The union cabinet today has cleared five changes to the national pension scheme (NPS). The most important of which is that the NPS now has EEE status and the corpus that you can withdraw is tax-free. EEE means, that the money you invest in the scheme (up to a limit) is exempt income tax (1st E), the growth of the money or profit while you remain invested is exempt from income tax (2nd E) and the corpus that you withdraw (subject to limits) is also exempt from income tax (3rd E). Here is what you should do now.
Prior to this announcement, NPS had a mix of EET and EEE status. That is, out of the final corpus, 40% has to be annuitized (that is, given to a life insurance company for pension), 40% was tax-free (EEE) and 20% was taxable as per slab (EET, T = taxable). Now the proposal essentially makes this 20% also tax-free. So do not get carried away assuming that you withdraw 100% tax-free. You can only withdraw 60% tax-free.
The other changes are:
- Higher employer contributions (14%) allowed for government employees NPS accounts
- Investments in Tier 2 by government employees will also qualify under 80 C deductions with a lock-in of 3 years (not clear about this final taxation)
- interest payment to be made in the case of delayed payout from the NPS
- Government employees can now choose the asset allocation (earlier they had a 15% fixed equity)
All five changes (incl EEE) will come into effect from April 1st 2019.
Should you invest in the NPS since it now EEE?
My take is, that you should not. Why? It still suffers from poor liquidity. If you quit before 60, 80% will be locked away for pension and you can only withdraw 20%. Do not delude yourself that you will only need the money when you retire at 60. Most people who are reading this will be too tired, too stressed out, too sick to work until 60.
EEE status for the NPS is a welcome move for all subscribers who joined the NPS only to reduce their taxable income by an additional Rs. 50,000. They will now get to pay less tax upon withdrawal (not zero as the pension will be taxable as per slab). However, please do not add more to NPS just because it is EEE. You will end up locking up your money, expose yourself to the performance risk of pension fund managers and lock up more money in an annuity.
I can now invest in NPS equity free of tax is it not?! No. The tax-free component has only gone up from 40% to 60%. If you think this is reason enough to be at the mercy of pension fund managers then good luck. Especially those who did not like index investing!
Buying a product that does not allow you to withdraw the full amount whenever you want only because part of the proceeds will be tax-free is silly.
I will agree that buying an annuity from a part of the retirement corpus is not a bad idea and is actually necessary for most people. However, why should I commit money to a scheme that itself will not give me a pension? I need to sign up with life insurers and only then get the pension. Look at the heavy price one will have to pay for EEE status. You can only work with pension fund managers who have more or less performed the same! So switching among them is not of much use. You cannot even say, I am retiring at 55, allow me to buy a pension for 40% of the corpus and give me the rest. You will have to wait until 60! Why? Because the government says so!
If I like a pension so much, I can get it from my EPF corpus and/or my stock or mutual fund corpus. I can manage this corpus anyhow I like, EPF gives me a high rate of return, I can withdraw anytime I want (75% of EPF before age 58) and I can do what I want with it, including getting a pension. People who appreciate this freedom will understand that the EEE status of NPS is cold comfort. I am pretty sure that most people aided by our wonderful media will not appreciate this fact.
Do not let the media fool you. EEE for NPS is not the same as EEE for PPF of EPF. Both PPF and EPF do not have any annuity requirements and a lock-in up to age 60
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