The Budget 2016-17 had a sweet-bitter surprise in store for most salaried individuals. While there are sweet bites like the increased HRA exemptions, partial withdrawal of NPS taxation, and additional deduction for home loan interests. Though the government had withdrawn a proposal to tax withdrawal of Employee Provident Fund (EPF), reports suggest that it may try to make withdrawal of EPF less attractive through other means.
As the sword is hanging on EPF, one of the most trusted savings plan of common man, what are the other options available to people to build a tax-free retirement corpus now?
Public provident fund
You can contribute to PPF for 15 years, and continue earning interest on the corpus if you do not withdraw it. You can keep invested in PPF even after the mandatory 15 year lock-in by a block of five years. The interest income is tax-free, and contributions made in PPF are also eligible for income-tax deduction benefits.
However, the government has already pointed out that tax-free income on PPF is a kind of dole extended to well-offs, and therefore, there are chances that the government may also make withdrawals from PPF partially taxable in the future.
MF retirement schemes
You can also consider mutual fund retirement schemes, which are now eligible for tax exemption under Section 80C. Just like EPF and NPS, you can claim deduction benefits. Depending on the composition of the scheme, it can either be completely tax-free or more tax-efficient than EPF.
If the equity component of the fund portfolio is 65 per cent or more, then the fund would be treated as equity fund and accordingly the long-term capital gains tax would be nil. However, if the equity component is less than 65 per cent, the fund would be considered debt fund. In case of debt funds, the long-term capital gain is taxed at 20 per cent after indexation.
NPS as an investment option
The finance ministry had decided to tax EPF corpus on withdrawal (which was later withdrawn) to bring EPF and the National Pension Scheme on par with each other. The 40 per cent of the NPS corpus, which was so far fully taxable, has been made tax-free during withdrawal. National Pension Scheme, or NPS, is a financial instrument developed primarily to promote pension planning for the common man.
Under this scheme, you get a unique pension account which is fully portable across job changes. You can open an NPS account with a minimum contribution of Rs 6,000 per year for Tier 1 accounts and Rs 1000 for Tier 2 accounts. NPS is regulated by the Pension Funds Regulatory Development Authority (PFRDA) and the money accumulated is invested through various government appointed fund managers.
NPS offers two account types namely Tier I and Tier II. While Tier I account is compulsory, Tier II is an optional account. You can choose the various asset classes like equity, fixed income classes, etc. where your NPS money will be invested. You can either exercise an active choice, where you choose to distribute money amongst various asset classes or opt for an auto mode where the distribution is done automatically based on your age.
You can choose to invest only up to a maximum of 50 per cent in equity asset class (Asset E) while the remaining funds should be invested in either government securities like bonds under Asset G or other fixed income securities under Asset C.
When you invest in NPS, you are eligible for a tax deduction of Rs 1.5 lakh under section 80CCD. If your employer is also contributing towards your NPS account, you can further avail 10 per cent of Basic Salary and Dearness Account (DA) under section 80CCD(2). So if your basic salary is Rs 4 lakh per year, you can avail an additional tax deduction of Rs 40,000. Furthermore, you can avail an additional tax deduction of Rs 50,000 under Section 80CCD (1b), if you invest more than Rs 50,000 in NPS. The one thing people overlook is that the deductions listed above are applicable only for tier 1 accounts and not for tier 2 accounts.
Unit-linked insurance plans
Unit-Linked Insurance Plans (Ulips) are very similar to mutual fund schemes except that they have a mandatory insurance component. So Ulips are a mix of insurance and investment plans. Ulips are considered to be one of better options for retirement saving because they offer equity, debt option or a mix of both. They offer tax deduction benefits and the withdrawal is completely tax-free.
Of course, one of the arguments against Ulips is high initial cost. However, if you are saving for retirement, the ideal time horizon should be 20-30 years. Over the long term, the cost turns out to be comparable to any other mutual funds.
Unlike the mutual fund retirement schemes, simple mutual funds can also be used for building a retirement corpus. Of course, you do not get Section 80C benefits, but there are many other ways of availing the deduction benefits.
The best way to save for a retirement is investing through monthly SIPs in large-cap, diversified equity mutual funds. Of course, you can opt for more than one fund as well-an equity-oriented hybrid fund along with a large-cap equity fund can also be used for the purpose.
Long-term capital gains from equity-oriented mutual funds are tax-free. Therefore, there is no income-tax on withdrawal, at least as per the existing tax laws.
A caveat
India is probably among a few countries where long-term capital gains from equities are still tax-free. Given the language of the Economic Survey and the fact that the government has actually imposed dividend distribution tax (DDT) on dividends earnings of more than Rs 10 lakh a year, we may be moving towards an EET (Exempt Exempt Tax) regime and the EPF may just be the beginning. If that happens, investors may have to significantly change their investment strategies over the long-term.
