For the salaried executive, when it comes to claiming tax breaks for savings – there’s a choice beyond your PF contribution and the 80C Investment avenues – its called the National Pension System or the NPS, through the corporate route. Almost everyone has heard about it, but not many have understood the scheme well enough to consider it seriously as an option for their retirement nest.  In this article, we explore the scheme in some detail, and highlight the working and advantages of the Corporate NPS scheme.

NPS subscriptions can be made under the following broad categories:

1. Government Employees – Central and State Government employees as well as employees of Central and State PSUs are covered under this categogy
2. Swavalamban Scheme – this is designed for the un-organised sector and government contributes a small amount to incentivize such accounts. Targeted towards Economically Weaker sections
3. Citizen NPS  – For the general public
4. Corporate NPS – This scheme is applicable for contributions by employer’s on behalf of it employees

The key features and advantages of the NPS scheme are outlined below –

• —Portable –

Subscribers can continue to contribute even after change in employment or employment status. It is also geographically portable – Subscribers can retain the same account even in case of transfer.

• —Low-cost

Low Transaction charges. Fund Manager charges of upto 0.25% (as against 1~2% charged by Mutual Funds /ULIP schemes)

• ——Choice of Fund Managers

Subscribers can choose their own Fund Manager, out of a list of seven reputed names

• —Choice of Fund Type

E – Aggressive investor can opt for Equity (upto 50%) scheme

C – Balanced investors can opt for Debt  schemes (excluding Government securities. Limit – Upto 100%)

G – Conservative investors can opt for G-Secs (Upto 100%)

Investors can decide the matrix of E:C:G suitable to their case.

Investors can also opt for a “unique” Life-cycle fund which  automatically adjusts the proportion of E:C:G investment based on the age of the subscriber.

The Tax Advantage

—Contribution to the extent of 10% of Salary (defined to include DA, but exclude all other allowances) is tax deductible in the hands of both employer and employee.

The employer can claim the contribution made as a deductible expense under section 36(1)(iva) and the employee can also claim deduction for the contribution made on his behalf by the employer under section 80CCD(2).

The important point to note here is that the deduction to the employee is available over and above the limit of one lac under section 80C. However, the “additional deduction” is available only when the contributions are made directly by the employer to the NPS account of the employee. This deduction is not available if the employee makes the contribution directly. It is therefore imperative for the employees / individuals to ensure that their employer is registered under the scheme.

Since the employee compensation in the private sector is largely based on fixed Cost-to-company (CTC) model,  Corporates who have not yet registered under this scheme can consider enrolling under NPS and offering it as one of the components to choose from, without any additional cash outflow at their end. There would of course be some additional administrative tasks related to payroll processing to keep track of the employee NPS contributions.

Illustration

For an executive with Rs 12 lacs Basic salary, a contribution of Rs.1.20 lacs can be made under the ‘corporate NPS’ (ie by employer deduction and direct deposit to employee’s NPS account). This contribution of Rs. 1.20 lacs would not be taxed in the hands of the employee.

For an employee at the highest tax bracket – not availing the benefit of NPS contribution would mean entailing an additional tax outflow of Rs.37,000. Effectively, it would be a choice between getting a cash salary of Rs. 83,000 (Basic 120000- Tax 37000) OR having 1,20,000 saved in an NPS account. Another way of looking at it is  – for the 83000 contribution that an employee contributes, the Government makes a contribution of 37000 to his account by way of taxes foregone! This means his contribution of 83,000 fetches a benefit of 37,000 – translating into a 44% (37000/83000) return in the very first year!!

If you have been wondering what ails the Scheme or why is it that its not so popular, despite its advantages, here are the catches –

1. Liquidity – this is perhaps the biggest dampener. Contributions cannot be ‘en-cashed’ in full. If a subscriber withdraws before age 60, only 20% can be en-cashed and 80% has to be applied towards purchase of annuity.After age 60, 60% of the corpus can be en-cashed, but minimum 40% still has to be necessarily applied for purchase of annuity.Saving grace here is a proposal to allow limited withdrawals for significant events  – marriage, medical emergency for specified ailments, housing, higher education needs.
2. Tax Impact – NPS is currently taxed under the EET format or the Exempt (at the stage of contribution) – Exempt (at the stage of accrual of savings) and finally Taxed – at the time of withdrawal.
   However, in case the withdrawals are entirely reinvested (as against the minimum requirement of 40%) in an annuity plan, then its only the yearly pension (annuities) that get taxed – this could reduce tax outgo significantly if there is no other active income in the years when the annuities are received. The downside is low returns from annuity plans, since they have to assure a fixed rate of pension. Choice of a good plan is therefore a crucial element that would help realize planned savings.Another way of mitigating tax impact is to postpone the withdrawals to a later year. Currently, the eligible “cash withdrawal” (i.e. 60% of the corpus) could be deferred for a maximum period of 10 years, while the mandatory annuity purchase requirement (to the extent of 40%) can be deferred for three years.A bonus on the tax front could come in the form of enactment of the proposal in the Direct Tax Code bringing NPS contributions also under the EEE taxation format – and exempting them at the withdrawal stage.

If you would like to know how we support NPS initiatives by corporates, click here for the scope of our services.