In Union Budget 2016, the Finance Minister proposed a one-time tax exemption to EPF subscribers to switch to NPS. There will be no tax levied for making such a switch from EPF to NPS.
Do note the transfer from EPF to NPS is only approved on paper. Many modalities are still being worked out. You can expect opposition from various quarters. However, since the switch is voluntary, you can expect such an option being available to EPF subscribers in the near future.
How can you Shift from EPF to NPS?
PFRDA (the pension regulator), came out with a circular dated March 6, 2017 detailing the process for shifting your funds from your EPF account to NPS Tier I account. You can go through the circular for the exact process.
Relevant changes have also been made to Section 10 of the Income Tax Act so that withdrawal from EPF (for investment in NPS) is not considered taxable income.
Additionally, such transfer amount will NOT be considered contribution of the subscribers for the purpose of taking income tax benefits. For instance, if you transfer Rs 10 lacs from EPF to NPS, the amount will not be considered for tax benefit under Section 80CCD in the concerned financial year.
Now the big question.
Given an option to switch from EPF to NPS, will you switch?
My answer is No. You must not switch from EPF to NPS.
Let’s see why.
1. EPF vs NPS: Taxation of maturity proceeds
EPF is EEE, NPS is EET.
Even though NPS has been offered many relaxations in the past union budgets, it remains an EET (exempt-exempt-taxable) product.
Up to 40% of the accumulated corpus at retirement is exempt from tax.
At least 40% of the corpus has to be used to purchase an annuity plan. Annuity income is taxed in the year of receipt.
Remaining 20% can either be withdrawn as lump sum (till the age of 70 in up to 9 annual installments or added to the amount used to purchase an annuity plan.
Even though there are ways to reduce your tax liability by withdrawing NPS corpus smartly, you won’t be able to save tax beyond a limit, especially if the NPS retirement corpus is large.
And NPS retirement corpus can get large if you invest heavily in NPS (which will be the case if both you and your employer are contributing to it).
No such issues with EPF. You can withdraw the amount at retirement and it is exempt from tax.
Why, in this world, will you make your tax-exempt funds taxable?
2. EPF vs. NPS: Mandatory purchase of annuity
Under NPS, you have to utilize 40% of the accumulated corpus at the time of retirement (superannuation or at the age of 60) to purchase an annuity plan.
Under an annuity plan, you pay a lump sum to the insurance company, and the insurance company provides you an income stream for life. Annuities are low return products and the annuity income is taxable. And it is not difficult to replicate performance of an annuity plan through other means.
Under EPF, there is no mandatory purchase of annuity. You can choose to use the maturity amount whichever way you want.
3. EPF vs NPS: You can operate EPF account only through your employer
EPF can only be operated through your employer.
With NPS, there is another way. You can open NPS account under All Citizens Model and contribute to it on your own. It is just that your employer won’t contribute to your NPS account.
If you want, you can invest in EPF through your employer and subscribe to NPS on your own. It cannot be other way round.
4. NPS vs EPF: Exposure to Equity
NPS provides up to 50% exposure to equity while EPF provides limited exposure to equity.
In my opinion, this aspect is overhyped. Even EPFO decided to invest 5% of incremental investments into equities last year, perhaps under similar pressure. The number was subsequently increased to 10%. There are talks of increasing the allocation to 15%.
Personally, I am not in favor of such a decision. EPF was a brilliant pure debt product and should have been left so.
I do concede equity investments do well over the long term. However, it is not that NPS or EPF will be your sole investments for retirement. If you want greater exposure to equity, then invest in equity funds on your own.
Why does one product have to do everything for you? Unfortunately, policymakers always look for one-size-fits-all-solution.
Let EPF be a pure debt product. If you want exposure to equity, you can do it on your own.
There is an additional accounting problem. The return on EPF is announced every year by EPFO. EPFO is providing fixed returns while a part of their underlying investments are market linked (after EPFO started to allocate a portion of incremental deposit to equity ETFs). It is not a wise move. The problem will only compound if the allocation to equity is increased. And from what I have read, the labor ministry is contemplating increasing equity exposure to EPF.
5. NPS vs EPF: Early retirement
If you exit NPS before retirement (premature exit), you have to use at least 80% of the accumulated corpus to purchase an annuity plan.
You can even exit EPF at switch of jobs and get your entire corpus. Do note you have to be unemployed for at least 60 days before you apply for withdrawal. Hence, technically, you cannot withdraw your EPF corpus at the time of mere job switch. But clearly, you can withdraw if you opt for an early retirement. And the amount is tax-free if you have contributed to EPF account for 5 years.
If you want to retire early (before the age of superannuation or turning 60), EPF scores over NPS.
Under NPS, you will be forced to purchase annuity for 80% of accumulated corpus. No such restriction with EPF.
By the way, I am not suggesting that you withdraw the amount. All I am saying is that you have better options with EPF.
6. NPS vs EPF: Liquidity/Partial Withdrawals
Very limited Partial withdrawals are permitted for medical treatment, purchase of first house and children education and marriage.
Must Read: Exit and Withdrawals Norms for NPS
EPF also permit partial withdrawals for various reasons including medical treatment, purchase of house, home loan repayment, children’s education and marriage. The quantum of withdrawal permitted depends on the reason for withdrawal.
EPF fares slightly better than NPS in terms of flexibility but I wouldn’t pay much heed to this aspect.
7. NPS vs EPF: Political clout
NPS will never have the political clout that EPF has.
We saw the reaction when EPF maturity amount was proposed to be taxed in Union Budget 2016. Amidst the public outcry, the Government had to backtrack swiftly.
Not sure if NPS will ever have that kind of clout. At least not in the near future.
I am not saying NPS taxation will get less favourable in the future. It is just that the Government won’t face much opposition as they faced in case of EPF if they were to tinker around with taxation of NPS.
Should you shift from EPF to NPS?
You can engage in this debate only if you have an option. If your employer offers only EPF, you have to pick EPF. If your employer offers only NPS, you have to pick NPS.
You have to consider aforesaid aspects only when you have an option.
If I have an option to choose between NPS and EPF, I will pick EPF.
In specific cases, it might also make sense to invest in NPS for additional tax benefits under Section 80CCD (1B). In that case, you can subscribe on your own. I have discussed this in detail in another post.
In the future, when there is an option to switch from EPF to NPS, don’t do that. Stick with EPF.
NPS is not a bad product per se. It is just that it pales in comparison to EPF.
Image Credit: OpenClipArtVectors, 2013. Modified. The original image and information about usage rights can be downloaded from Pixabay[DOT]com.
The post was first published on September 28, 2016 and has been updated since.