NPS: Employer’s contribution can make a big difference

Amid so many worries in our working lives, the one which frequently haunts our minds is whether we will be able to lead a comfortable retired life — particularly if we are not entitled for any pension once we retire.

So how can you ensure a regular income stream after retirement?
Nowadays, there are various products available in the market specifically for the purpose of retirement planning, out of which some are purely debt-oriented, whereas others are equity-oriented and some are a combination of both.

The choice of the product depends on age, income and duration to reach retirement age besides a person’s risk appetite. One such pension scheme sponsored by the Government of India is the National Pension Scheme (NPS), which by virtue of its design aims at benefiting people when they retire.

But the real tax bonanza was given in the 2011 budget in respect of contribution by the employer to NPS which will go a long way in making the retirement planning more tax effective and useful.
Earlier, contribution of NPS by employer was included within Rs1 lakh limit of section 80C.

In the 2011 budget the finance minister excluded the contribution made by employer to your NPS account from the overall limit of Rs1 lakh. Now you can claim the deduction without any limit. However, this is subject to a restriction of 10% of your basic salary.

Tax treatment for contribution
If you have a Provident Fund account where your employer is also contributing, you are getting a deduction up to Rs1 lakh for this anyway. Here the contribution made by your employer up to 12.5% of your basic salary is exempt from tax.

However, any amount contributed by your employer to your NPS account is treated as part of your salary and is included in your income but you can claim deduction under Section 80C for this too — thus, effectively making it exempt from tax within the limit of 10% of your basic salary. This is very useful and tax efficient for you particularly if you fall in the maximum tax slab.

Tax treatment at the time of retirement
The contribution made towards NPS gets accumulated in your account till you reach the age of 60, after which you have the option to withdraw up to 60% of the accumulated balance. For the balance 40%, it is mandatory for you to purchase an annuity from any of the life insurance company registered with the Insurance Regulatory and Development Authority.

The annuity received by you for each year becomes taxable like any other income but since the annuity is received after you have retired from active employment, the effective rate of tax also comes down drastically.

After purchase of annuity to the extent of the mandatory 40% of the accumulated balance in your NPS account, you have full liberty to use the balance money as you wish.  Moreover, 60% of the balance in NPS received by you when you reach 60, is not taxable, thus for all practical purposes you save tax on 60% of the contribution made by your employer.

Tax benefits
In case you do not opt for NPS contribution by your employer up to 10% of your basic salary, you will have to pay tax on this amount received. If you are in the highest tax slab, you will only receive ¤70 in hand against Rs100 being invested.

In the long run, the difference of Rs30 of the tax component being saved through contribution in the NPS will translate into a substantial corpus.

Moreover, this is not just deferment of your tax, as you need to purchase annuity for only 40% of the balance, whereas the 60% is completely tax free. You can invest this amount in the instruments of your choice depending on your risk appetite. In case the rate of interest offered by banks on FD is attractive, you can supplement your annuity income with bank interest from FD.

Even as your employer is contributing to your EPF account, he can also make a contribution towards your NPS account. If this NPS contribution is not part of your salary structure, approach your HR department to get the salary restructured.

In addition to the tax benefits, this option of routing your savings helps you in ensuring compulsory savings in the long run. Once you have exercised the option of NPS contribution by your employer, he will deduct this money from your salary and remit the money to your NPS account.

This will ensure that you build a good corpus by the time you retire. This will also bring in some financial discipline for those who are not good savers by nature and tend to spend the money impulsively.

So open an NPS account not only to ensure a comfortable retirement but also to minimise your tax liability.

The writer is CFO, ApnaPaisa.com, a price comparison engine for loans, insurance and investments. He can be reached at balwant.jain @apnapaisa.com