NPS gets an upgrade

At first sight, the change is a simple one. The government has introduced a new withdrawal option for subscribers of the National Pension System (NPS). Once they retire, they can now choose to receive part of their pension fund as regular payments until they are 75 years old. These payments can be monthly, quarterly, every six months, or yearly, depending on the subscriber's decision. They can take out up to 60 per cent of their pension in this way. The agencies managing NPS will share this information and provide resources like FAQs and podcasts to help explain how this new option works. In reality, this is a huge enhancement to the NPS and drastically improves the post-retirement situation of NPS members.

Before this change, this happens when an employee who has NPS retires: They must use 40 per cent of their total pension savings to buy a regular income stream through an annuity from an insurance company. This is mandatory. The money used to buy the annuity is also not taxed. However, the income stream from the annuity is taxed as income. But, any money made from the annuity later on is subject to income tax. The remaining 60 per cent can be withdrawn as a lump sum. This withdrawal is also tax-free. Additionally, there's an option of delaying withdrawal until 70. This delay can be done individually for the entire amount, the annuity or the lump sum part.

All in all, this is a flexible system and one where all withdrawals are tax-free. However, this tax holiday ends when you retire and withdraw your NPS corpus. Past that point, all income you derive from annuities, investments, etc., is normal income (or capital gains, as the case may be) and is taxable. So, these are the two pain points with NPS today. One is the taxability of further income, and the other is that whenever you withdraw the lump sum, you must withdraw all of it. You cannot withdraw it slowly, bit by bit.

Until now, the changes being done fix both these pain points. As I've described at the beginning of this column, the new arrangement is that when the time comes for an NPS retiree to start using the lump sum, it can be withdrawn monthly, quarterly or yearly. This can continue till the age of 75. This means that the remaining part, which you do not withdraw from, continues to earn the normal returns in the NPS fund they are invested in. These returns are tax-free, so the periodic withdrawals you make are tax-free income. This is a pleasant contrast from when you withdraw the lump sum and invest it in a normal savings vehicle like a mutual fund or a bank deposit.

So, post-retirement, this new SWP facility is quite a bonanza and is actually a transformative improvement in the attractiveness of the National Pension System. The only thing that I need help understanding is the age limit. Why 75? Nowadays, 75 is not old age, and many people stay healthy and have useful second careers for many years after their formal retirement. All age limits in NPS are arbitrary and should actually be left to the retiree. If I work actively till 75 and then want to withdraw my corpus till I'm 90 gradually, why should that be a problem with the government?

Thus, the new withdrawal option is a game-changer for NPS subscribers. Allowing phased withdrawals until age 75 provides retirees with regular income that remains tax-free. This gives NPS members control over their retirement finances and to set a withdrawal schedule suited to their needs. The lump sum that had to be withdrawn can now be tapped gradually, allowing the remaining corpus to earn tax-free market returns. This may transform retirement planning for many retirees by providing a supplemental income stream alongside other retirement investments. Addressing two major pain points - taxation of income and compulsory lump sum withdrawal - puts NPS on par with other retirement schemes. This added flexibility and continued tax advantage make retirement more secure for those invested in NPS.

Of course, the really big pain point of the NPS remains. The annuity options offered by insurance companies (like everything else they do) are overpriced and underperforming black holes that take money out of retirees' pockets and feed the insurers. The goal of the NPS annuity option is that retirees should have a regular income and not spend the money in one go. That goal is better served by making the annuity part a compulsory long-term SWP plan from the NPS. The NPS is a much better option for long-term withdrawal than the self-serving products that Indian insurance companies peddle.

Also read: PFRDA introduces reforms for NPS withdrawals