National Pension Scheme : A Tax Exemption or tax deferment

Year after year , pre-budget discussions in media build upon expectations to Taxpayers of higher exemptions and deduction limits, no matter what is the economy scenario and whether govt has manoeuvrability on the same or not. It was no different even this year.Almost all media houses predicted increase in deductions like Section 80(C) and raising of exemption limit. But Finance Minister was more than justified in disappointing the taxpayers owing to the tight fiscal situation.Still he came out with some increments and promised to provide more head-room , as and when fiscal situation improves. Lets have a bird view of his major announcements affecting our Taxation -

1. Exemption on transport allowance for salaried class increased from Rs. 800 per month to Rs. 1,600  per month. It will lead to an increase of Rs.9,600 in deductible income.
2. Exemption limit on health insurance for self and dependents have been increased to Rs. 25,000 from Rs.15,000. In most cases a family of 4 gets a health insurance of 5 lakh for about Rs.15,000, so very difficult to make use of this increase.
3. A new exemption of Rs.50,000 have been proposed for investment in National Pension Scheme under section 80CCD(1). This exemption is in addition to 1.5 lakh exemption already available for investment under Section 80(C) instruments, listed here
4. Wealth tax have been abolished. I hope most of us will not know that we were liable to pay tax on movable and immovable assets worth over 30 lakhs.But this rule won't be there anymore.
5. Govt will reintroduce tax free infrastructure bonds. Interest on these long term bonds will be exempted from income tax. Details are awaited on the same.

Out of the above features, its the National Pension Scheme (NPS) which has generated the maximum curiosity, as till now it was overshadowed by other alternates available under Section 80(C). Below is an analysis of the same -

What it is ?

It is a pension product being managed by professional fund houses appointed by Central Govt. Presently five fund houses (ICICI Prudential, Kotak, Reliance, SBI, UTI) are licensed to manage NPS.

Where does it invest ?

NPS is a diversified instrument having exposure to

• NIFTY stocks ONLY - In the ratio of their contribution to NIFTY Index
• Corporate Bonds - Debt instruments issued by corporates
• Government Securities - Debt instruments issued by central and state govts
• 
  

One has to declare his allocation of contribution among above fund categories.But equity exposure is limited upto 50% of the contribution only, i.e. one can allocate upto half of contribution to equity funds only.

You can also give the asset allocation discretion to the fund house, in which case they will allocate it as per your Lifestage needs, like e.g. those at younger age will have more exposure towards equity than those nearer to retirement phase.  

All five fund houses licensed for NPS have their respective funds under each of the three categories.

An NPS subscriber can choose only one fund house for all the three categories.

Fund House	Equity Fund	Corporate Bond Fund	Govt. Sec Fund
SBI Pension Fund	14.06%	11.88%	10.57%
UTI Retirement Solutions	13.78%	11.50%	10.20%
ICICI Pru Pension Fund	13.47%	11.36%	9.97%
Kotak Pension Fund	13.46%	10.85%	9.83%
Reliance Pension Fund	13.08%	10.41%	9.80%

Annualised Returns for Last Five Years for Different NPS Schemes Available

What are rules of Maturity or Withdrawal ?

NPS has a COMPULSORY provision of availing annuity out of total withdrawable corpus.There are two ways of withdrawal of the corpus -

1. When investor turns 60 - He/She needs to buy an annuity with at least 40% of the withdrawable corpus.
2. Before investor turns 60 - He/She needs to buy an annuity with at least 80% of the withdrawable corpus.

Rest of the amount can be withdrawn subject to applicable taxation as mentioned below.

What is Taxation ?

Apart from 1.5 lakhs exemption available under Section 80(C), NPS provides an additional Rs.50,000 exemption under Section 80CCD(1).

Additionally there is another limitless exemption under Section 80CCD(1B) where upto 10% of your basic and dearness allowance - contributed by your employer to NPS account in your name - becomes Tax free.

One can also replace Employee provident Fund contribution by NPS , but rules and guidelines for the same are still awaited.

But currently NPS comes under Exempt Exempt Taxed (EET) category, which means that even though investments upto applicable limits and interest or gain earned is Tax free , total corpus at the time of withdrawal becomes taxable. So , it practically means that it is more of TAX DEFERMENT instrument. You don't pay tax today but you will have to pay tax at the time of maturity on the total investments plus all the gains made.

To summarise following are the set of Pros and Cons -

Pros -

1. Additional Tax Exemption
2. Allocation across debt and equity instruments
3. Option of switching among Fund Houses

Cons -

1. Compulsory Annuity
2. Tax on the full withdrawal amount*
3. Equity allocation limited to 50%

While additional exemption may look tempting , but one should not invest in NPS for the purpose of availing tax benefit only. Decision to invest or not invest should be taken after a holistic consideration of all factors related to NPS and one’s need only.

* Experts believe that in future Govt will exempt withdrawal amount from tax according to global standards

We have made a list of all other exemptions available under section 80 C here. Let us know what do you think about this blog in comments or by writing to us on healthynivesh@gmail.com

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