retirement planning entails. However, my hunch is that NPS will more than match up to mutual funds now. For the long time-periods involved, another factor could be stability in rules and regulations. A retirement-oriented instrument like the NPS is likely to have a high degree of regulatory stability over long periods. This is specially so because it's closely tied to government employees. Moreover, when changes do come, will always be in the interest of investors rather than to their detriment. This is borne out by history. However, this has not been the case with mutual funds and stocks, witness the recent imposition of long-term capital gains tax on equity mutual funds and stocks.
All in all, this amounts to a drastic upgradation of NPS' suitability as a retirement option for any Indian saver. There are still some niggles but I fully expect those to get ironed out too well before the first generation of NPS retirements start for government employees. Of course, no one is going to come and try and convince you about NPS. The flipside of NPS' low cost is that there's no one to pay any commissions to agents and nowhere to pay them from. You'll have to learn about NPS yourself and push yourself to invest in it. Of course, investor-centric resources like Value Research are always there, but to take advantage of the rejuvenated NPS, you'll have to take the initiative yourself.