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Taxation of corpus discourages investors
Why should the NPS corpus be taxed when other instruments like PPF, ELSS and life insurance are tax free
The tax treatment of the corpus is the basic reason why many investors are not joining the NPS. Only 40% of the corpus is tax free, compared to 100% in other retirement products such as EPF and PPF. NPS rules require that 40% corpus is put into an annuity.
This eventually gets taxed because the pension is fully taxable. Since the pension from the annuity is a mix of the principal and the gain, the investor effectively pays tax not only on the gains but also on the invested capital. Most people find this unacceptable.
The unfairness doesn't stop here. Though it is a long-term investment, NPS investors are not eligible for the tax benefits that other investors enjoy. Investors in stocks and equity funds don't have to pay any tax on long-term capital gains. But investments in the equity funds of the NPS get taxed. Investors in debt schemes are taxed at a lower rate after three years and also enjoy indexation benefit. But NPS investments are not eligible for inflation indexation.
In its current form, the NPS is a confusing mix of EET and EEE. A portion of the corpus is tax free on retirement. Another portion is put into an annuity but eventually gets taxed. A smaller portion is taxable if withdrawn on maturity. This portion can escape tax only if it is handled well. For the average investor, this is quite complicated to say the least. The rules need to be simplified to make the scheme more acceptable to investors.
It is interesting to note that investors who opt for the NPS usually limit their contribution to Rs 50,000 in a year to avail of the additional tax deduction under Section 80CCD(1b). Placing a limit creates an artificial ceiling and the investment becomes the default level of saving for the individual irrespective of what his actual requirement may be. Given that a pensioned society is the stated goal of the government, these tax wrinkles in the NPS need to be ironed out.
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