NPS Makeover - A Case of Misplaced Priorities

NPS launched in 2004 for central govt. employees was extended to All Citizens in 2009 and to the corporates in 2011. Since then it's become a popular choice for Corporate Employees, especially those under Old Regime. As of March-2025 NPS had 22.5 lac Corporate employees and just under 40 lac -All Citizens.

However, since the introduction of New IT Regime in 2020, the onboarding of new subscribers under All Citizens Model has tapered. The primary reason being withdrawal of tax benefits accorded under Section 80C(₹1,50,000 p.a) and 80CCD(1B) (₹50,000 p.a) to NPS investments for the New Regime.

PFRDA is now trying to make NPS attractive by introducing sweeping changes to investment choices as well as withdrawal options, hoping that making NPS more flexible may appeal to young professionals and nudge them to embrace it. Some of these changes are

• Allowing a 100% equity investment option for non-government subscribers, letting young investors potentially earn higher returns by increasing their allocation to equity funds (from 75% earlier to 100%).​

• Introducing multiple scheme frameworks (MSF), which enable greater customization of portfolio construction and allow subscribers to switch between different investment options more freely.​

• Reducing the minimum lock-in period and offering an early exit option from NPS after 15 years, which adds liquidity for subscribers who may need funds due to life events or career changes.​

• Easing withdrawal norms so that a larger portion of the corpus can be withdrawn as a lump sum at retirement(60% to 80% proposed for Non Govt), with more relaxed rules around partial withdrawals for specific needs.

These changes surely help existing subscribers, but I have my doubts regarding their ability to rope in young professionals as these reforms do not address the underlying concerns of the Gig / Professional community. For professionals under New IT Regime, NPS just does not compare favourably to plain vanilla Mutual Fund Investing. Why? You may ask!

The answer is "The 40% Annuity Penalty" on the corpus at the exit gate at 60. Lets unpack this further:

Old IT Regime NPS Subscribers: NPS works really well for them as they get the most favoured Exempt-Exempt-Exempt(60%) Section 80C(₹1,50,000 p.a) and 80CCD(1B) (₹50,000 p.a). Hence, they can live with 40% Annuity and the Tax levied on it.

Salaried New Regime adoptee with Employer Contribution: They also get tax deduction upto 10% of their salary contribution to NPS by the Employer. In terms of outcome, its similar to the previous case.

Professional under New Regime: This group however, follows the path of T-E-E(60%)T(40%). The 60% Tax exempt withdrawal in NPS is good, but not "good enough" to overcome the fact that the initial investment was post tax. In fact tax on 40% annuity at slab rate is kind of unfair to the professionals.

A Case for Double Taxation

For all purchased annuities, any annuity option other than Return of Purchase Price (ROP) inherently imposes Double Taxation.

Firstly, the money used to buy policy is Post Tax.

Next, for any policy that's not ROP, the purchase price is kind of amortised over the lifetime of annuitant and added to annuity paid(difference in annuity between Non ROP and ROP options). As all annuity payments are fully taxed at slab rate, it leads to double taxation on the Purchase Price.

For contrast, you may compare this with an SWP, where when you sell MF units, you are taxed only on the difference between Redemption NAV and Purchase NAV and never on the full redemption.

(which do not have a tax break at the time of purchase)

Conclusion:

The changes to NPS are welcome and they do help existing NPS subscribers providing increased flexibility in deploying their funds while also making it easier to withdraw in case of any exigency.

However, it does little to expand the base to include Professionals especially under the New Tax Regime(the largest base of young citizens). It would behoove PRFDA to incentivise the professionals to join NPS in order to secure their retirement. Increasing the Tax Free Withdrawal to 80%(proposed) can help. Adding sweetener like, extending 80CCD(1B) to new IT regime can help.