The latest Union Budget has made significant tax concessions for withdrawal from NPS corpus at the time of retirement. In this post, I will discuss these budget proposals pertaining to NPS.
Please understand this is my initial understanding of the budget proposal. I will update the post as I develop better clarity.
Up to 40% of accumulated corpus exempt from Income Tax
In the latest budget proposal, 40% of the accumulated NPS corpus has been made exempt from income tax. This is a significant move.
NPS used to fall in Exempt-Exempt-Tax (EET) category. With this move, at least a part of the accumulated corpus is exempt from income tax. So, with this move, NPS lies somewhere between EET and EEE category.
Please note the tax exemption is only for the withdrawal at the time of retirement. If you withdraw before retirement, this exemption is not available.
So, of the accumulated NPS corpus at the time of retirement,
- 40% of the corpus is exempt from income tax. You can withdraw this amount lump sum and will have to pay zero tax.
- 40% of the corpus must be mandatorily converted to annuity. Annuity (or pension) income will be taxed in the year of receipt. You will be taxed at marginal income tax rate (income tax slab) on this annuity income.
What happens the remaining 20%?
For the remaining 20%, you have multiple options.
You can either choose to purchase annuity for this amount too. If you opt for annuity, annuity will be taxed in the year of receipt (as mentioned in point b).
Alternatively, you can withdraw this 20% along with the 40% (which is exempt) at the time of retirement. So, essentially, you withdraw 60% lump sum at the retirement. As the rule goes, only 40% is exempt. You will have to pay income tax on the remaining amount. This is a bad idea.
You have a way out. As I had discussed in one of my earlier posts, there is an option to withdraw from NPS in up to 10 annual (not necessarily equal) installments. You can withdraw this amount over the next 10 years as and when you need (or in the years where you tax liability is lower).
Additional Read: Common Doubts about NPS
Do note some of the aforementioned posts are dated. I will update these posts in due course of time.
If you withdraw from NPS before retirement, you can only withdraw 20% as lump sum and the remaining 80% is to be mandatorily used to purchase annuity plans. The latest proposal will also discourage investors from exiting from NPS before retirement.
Reduction in Service Tax
Since 40% of the accumulated corpus has to go towards purchase of annuity, there is an additional move in the budget proposal that is beneficial to investors. Annuity services provided by National Pension System (NPS) have been made exempt from income tax.
This will improve periodic annuity income to a certain extent. Earlier, the applicable service tax rate was 3.5%.
Tax Treatment in the event of death of NPS Subscriber
In the event of demise of NPS subscriber, the entire NPS amount (drawn as lump sum) shall be exempt from Income Tax.
As I understand, the exemption is only for lump sum withdrawals in the event of demise of NPS subscriber. In the nominee chooses to purchase annuity (or has to purchase annuity as per NPS rules), the annuity income will be taxable in the year of receipt.
Portability from EPF (or recognized provident fund) to NPS
As one time exemption, you can port your EPF investments to NPS without attracting any tax. This is useful for such investors who want to switch from EPF to NPS.
You will need a lot of support from your employer in this matter.
With the latest proposals in the budget, the case of NPS is quite strong at least from the taxation viewpoint. Before these moves, NPS was essentially tax deferral. However, now, you can see some serious tax benefit from investing in NPS.