The New Pension Scheme just got better

The New Pension Scheme (NPS), which has failed to take off despite its near-zero expense structure, is set to get a new lease of life.

If the revised discussion paper on the Direct Taxes Code (DTC) is passed into law, NPS, which was thrown open to all Indian citizens on May 1, 2009, could turn out to be the best way to build a retirement kitty.

DTC seeks to replace the archaic Income Tax Act of 1961.
The discussion paper places NPS in the exempt-exempt-exempt (EEE) category, meaning investments in the scheme, returns earned during the tenure and the amount received at maturity will all be tax exempt.

Currently, investments into NPS come under the exempt-exempt-tax (EET) category, wherein the amount received at maturity is taxable. This has worked against the scheme, considering the other modes of saving tax are in the EEE category.

This could change and soon. “It is proposed to provide the EEE method of taxation for Government Provident Fund, Public Provident Fund (PPF) and Recognised Provident Funds and the NPS administered by Pension Fund Regulatory and Development Authority. Approved pure life insurance products and annuity schemes will also be subject to EEE method of tax treatment,” the discussion paper stated.

“As per the revised discussion paper New Pension Scheme, Public Provident Fund or Superannuation Fund will not be taxed during contribution, accretion and withdrawal,” said Parizad Sirwalla, partner - tax, B S R and Co. “Under NPS there was some ambiguity which has now been clarified,” she added.

NPS is a tool where someone between 18 and 55 years can invest a minimum of Rs 500 four times a year or Rs 6,000 annually. The permanent retirement account number needed for NPS investment can be opened at various centres including select bank branches and even India Post offices.

Also, NPS uses the equity route partially to build a retirement kitty, which the Employees Provident Fund (EPF) and PPF do not. Other products that help one build savings using the equity route, such as tax-saving mutual funds and unit-linked insurance plans, have now been put under EET and hence the tax works out to be in favour of NPS.

“Any fresh investments in new instruments such as Ulips will be taxed at withdrawal. Though the final fineprint is yet to be seen, in case of new investments in mutual funds and Ulips, withdrawals made later will be taxed,” Sirwalla said.

Insurance products where pure life insurance cover is provided will continue to enjoy the benefits of tax-free maturity proceeds.
Suresh Surana, founder and director at RSM Astute Consulting, said, “As pure life insurance products are specifically mentioned, looks like Ulips may not be covered and hence redemption in fresh Ulips should be taxable as per the discussion paper. So, to that extent, NPS may be having an edge over units of MF or over Ulips in terms of beneficial tax treatment.”

But this is not to say that those who have already made investments in Ulips or tax-savings mutual funds should start fretting. Withdrawals made in only fresh investments in these instruments after the DTC comes into effect will be taxed.
NPS also has the benefit of lower expenses —- at as low as 0.0009% a year, its fund management charges are the lowest in the market.

A 30-year-old who invests Rs 10,000 per quarter in NPS, and invests for the next 30 years, would have accumulated Rs 68-69 lakh at the end, assuming the investment generates a return of 10% per year. A similar investment in a unit linked insurance plan (Ulip) offered by any of the insurance companies would generate around Rs 55.6 lakh, a difference of Rs 12.4 lakh, assuming a fund management charge of just 1%.

Again, this Rs 55.6 lakh is earned before tax is paid. If Ulips are brought into the EET regime, someone in the top tax bracket of 30% would pay a tax of Rs 16.6 lakh on maturity and would take away around Rs 38-39 lakh, which would be lesser by Rs 30 lakh in comparison to Rs 68-69 lakh earned in case of NPS.

Ulips have a fund management charge of 0.75-1.75% of the value of the investment every year. NPS, on the other hand, has a fund management charge of 0.0009%. To give readers a sense of proportion, even at the lower level of 0.75%, the fund management charge of insurance companies is over 800 times more than that of the fund management charge of NPS. At the upper level of 1.75%, the fund management charge of Ulips is around 2,000 times the fund management charge of NPS.

The cherry on the pie is the additional benefit NPS subscribers get if they invest in this financial year, as announced in the Budget in February 2010. “To encourage the people from the unorganised sector (non-government employees) to voluntarily save for their retirement and to lower the cost of operations of the NPS for such subscribers, government will contribute Rs 1,000 per year to each NPS account opened in the year 2010-11,” finance minister Pranab Mukherjee had said in his Budget speech.

This initiative is called “Swavalamban” and all those who start investing in NPS this year and park Rs 1,000-12,000 per annum between April 1, 2010 and March 31, 2011, will get the additional fund allocation from Rs 100 crore set aside for this scheme. Even though NPS is expected to move onto the EEE regime only in April, 2011, it might be good to start to investing in it to get the Rs 1,000 per year the government plans to invest in every NPS account for three years.