Forcing subscribers to buy annuities is a bad idea
Finance minister Arun Jaitley has done well to roll back his taxation plans on the EPFO, not because he was taxing the middle-class but because the proposals were unfair. First, to the extent employees were contributing more than the statutory amount to the EPFO, they were being taxed already. More important, he was forcing people to buy lower-paying annuities. Also, to the extent the same tax proposal did not apply to bureaucrats, it was unfair. But that’s the easy part of the job. The principal reason for Jaitley’s proposal was to bring parity between the EPFO and the National Pension System (NPS), and this hasn’t happened. Under the NPS, 40% of the corpus had to be mandatorily converted into an annuity scheme and 60% would have been taxed. Under Jaitley’s plan, 40% will still be converted into an annuity, 40% can be withdrawn tax-free and a tax will have to be paid on the remaining 20%—that’s better than earlier, but why force NPS-subscribers into this sub-optimal plan? Right now, they earn 10-11% while, with annuities, they will earn 6-7%—that’s the current rate for an annuity is given for life to an individual and then the spouse with the capital returned to the child on their death.
There is actually a simpler way, let the person keep the fund with the NPS post-retirement but withdraw it over a 15-20 year period so as to avoid a tax shock. An example makes it clear why this is infinitely better. Assume R100 has to be annuitised right now and the husband/wife of the subscriber gets R7 per year till he/she dies in, say, 25 years, after which the child gets R100. Now, let the person withdraw this corpus of R100 in 14 equal instalments, or R7.14 per year so that both schemes are on a par. So, after Year 1, the person will have R92.86 left in the account. This, however, will continue to earn, say a 9% return, so it will become R101.22 by Year 2. Now withdraw another R7.14 and the balance becomes R94.07454 … Do the exercise for 25 years, and you find the amount that can be given back to the child is just under R203! Work with a lower earning of 8%, and the child can get R120; at 7%, while the couple gets the same annuity of R7.14, their child gets R59 after 25 years. The finance minister would do well to get his bureaucrats to do this exercise in order to make NPS more competitive and also clean up the tax treatment given to other investment schemes since what is available today is a veritable dog’s breakfast.