The National Pension System (NPS) has gained limited traction with India’s retirement savers, despite the many policy nudges to make it attractive compared to the government-backed Employees Provident Fund (EPF) or Public Provident Fund (PPF). The NPS Corporate and All Citizens models together managed assets of less than ₹1 lakh crore in May 2021. The pension regulator is thus quite right to lobby for dismantling some of the unfriendly features that have proved significant barriers to the NPS’s popularity. But the tweaks announced last week — increasing the contribution age from 65 to 70, raising the premature withdrawal limit to ₹2.5 lakh and waiving the compulsory annuity rule for corpuses up to ₹5 lakh — simply don’t go far enough to make the scheme attractive to savers.

The two biggest deterrents to savers looking to use NPS are its compulsory annuitisation rule and taxation of maturity proceeds. While both the EPF and PPF act as pure accumulation vehicles, allowing investors to withdraw their entire corpus at maturity at retirement, to deploy as they like, NPS forces all its subscribers to deploy 40 per cent of their final corpus in an immediate annuity plan. The EPF and PPF have traditionally enjoyed an EEE tax regime, where contributions, returns and final withdrawals are all tax-free (the EPF saw tax breaks on returns partly trimmed in the 2021 Budget). But the tax regime for NPS can at best be described as ETT. While initial contributions enjoy tax breaks, the pension income that subscribers receive from the annuity plan gets taxed at slab rates. Apart from being paternalistic and assuming that retirees won’t make the right choices with respect to their own savings, NPS’ compulsory annuitisation rule fails to recognise that immediate annuity plans in India are quite badly designed. All immediate annuity plans offered by insurers require buyers to subject themselves to a lifelong lock-in, for unattractive returns of 4-5.5 per cent. Fixed pension payouts over the pensioner’s lifetime don’t account for the impact of inflation on purchasing power. A GST levy on the purchase price and tax treatment of annuity income on par with salary income, adds insult to injury. It is no wonder then, that most retirees with regular income needs shun annuity plans. Despite changeable returns, they vastly prefer the safety of small savings schemes, the liquidity of bank deposits or the tax-efficiency of systematic withdrawal plans offered by mutual funds.

The Centre and the pension regulator can quite easily address these issues by entirely doing away with the 40 per cent annuitisation rule in the NPS, irrespective of the corpus size, to allow subscribers the freedom to decide where they will invest their retirement nest-egg. They must simultaneously push for better-designed annuity products so that retirees who value certainty of income can opt for them on merit.

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