NPS Withdrawals Now Tax-Free! Can You Depend On It For Your Retirement?
Dec 17, 2018

Author: PersonalFN Content & Research Team

On December 06, 2018, the union cabinet took some reformatory decisions about National Pension System (NPS) that will reward approximately 18 lakh government employees.

Key changes to NPS…

  • The central government will increase its contribution to the tier-1 accounts of all government employees from the current 10% (of basic plus DA) to 14%.

  • Contribution of government employees to tier-2 accounts will get them income tax deduction under Section 80C upto Rs 1.5 lakh provided they remain invested for 3 years.

  • At the time of withdrawal, 60% of the amount won’t attract any tax. The remaining 40% amount, which has to be mandatorily utilised to buy an annuity, is exempt from tax even at present. With this, all NPS proceeds would be completely tax-free. NPS is now at par with other retirement-oriented schemes such as Employees’ Provident (EPF) Fund and Public Provident Fund (PPF) among others.

  • Now government employees can select pension funds and investment patterns more conveniently. Clarity on this point is awaited.

Pension reforms targeting multiple objectives…

Once upon a time, finding an employment opportunity in a government department was an achievement.

Only government jobs had a dependable pension scheme sponsored by the government. From the defined benefit model, the government switched to defined contribution pension model from 1st January 2004. In other words, the government didn’t guarantee any particular amount of pension and it didn’t entirely foot its bill.

This was one of the many reasons why the then NDA government lost the Lok Sabha 2004 elections.

Fast forward to 2018, the present government seems to be taking every voter cautiously, especially after BJP lost three important states to the opposition parties. After all, 18 lakh households can play a crucial role in deciding the fate of any government.

Although the intent here is not to discredit the government’s efforts in introducing the pension sector reforms in India, the timing of introducing such changes hints at other objectives as well.

The government is likely to shell out around Rs 2,840 crore in FY 2019-20 to fulfil the promise of contributing 4% more to the NPS accounts of government employees.

The government’s press release on NPS reforms talks primarily about the changes introduced for government employees, barring that of tax exemptions applicable to all NPS subscribers on the lump sum amount at the time of withdrawal. The government is yet to clarify if the contribution of subscribers other than government employees under tier-2 account will qualify for deduction under 80C of Income Tax Act.

If you think that NPS will take care of your retirement, read further.

As reported by the Economic Times dated December 11, 2018, HDFC Pension Fund has come out with an interesting finding. It says, at 10% contribution from an employee and 14% contribution from the government, a subscriber can accumulate a corpus which will be enough to generate a pension of approximately 64% of one’s last drawn salary.

NPS alone can’t fulfil your retirement needs…

Unlikely. It’s noteworthy that although the proceeds of NPS are tax-free, the pension is still taxable.

Moreover, going by the study of HDFC Pension Fund, pension equivalent to 64% of one’s last drawn salary would look insignificant when adjusted for inflation. If you live 20-25 years post-retirement, an annuity of an amount equal to approximately 2/3rd of your last drawn salary would be inadequate for you.

What’s the way out?

If you haven’t done retirement planning until now, you shouldn’t delay it further. While NPS remains a good retirement saving option, at least for government employees, you should invest in other investment alternatives as well which include PPF and mutual funds among others.

Why is retirement planning necessary?

  • To meet daily expenses post-retirement

  • To address medical emergencies

  • To deal with contingencies (Situations such as natural calamities, theft, fire, loss of loved ones, etc., wreak havoc emotionally and financially) 

  • To counter the negative effects of inflation on your household budgets 

  • To be financially independent

To estimate the amount you need for a blissful retirement, use PersonalFN’s retirement calculator, an online tool that helps you calculate your retirement corpus. Further, you can use this Retirement Calculator to find out the future value of your current expenses.

PersonalFN’s retirement calculator requires some basic inputs from your side, such as your retirement age, life expectancy, inflation, expected return on investments, your current portfolio size and expected retirement expenses. The calculator will help you recognise how much you need to grow your wealth before you hang your boots up and plan accordingly.  Upon utilising this, you will realise that inflation is the biggest hurdle in your retirement planning.

And as we have seen earlier, fixed income instruments such as FDs don’t help in wealth creation because they can’t keep up with inflation.

What’s the suitable option then?

If you invest in diversified equity mutual funds through Systematic Investment Plans (SIPs), you would be able to build a sufficient corpus for your retirement.

A monthly SIP of Rs 15,000 in a worthy diversified equity fund can help you accumulate Rs 1.5 crore over 20 years and Rs 2.8 crore over 25 years, assuming you clock a 12% rate of return. If your investments fetch you 15% returns, the SIP will accumulate Rs 2.2 crore over 20 years and Rs 4.9 crore over 25 years.

That’s the power of compounding which makes equity mutual funds a perfect investment avenue for retirement planning.

Moreover, investing in direct plans offered by mutual funds can fetch you even higher returns.

Watch this video to know how to select a winning mutual fund for your retirement

While investing in mutual funds for your retirement, you may adopt a time-tested core and satellite investment strategy.

Editor’s note:

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