Limit on employer's contribution to retirement plan: All questions answered

Contributions to NPS may need to be scaled down

Budget 2020 imposed a limit of Rs 7.5 lakh on employer’s contribution to retirement funds. In this article, we will try and answer some of the key questions our readers have raised.

What tax exemptions do employees enjoy currently on their employer’s contribution to various retirement funds?

There are three types of retirement funds that employers contribute to: Employees’ Provident Fund (EPF), superannuation fund, and National Pension System (NPS). The limits on employer’s contributions that are tax exempt for the three of them are as follows:

• Employer contribution to EPF or a recognized PF of up to 12 per cent of Basic + DA, without any absolute ceiling;

• Employer contribution to NPS of up to 10 per cent of Basic + DA, without any absolute ceiling;

• Employer contribution to approved Superannuation fund of up to 15 per cent of Basic + DA, up to an absolute ceiling of Rs 150,000 per year.

If you look at Section 80C, there is no limit on the contribution you can make via each instrument, but there is an aggregate ceiling of Rs. 1.5 lakh. “For employer contribution to pension funds, there is an absolute ceiling in the case of Superannuation Fund, but none in the case of EPF and NPS. In percentage terms, a person’s employer could have contributed up to 37 per cent of his basic to these three funds, and that amount would have been tax exempt. Also, there was no aggregate ceiling in absolute terms for all the pension schemes combined. Now the government is proposing a ceiling of Rs. 7.5 lakh,” says Arvind A Rao, chartered accountant, Sebi-registered investment adviser and founder of Arvind Rao & Associates.

With effect from April 1, 2021, if the employer’s contribution exceeds the ceiling of Rs. 7.5 lakh, it will be treated as perquisite in the hands of the employee and taxed at the marginal income tax rate. Moreover, the government has also proposed that any annual accretion by way of interest or dividends attributable to the portion of the excess contribution may also be treated as perquisite and taxed accordingly.

Why has this been done?

This was a very good tax-saving tool for people with high salaries—with no absolute ceiling (except in the case of superannuation fund). This part of their salary would accumulate in their retirement accounts, and they were able to save 30 per cent plus tax on it. “The principle as indicated by the policy makers was that employees are being given greater flexibility to decide where to invest and how much. It is also mentioned that there is a need to address the tax breaks being availed by higher-income employees,” says Preeti Chandrashekhar, India Business Leader – Health and Wealth, Mercer.

Who will be impacted by this?

This step will chiefly impact people who have high salaries. Ritobrata Sarkar, Head of Retirement, India, Willis Towers Watson ran some numbers. Here are some of the conclusions he arrived at:

• For those who are only eligible for EPF: Any employee earning basic salary (+DA) in excess of Rs. 5,21,000 per month will be directly impacted (as statutory employer contribution to EPF will be higher than the aggregate ceiling).

• For those who are eligible for EPF and NPS: Any employee earning basic salary (+DA) in excess of Rs. 2,84,000 will be impacted (assuming employer contribution to NPS is 10 per cent of Basic in addition to statutory PF contributions).

• For those who are eligible for all three benefits: Any employee earning basic salary (+DA) in excess of Rs. 2,27,500 will be impacted (assuming employer contribution to NPS and superannuation of 10% of Basic and 15 per cent of Basic respectively, in addition to statutory PF contributions).

What should you do?

According to Sarkar, if your employer’s contribution exceeds the Rs. 7.5 lakh limit, it could lead to cash flow issues. “An employee will be required to pay tax on contributions now, while the funds can be withdrawn only at retirement,” he says.

This change will also cause tracking, accounting and administration difficulties for employees, who will have to keep track of what is taxable income from each retirement fund and aggregate such income in order to arrive at his/her tax liability, accurately. In addition, the calculation of the annual accretion will be complicated, especially on NAV-based plans, e.g. NPS and unit-linked Superannuation plans, and it will also be difficult to carve out the interest explicitly earned on the contributions above the threshold limit.

Rao says high-salaried employees may have no option but to restructure their salaries and scale down their employer’s contribution to retirement plans.

One result of this measure could be that in the short-term high salaried employees could be discouraged from opting for voluntary retirement benefits, like NPS. While making any decision, however, employees need to consider their overall target retirement corpus that will be adequate to sustain them post retirement. Employees will need to weigh the pros and cons of voluntary retirement contributions against other investment options available. Says Sarkar: “12 per cent of statutory EPF contribution is not going to be enough, according to a study conducted by Willis Towers Watson. Employees need to save at least 20 per cent of gross salary to build a reasonable retirement corpus.” He adds that even with the tax being imposed, low fund management charges and overall returns on voluntary retirement plans (e.g. NPS) may still make retirement savings through them worthwhile.