The Pension Fund Regulatory and Development Authority (PFRDA) has recently proposed key changes for non-government NPS subscribers. Currently, an investor is allowed to withdraw 60% of the corpus and the balance 40% has to be compulsorily converted into an annuity.
For the uninitiated: Annuity basically means that your 40% amount is converted into a FD type instrument and you get a fixed amount every year (called pension) till your death and on your demise the amount is paid to your nominee (there are other multiple options; this is the most basic and popular). Pension is taxable as per your tax slab.
The 60% corpus which was allowed to be withdrawn was tax-free.
Under the new proposal, investors may be allowed to withdraw 80% of their corpus while only 20% goes into annuity. However, there is a rider attached to this withdrawal. 60% would continue to be tax-free but the 20% would be taxed. In fact, the entire corpus would be taxed at the marginal tax slab to which the investor belongs. Now this may prima facie appear to be quite stringent as you are taxed not only on the profit element but also on the contributions made by you.
We have taken an assumption that suppose you have made monthly contributions to NPS and you have a 12% CAGR, with a contribution over 15 years, you land up paying 17% additional tax in case you have opted for the option of 80% withdrawal (Option B). We will refer to the 60% withdrawal as Option A.
Under Option A, the investor withdraws 60% as lumpsum, tax-free, while the remaining 40% goes into annuity (assumed to provide approx. 8% p.a.).
Under the proposed 80:20 rule (Option B), the investor withdraws 80% as lumpsum, but 20% can be invested only net of tax. Also, the annuity amount will be 50% of that under Option A.
Now consider this:
In Option A, you have a yearly cashflow which is double that of Option B. What it means is that if you receive ₹1 lakh in Option A, under Option B it will be ₹50K.
Under Option B you will receive more funds upfront; less the tax paid on the 20% additional withdrawal.
If we invest these funds (Option B) as compared to investing the additional pension on (post-tax) every year, at what point of time and at what rate of return do you break even?
Break-even is achieved at 10 years with a CAGR of 10.6% p.a.
What this means is that if you earn anything less than 10.6% p.a. and the period is less than 10 years, Option A is better. But if you are investing the funds for more than 10 years and are achieving a CAGR higher than 10.6%, then Option B should be your choice.
For investors who are comfortable managing their investments and want more control over their retirement corpus, Option B could be a powerful way to maximize both liquidity and growth. It offers greater financial freedom by giving you access to a larger upfront lumpsum, which can be used for investments or major life goals.
If interest rates go down, then at times Option A may also look attractive. Secondly, if someone is in a lower tax bracket the dynamics can change. These are just back-of-the-envelope calculations and for each individual the scenario could be different depending on when you started investing, accumulated corpus, scheme opted for, returns, etc.
The above is based on certain assumptions and for each individual the model would vary.
Note: This post is only for informational purposes.
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