In a circular dated 27 Oct 2023, the Pension Fund Regulatory and Development Authority (PFRDA) announced the introduction of a Systematic Lump Sum Withdrawal facility in NPS. Here are the details.
What are the existing NPS withdrawal rules, and where does this proposal fit?
Existing rules: After the age of 60, an NPS subscriber has the following options:
Option 1: Normal exit. Here, the subscriber has to buy an annuity for at least 40% of the accumulated corpus, and the rest can be withdrawn free of tax in one shot.
Options 2: Extend the time of withdrawal to age 70. The subscriber can continue to invest normally and get tax benefits as usual. This is a smart choice for those who do not need the NPS corpus immediately. An annuity purchased at age 70 will offer a higher interest rate. Also, the total taxable income at age 70 may be lower for some people. See: Higher annuity rates of LIC Jeevan Akshay applicable from Feb 2023
Option 3: This option has different choices, but no further contributions are allowed.
- Choice 1: Defer lump sum payout by max ten years and annuity payout by three years. After this period, the annuity must be purchased and the lump sum withdrawn.
- Choice 2: Defer only annuity (max three years) or only lump sum payout (max ten years). After this period, the annuity must be purchased and the lump sum withdrawn.
- Choice 3 (old rule): Phased withdrawal of lump-sum amounts to 70 with a minimum withdrawal of 10% each year. The catch here, the annuity will have to be purchased immediately.
Note: Please consult this guide on implementing these choices: How to withdraw from NPS by optimising tax and market fluctuations after 60.
What is the problem? As per earlier rules, for annual withdrawals, “the subscriber
has to initiate the withdrawal request each time, and the request has to be authorized as the case may be,” says the PFRDA draft proposal.
Rule change to option 3 and choice 3: The lump sum can now be paid systematically on a periodical basis viz monthly, quarterly, half-yearly or annually for a period until the age of 75 in an automated manner with a one-time request. This will apply to Tier I and is expected to be expanded to include Tier II later.
Note: The annuity clause (min 40%) is still mandatory. This Systematic Lump
sum Withdrawal (SLW) is only applicable to amount not annuitized. That is the SLW will be applicable only for the lump sum portion. Subscriber can either opt for annuity immediately or defer annuity till 75 years
- No further contributions are allowed in Tier I
- After setting up an SLW, it can be cancelled anytime, and the eligible balance redeemed.
- It is not clear if partial withdrawals are allowed post-setting up of SLW.
- Our understanding is that a SLW should be set up at the time of exit. It is not clear if it can be done later.
- During SLW, subscribers can opt for scheme Preference or pension fund manager change. However, it will be applicable only for the lump sum portion. If not withdrawn, the annuity portion (if not purchased) will remain per the existing scheme choice, and no changes can be made.
- The lump sum withdrawal (max 60%) is tax-free, and so is the SLW.
- Please bear in mind that the corpus is still market-linked. Therfore depending on the market conditions, the corpus may deplete faster because of the continuous withdrawals.
- It would be better for PFRDA to introduce a separate money-market asset class for the retiree to shift a portion of the lump sum and initial systematic withdrawals from that cash component.
- It is unclear if government employees will be allowed the SLW option.
Retirees who can afford to keep the lump sum in the NPS and gradually withdraw it can opt for the SLW. “Afford” means the retirees have “enough” assets elsewhere, and their reliance on the NPS corpus is not high.
The SLW is a step in the right direction. It is most useful for retirees who have saved up a large enough corpus to leave the money in NPS and save on tax. If they had to withdraw the lump sum (which is tax-free) and invest it elsewhere, there is a tax incidence upon that withdrawal. With NPS SLW, one can withdraw as necessary and pay no tax. However, this luxury is only possible when one has enough liquid assets elsewhere.
In summary, the NPS systematic withdrawal facility can benefit financially independent retirees. However, it would be best done from a money market-like asset pool instead of long term gilt or corporate bonds (classes G or C). If this remains unchanged, retirees must be educated that such systematic withdrawals can be risky as long-term bonds are volatile. Any extended period of poor returns can result in a faster depletion of the NPS corpus. So ample precautions are necessary.
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