Tax on pension corpus: Jaitley just shrank your retirement kitty

Withdrawals from EPF and NPS to have same tax rates

Taxpayers would not be too happy at Finance Minister Arun Jaitley's move to tax employees' provident fund (EPF) and other recognised PFs on contributions made on or after April 1.

PF schemes hitherto enjoyed the tax status of exempt-exempt-exempt (EEE, meaning no tax on contribution, interest or at withdrawal). The change has been done to put it on a par with the tax rule for the National Pension System (NPS), which is EET or exempt-exempt-tax.

"The expectation was that the NPS scheme will be brought under the EEE regime, in line with the EPF and PF schemes. This move might help boost investment in NPS," said Homi Mistry, partner, Deloitte Haskins & Sells. (I'M TAXED, THEREFORE I AM)

EPF would pay 8.8 per cent in 2015-16. NPS (Scheme E Tier-I) had returned 8.78 per cent annualised in the past three years. In the past year, it returned -12.91 per cent. What the Budget proposes is that 60 per cent of what you finally withdraw from EPF will be taxed.

In NPS, 60 per cent of the corpus would be taxed on withdrawal at retirement and the rest 40 per cent would have to be put in an annuity fund. However, an annuity fund that goes to a legal heir will not be taxed.

• Union Budget 2016: Complete Coverag

The finance ministry clarified in the evening that if the rest 60 per cent of the corpus is not withdrawn and put in an annuity plan, it will not be taxed. But since the annuity income will be taxed anyway, it takes away the choice from an individual to invest in instruments that they are more comfortable with. Annuity plans pay around 6.5 -7 per cent presently.

"The tax on 60 per cent of withdrawal from EPFO is probably an effort to bring taxation of various retirement schemes on a par," said a consultant.

NPS was completely taxable on maturity (on retirement), while EPF was not. So, many taxpayers had not opted for NPS, despite an additional tax deduction of Rs 50,000 given in the previous Budget on contribution under Section 80CCD (1B).

Besides the decision to equalise NPS and EPF tax treatment, the Budget has also proposed reducing the service tax on single premium annuity products from 3.5 to 1.5 per cent.

"This move is a positive for policy holders because single premium annuity products are usually high-ticket policies and service tax also works out to a fairly high sum," said Sujoy Manna, vice-president (products) at HDFC Life Insurance.

In the case of NPS, subscribers have to use 40 per cent of the accumulated corpus to purchase an annuity. With other superannuation schemes offered by employers, a part of the accumulated corpus is used to purchase an annuity. So, the amounts tend to be huge, and reducing the service tax will be a benefit.

In a single premium annuity plan, the policyholder purchases an annuity and starts receiving a pension. The frequency of the payouts can be monthly, quarterly, half-yearly or annually.

• Union Budget 2016: Complete Coverage

Photograph: Lucy Nicholson/Reuters