Amidst so many worries in our working lives, there is another worry which recurs frequently into our minds as to whether we will be able to lead a comfortable retired life. Particularly if we are not entitled for any pension once we retire.
So how can you ensure regular income stream after retirement?
Nowadays there are various products available in the market purely for the purpose of retirement planning. Out of which some are purely debt oriented, whereas others are equity oriented and some are a combination of both. The choice of the product depends on the age, income and duration to reach retirement age besides a person’s risk appetite. One such pension scheme sponsored by the Government of India few years ago is National Pension System (NPS) which by virtue of its design aims at benefiting people when they retire. But the real bonanza from tax angle was given in the budget of 2011 in respect of contribution by the employer to NPS which will go a long way in making the retirement planning very tax effective and useful.
Earlier contribution of NPS by employer was included within 1.50 lakhs limit of section 80C. In 2011 budget Finance Minister excluded the contribution made by your employer to your NPS account from the overall limit of Rs. 1.50 lakhs. So now you can claim the deduction here without any limit. However this is subject to a restriction of 10% of your basic salary.
Tax treatment for contribution
If you have a Provident Fund account where your employer is also contributing to it, you are getting a deduction upto Rs. 1.50 lakhs for your contribution.
Here the contribution made by your employer only upto 12.5% of your basic salary is exempt from tax. However any amount contributed by your employer in your NPS account is treated as part of your salary and thus included in your income but you can claim deduction under Section 80CCD(2) for this too. Thus effectively making it exempt from tax within the limit of 10% of your basic salary without there being any upper monetary limit. This is very useful and tax efficient for you particularly if you fall in the maximum tax slab.
Tax treatment at the time of retirement
The contribution made towards NPS gets accumulated in your account till you reach the age of 60 years, after which you have the option extend it till 70 years or to withdraw up to 60% of the accumulated balance out of which 40% is tax exempt and you have to pay tax on balance 20% withdrawn. For the balance 40%, it is mandatory for you to purchase an annuity from any of the Life Insurance Company registered with IRDA. So in case you decide to utilize 60% of the accumulated balance for purchase of annuity the entire corpus becomes tax free at the time of withdrawals.
The annuity received by you for each year becomes taxable like any other income but since the annuity is received after you have retired from the active employment resulting into reduced income, the effective rate of tax also comes down drastically.
After purchase of annuity to the extent of mandatory 60% of the accumulated balance in your NPS account, you have the full liberty to use the balance money as you wish. Moreover 20% of the balance in NPS received by you, when you reach 60, is not taxable, thus for all practical purposes you save tax on 20% of your contribution made by your employer and taxed at reduced rate on staggered manner during your retirement days. This is indeed very tax effective.
Tax benefits explained
In case you do not opt for NPS contribution by your employer up to 10% of your basic salary, you will have to pay tax on this amount received. If you are in the highest tax slab, you will only receive Rs. 70 in hand against Rs. 100 being invested. In the long run, the difference of Rs. 30 of the tax component being saved through contribution in the NPS will translate into a substantial corpus.
Moreover this is not just deferment of your tax, as you need to purchase annuity for only 60% of the balance, whereas the 40% is completely tax-free. You can invest this amount in the instruments of your choice depending on the flavor of the day and your risk appetite. In case the rate of interest offered by banks on FD is attractive, you can supplement your annuity income with these bank interest from FD.
Even as your employer is contributing to your EPF account, he can also make a contribution towards your NPS account. If this NPS contribution is not part of your salary structure, approach your HR department to get the salary restructured.
In addition to the tax benefits, this option of routing your savings helps you in ensuring compulsory savings in the long run. Once you have exercised the option of NPS contribution by your employer, he will deduct this money from your salary and remit the money to your NPS account. This will ensure that you build a good corpus by the time you retire. This will also bring in some financial discipline in those of you who are not good savers by nature and tend to spend the money impulsively.
So open an NPS account with designated point of service centers not only to ensure a comfortable retirement but also minimizing your tax liability.
(The author is a CA, CS and CFP. He can be reached at jainbalwant at gmail.com and @jainbalwant)By Balwant Jain (CA, CS and CFP)The author is a CA, CS and CFP. Presently working as Company Secretary of Bombay Oxygen Corporation Limited. Views are personal., He can be reached at firstname.lastname@example.org and @jainbalwant