Retirement Tax Benefits - EPF, VPF, PPF, Mutual funds, SIPs and NPS

You do retirement planning to ensure that you have enough financial resources to meet your needs after you stop working. Your retirement fund accumulated over the years looks good.

Pension plans not only cover post-retirement expenses but also offer tax benefits. Income Tax Act to introduced tax benefits for retirement plans to encourage investments in pension plans. Don’t relax yet. All that money you get on retirement may still be taxed.

You have to maximize your returns considering inflation and taxes. To lower the tax incidence or to avoid paying taxes at all, you should invest in the right products.

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Why are the retirement returns taxed?

Retirement returns are taxed because even though you’re retired, you’re still earning by way of pension. Tax is not only payable on salary, it is also payable on other incomes like rent, capital gains (long and short term), dividend, interest from investments, etc. Likewise, pension is taxed as per the tax slabs applicable to senior citizens (60 years and above) and super senior citizens (80 years and above). Pension income is taxed on the basis of how it is received: lump sum (commuted) or periodically (non-commuted).

• Commuted pension is tax-free for government employees. For non-government employees receiving gratuity, only 1/3^rd of the pension is exempt, whereas, half is exempt if they haven’t received gratuity.
• Non-commuted pension is taxed as per your slab rate.

For Financial Year (Previous Year) 2018-2019 and Assessment Year 2019-2020, income up to Rs 3 Lakhs is exempt for Senior citizens. For Super Senior Citizens, the limit is up to Rs 5 Lakhs. Post-retirement income (pensions and annuities) received over and above the exemption limits will attract taxes. Therefore, consider tax incidence while planning for retirement income.

See Also: NPS Contribution

There are three phases of investment:

1. Deposit: Funds deposited in retirement schemes

2. Interest: Deposits earn interest

3. Maturity: The maturity proceeds that you receive

There are two tax regimes applicable for retirement income:

1. EEE (exempt-exempt-exempt)

2. EET (exempt-exempt-taxable)

Investments having EEE exemption status are exempt from tax at all the 3 phases of investment. Whereas investments having EET are exempt in the first two stages but the maturity proceeds are taxable. To minimize tax:

• Invest some funds in products with EEE status
• Invest some more in products with EET but make sure that the yearly payout doesn’t breach the exemption limits.

SEE ALSO: Pension Plans in India

How are Provident Funds (EPF, VPF and PPF) taxed?

As a general rule, contribution and interest on EPF are deductible under Section 80C. Maturity proceeds are tax-free.

Many EPF subscribers don’t withdraw their balance even after retirement or quitting the job to keep earning interest. Unfortunately, they’re not aware of the tax implications of such acts.

Even if you resign or are terminated, your EPF subscription remains active until you take up a new job and transfer the balance or withdraw it. Active accounts continue to earn interest only in formal employment. EPF interest earned when in unemployment is taxable.

The rules are different for retired citizens over 55. Their EPF account remains active only for three years after which it becomes inoperative or inactive. Such accounts:

1. Don’t earn any interest.

2. The accumulated interest is taxable.

Therefore, EPF doesn’t always have EEE tax status. Let us evaluate this under different scenarios:

1. EPF withdrawal before 5 years of service:

• EPF withdrawal before completing 5 years of continuous service is considered as a taxable income.
• However, if your service was terminated due to reasons beyond your control like ill health, closure of employer’s business, etc., no income tax is applicable.
• Such income is taxable in the year in which withdrawal was made.
• The employer’s contribution along with the accumulated interest is taxed as ‘profits in lieu of salary’.
• Interest accumulated on your contributions will be taxed under the head ‘Income from other sources‘.
• The tax deductions that you claimed on your contributions so far will be revoked and taxed.

2. EPF withdrawal after 5 years of service or immediately after leaving a job:

• EPF withdrawal after completing 5 yrs of service or immediately after leaving a job is not taxable. It is not necessary that you work for 5 years with the same employer.
• Such interest income is exempt under Section 10(12) of the Income Tax Act.

EPF Withdrawal Rules:

On changing the job, you must transfer the EPF balance in previous company to the new company’s EPF account.

3. EPF withdrawal after 5 years of service without contributions:

• EPF interest income is taxable if you’re not employed.
• If you resign, retire or are terminated from your job and don’t withdraw EPF immediately, interest income is taxable during such non-contributory period.
• The interest income earned during the employment period is still exempt from tax.

