New rules of NPS: Should you opt for systematic lump Sum withdrawal?

The Pension Fund Regulatory and Development Authority (PFRDA) has allowed National Pension System (NPS) subscribers to withdraw up to 60 per cent of their pension corpus, periodically through the Systematic Lump Sum Withdrawal (“SLW”) service.

In a circular dated October 27, PFRDA proposed to provide the option of phased withdrawal of the lump sum through Systematic Lump Sum Withdrawal (SLW) facility. 

“The subscribers are allowed to withdraw up to 60 per cent of their pension corpus, through the SLW on a periodical basis viz. monthly, quarterly, half-yearly or annually for a period till 75 years of age as per the choice at the time of their normal exit,” read the circular. 

As per the existing guidelines, the NPS subscribers post 60 years/superannuation can defer availing of annuity and withdrawing the lump sum on any combination till 75 years of age. The lump sum amount can be withdrawn in a single tranche or it can be withdrawn on an annual basis. If withdrawn annually, the subscriber has to initiate the withdrawal request each time.

“The pension that a subscriber would receive upon purchasing an annuity is supplemented by withdrawals made using the recently implemented SLW mechanism. This option is only available on lump sum NPS corpuses after the annuity is purchased, and it can be selected at the time of Superannuation (Retirement),” said Soayib Qureshi, Partner, PSL Advocates & Solicitors. 

How the SLW option benefits subscribers?

With the SLW option, the process becomes automated, eliminating the need for a request every time. The proposal states that automating the periodic selection of SLW would maximise retirement benefits by adding flexibility and liquidity. 

Subscribers would also benefit from market-linked investment gains for the money that stays invested in Permanent Retirement Account Number (PRAN) according to their investment preference and is not withdrawn.

 

“Additionally, the SLW facility will lower the risk of reinvestment associated with one-time lump sum withdrawal," said Qureshi. 

However,  for the duration of this SLW, subscribers will not be able to contribute (only in Tier 1) and during the period, partial withdrawal is also not permitted.

Under NPS, two types of accounts are available to the subscriber, i.e., Tier I and Tier II: 

Tier I account is one where money is deposited into each subscriber's personal account by both the government and the subscriber. Every month, the  subscriber is required to deposit 10 per cent of their Basic Pay and DA into their Tier-I account, which is matched by the employer's contribution. While they are employed, the regular NPS contributions and the accrued sums are shown in their PRAN and will be used to fund their pension when they retire. 

Tier II account allows users to save money voluntarily, with the freedom to take it out whenever they choose. To start a Tier II account, you must have both PRAN and a current Tier II account. Since Tier II is a voluntary savings account, no money is contributed to your Tier Il account by the government, and there are no tax advantages associated with the contributions.

According to Qureshi,  NPS Tier I subscribers prematurely, can withdraw, less than or equal to Rs 1 lakh- lumpsum amount without any tax being levied. For withdrawal over Rs 1 lakh, up to 20 per cent of the total amount will be subject to income tax, whereas 80 per cent of the total contribution must be invested in annuities.

As for NPS Tier II subscribers, they “are able to make as many withdrawals as they like. The NPS Account thus becomes similar to any other bank account used for savings,” said Qureshi.

Tax deductions offered to NPS Tier 1 Subscribers

On the employee's and employer's NPS contributions, a tax exemption of Rs 1.5 lakh is available. The Income Tax Act's Sections 80CCD(1), 80CCD(2), and 80CCD(1B) provide for the claim of tax benefits.

1. 80CCD(1): Self-contribution is covered by Section 80CCD(1), which is under Section 80C. Self-employed people may deduct up to 20 per cent of their gross income, while salaried employees may deduct no more than 10 per cent of their pay.
2. 80CCD(2): Section 80CCD(2), which is a subset of Section 80C, addresses the employer's NPS contribution. Self-employed people are not eligible to claim this benefit. An employee may deduct up to 10 per cent of their base pay plus Dearness Allowance (DA) or the employer's NPS contribution, whichever is greater.
3. 80CCD(1B): Under this section individuals can claim an additional amount of Rs 50,000 for any other self-contributions as NPS tax benefit.

Further, any withdrawal up to 60 per cent of the fund from NPS is exempted as per Section 10(12A) of Income Tax Act, 1961.

“When both types of accounts mature, the tax benefits are determined by the individual's IT slab, with 40 per cent of the corpus under annuity being taxed annually,” said Qureshi. 

Should you opt for the SLW?

According to Ritika Nayyar, Partner, Singhania & Co., the true worthiness of this scheme is subjective and will depend on the financial needs/circumstances of the individuals, their requirements, their future plans, lifestyle, etc.

“Individuals may consider this as a mechanism to generate an additional fixed/regular source of income which could be used in budgeting for buffer on any recurring medical expenses, expanding investments, providing well for themselves post retirement etc. by being another stream of income,” said Nayyar.

“SLW is suitable for all retirees who want to benefit from systematic cash flows in their post-retirement phase, which allows them to meet their periodic expenses. Another advantage is that the NPS member can choose for the cash flow to flow on a regular basis, and the SLW to be requested only once,” said Qureshi

According to Casparus Kromhout, MD & CEO of Shriram Life Insurance, liquidity being one of the very important features of any investment, periodical withdrawal of 60 per cent of the fund value is going to be an attractive feature in NPS. 

“Investors have more flexibility in the instrument and will be more attracted to it, keeping in mind it has shown very good performance in terms of returns in past few years. As far as percentage is concerned, it is relative. It may vary from individual to individual and his financial needs,” said Kromhout.

The new withdrawal option is a game-changer for NPS subscribers:

Dhirendra Kumar of Value Research explains how the phased withdrawals allow retirees control, flexibility and continued tax advantage. 

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.