Example: You joined a company at the age of 23 and started contributing to EPF. At 45, you decide to quit and establish your own business. In such cases, if you don’t withdraw EPF immediately the interest is taxable.

• The interest income earned during the non-contributory period is a taxable even though your total service is more than 5 years.
• Interest is taxed on an accrual basis. You have to declare such interest income accrued in each financial year in the ITR under the head ‘income from other sources’ and pay tax.

Note:

• In case, you’re contributing to a Recognized Provident Fund maintained by a Private Trust of your Company and not EPF, interest exceeding 9.5% is considered as salary income and taxed.
• Transfer of funds from one EPF account to another and consolidation of multiple EPF accounts are not taxable.

VPF Tax Benefits

• VPF has EEE tax status.
• Contributions to VPF are eligible for tax deduction under Section 80C of the Income Tax Act up to Rs 1.5 Lakhs a year.

PPF Tax Benefits

Public Provident Fund (PPF) is among the few options exempt from tax at all three both investment and maturity stages under Section 80C and Section 10 (10D) of the Income Tax Act, respectively.

Mutual Funds Taxation

Investment in mutual funds generates income which is taxable under two heads:

• Capital gains
• Income from other sources

Mutual fund is a capital asset. Therefore, the profit or gain arising from the sale of mutual fund units is a capital gain. Capital gains can be short-term capital gains (STCG) or long-term capital gains (LTCG). Such capital gains are taxed in the year of sale of the mutual fund units.

Tax on capital gains arising from the sale of mutual funds is calculated based on the time you stay invested in them. This is called the holding period of mutual funds.

Holding period can be of two types:

• Short-term

• Long-term

Capital gains tax on different types of mutual funds:

1. Capital Gain Tax:

A. ELSS Tax Benefits:

Investment in ELSS is eligible for tax deduction under Section 80C of the Income Tax Act, 1961, up to the ceiling limit of Rs 1,50,000 a year. ELSS can save taxes up to Rs 45,000 a year. Since ELSS has a lock-in period of 3 years, you can only earn LTCG. After 3 years, on redemption of the ELSS units, LTCG up to Rs 1 Lakh is tax-free. LTCG beyond Rs 1 Lakh is taxed at 10% without indexation benefit.

Note: Indexation is a method to consider the rise in inflation between the year of purchase and sale of debt fund units. Thus, indexation brings down the quantum of capital gains.

B. Other equity mutual funds:

• LTCG on all other equity mutual funds of up to Rs 1 Lakh is tax-free; any amount in excess of Rs 1 Lakh is taxed at 10% without indexation benefit.

• STCG on the sale of other equity funds before 12 months is taxed at 15%.

C. Debt funds Tax:

• LTCG on debt funds is taxed at 20% after indexation.

• STCG on debt funds are added to income and taxed as per the income tax slab applicable to you.

D. Balanced funds Tax:

• Hybrid funds having at least 65% exposure to equity are taxed the same as gains from equity funds.

• Hybrid funds having a majority of exposure in debt instruments are taxed the same as capital gains from debt funds.

How are SIPs taxed?

Taxation rules for gains from SIPs changes according to the type of mutual fund (equity, debt or balanced) and the holding period (long-term or short-term). For taxation purposes, each individual SIP is treated as a fresh investment taxed separately.

Say you begin a SIP of Rs 10,000 a month in an equity fund for a year. Every SIP, i.e. investment of each month, is considered to be a separate investment. If you decide to sell the entire corpus, i.e. investments plus gains, all your gains will not be tax-free. The gains on the first SIP, i.e. first-month investment will be tax-free. This is because only that particular month’s investment will have completed a year. The rest will be subject to short-term capital gains.

2. Dividend distribution tax (DDT):

• The dividends earned on mutual fund units, attract “Dividend Distribution Tax”. The Mutual Fund deducts tax at source and distributes it to the investors.

• DDT is applicable only on dividend earned on non-equity oriented mutual funds and not on Equity Oriented Mutual Funds.

3. Securities Transaction Tax (STT):

• A mutual fund company levies a Securities Transaction Tax of 0.001% when you sell units of an equity fund or balanced fund.

• STT is not levied on the sale of debt fund units.

NPS Tax Benefits

A. Tier 1 Account:

1. For salaried subscribers:

• Employee’s contribution up to 10% of salary (Basic + DA) is eligible for tax deduction under Section 80CCD (1) of the Income Tax Act. You can claim a maximum of Rs 1.5 Lakh p.a.

• Employer’s contribution of up to 10% of salary (Basic + DA) can be claimed as deduction under Section 80CCC (2). The maximum limit is Rs 1.5 Lakhs p.a.

• Rs 50,000 can be claimed as a tax deduction under Section 80CCD (1b) for voluntary contributions made to NPS by you.

Section 80C + Section 80CCD (1b) = INR 2 Lakhs.

The aggregate deduction under Section 80C, Section 80CCC and Section 80CCD (1) towards NPS cannot exceed Rs 1.5 Lakhs per year.

This deduction is available only for salaried employees.

2. For self-employed subscribers:

You can claim a deduction of up to 10% of the gross income under Section 80CCD of the Income Tax Act. Maximum limit deduction that can be claimed is Rs 1.5 Lakhs p.a.

2. Tier 2 Account:

NPS Tier 2 Account is meant for voluntary savings. You are free to withdraw savings from this account whenever you wish. Hence, you can't claim any tax benefits for contributions made to this account.

• Tier 2 NPS Account offers no tax benefits.

• Withdrawals within a year of investment will be taxed as short-term capital gains tax. Withdrawals after a year attract long-term capital gains tax.

• Debt funds will be charged at 10%.

• Equity funds are not taxed.

NPS maturity tax benefits:

• Out of 60% of NPS corpus withdrawn at maturity, 40% is tax free.
• Annuity payments received by way of annuity purchased with the remaining 40% of NPS corpus are taxed.

Tax implications of other retirement plans

1. Tax-free bonds:

The interest on such bonds is tax-free. However, if you sell the bonds on stock exchanges you have to pay capital gains tax.

If you fall in higher tax brackets, you can earn higher effective interest on tax-free bonds.

Example: Let's say, you invested Rs 10,000 in Indian Railways N7 Series bonds offering interest at 8.23% p.a. for 10 years. Say you fall in the 30% tax slab. If interest was taxable, you’d earn Rs 823 less tax @30% = Rs 576.1 a year. Since interest is tax-free you earn Rs 823 a year. Thus, the effective yield that you earn is 11.7%.

Effective yield = Coupon / (1-tax rate)

2. Monthly Income Schemes (MIS):

MIS income is taxable as per your tax slab rate. It has no TDS.

3. Monthly Income Plans (MIP):

Compared to MIS, MIPs are more tax-efficient. MIS investments have equity exposure (usually less than 65%). Hence, these are categorised as debt funds and taxed accordingly.

1. STCG is taxed at the normal income tax rate.

2. LTCG is taxed at 10% without indexation benefit and 20% with indexation.

4. Senior Citizen’s Saving Scheme Tax:

The interest earned on SCSS is clubbed with income and taxed. If annual interest exceeds Rs 10,000, TDS is applicable.

If your annual income falls under exemption limit, you can submit Form 15 H and request not to cut TDS. Investments made in SCSS can be claimed as deduction under Section 80C.

5. ULIP Tax:

• The premiums paid can be claimed as a tax deduction up to Rs 1.5 Lakhs under Section 80C of the Income Tax Act, 1961.

• Capital gains and maturity amount of ULIPs are tax free under Section 10(10D).

6. Fixed deposit Tax:

• Interest earned on fixed deposit is fully taxable.
• FD interest above Rs 10,000 attracts TDS at the rate of 10%.
• TDS is cut at 20% if you haven’t provided PAN.
• If you fall in tax brackets of 20% and 30% but TDS is deducted, you have to pay the extra tax.
• Banks aggregate the FD interest across all their branches. Therefore, investing in two branches of the same doesn’t save TDS.

7. Recurring Deposit Tax:

• Recurring deposits attract TDS.
• Investment made in a recurring deposit every year is considered income for the year.
• Interest earned from recurring deposit attracts TDS at 10%.
• TDS will be cut at 20% if you haven’t provided PAN.
• Interest up to Rs 10,000 is not taxable.

8. Savings Banks Account Tax:

• Interest on savings bank account is taxable as per the slab rates applicable to you.
• A maximum interest of Rs 10,000 can be deducted under Section 80TTA per year by individuals and HUF.

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