Retirement benefits have long been projected as an entitlement —something the employer owes the employee in return for the productive years spent in employment. What governments across the world have realised is that paying retirement benefits for 30-40 years requires funding of mammoth proportions. It is also unfair to tax a younger population to pay pension to an aging population.
The accepted view now is that the benefit one gets in retirement depends on the amount one contributes and the return earned on that contribution. We live in times when people work for multiple employers or for themselves, and prefer negotiating their pay packets. The time to dismantle the entitlement framework is here.
However, the EPF is the wrong place to begin. The statutory provident fund (SPF), which government employees contribute to, has the highest tax concessions and reeks of entitlement. Government employees, who began working before 2004, continue to receive assured, inflation-adjusted pension benefits. If you had a retired uncle chuckling at his Rs 100,000 plus pension that is far higher than his last pay as a bureaucrat 30 years ago, you know how unfair that entitlement is. Unless SPF is dismantled or made super unattractive compared to newer options, we won't be able to end the entitlement era.
The EPF, which all private sector employees contribute to, is torn between the finance ministry, which does not want to fund the deficits or provide too many income tax concessions, and the labour ministry, which is reluctant to modernise the management of funds or give up the demand for high rates of return.
The EPFO manages the money of small er subscribers (with monthly income of less than Rs 15,000), establishments that have not set up their own trust (the 3.7 crore subscriber number is not all). Many large organisations have a trust that manages this money, and have to comply with government guidelines. EPF is restrictive, arcane and out of tune with the times. The EPS carved into it is a nightmare. Making EPF worse by pulling the plug on tax concessions is a bad move.
The universal understanding is that people may not do what is good for them and sys tematically ignore the risks of languishing in poverty in old age. Therefore, governments provide tax concessions to nudge people to save for retirement. In the Western world, the idea of tax deferral is well understood. The definitions of income and the taxability of interest, capital gains and dividends have been clearly laid out and unambiguously applied over the years. In this context, it is easy to understand that a tax deduction that is allowed while one contributes to a retirement plan will be added to the taxable income on withdrawal. Importing this principle into India is not a good idea.
In our system, the tax concessions for retirement planning is a big muddle of confused ideas and there is no parity or clarity in the way in which taxes apply across products. Consider just one aspect. The tax deduction in EPF is on the contribution made by the employee. If the principle used is deferred taxation, it is the contribution, not interest that should be taxed at the time of withdrawal. But the final corpus includes the employer's contribution, which did not enjoy any tax deduction.
Therefore, it should be exempt at the time of reduction. But for government employees both components are exempt, so both should be taxed at withdrawal. No, we are not talking about them at all. But, wait! There may be employees who contributed more, and their withdrawal should be apportioned between what was tax-deducted and what was not. What about independent corpuses built by the self employed? Exempt if it is PPF. Taxable if it is NPS. You get the drift. This muddle cannot be resolved by tinkering with the tax rules
My suggestions are:
First: Do not make the employer the provider of retirement benefit. A large number of people work for multiple employers or are self-employed. Even a 21-year old knows how to negotiate the CTC. Make employers the administrative enablers that make the deduction and invest on behalf of the employee, if at all. Apply this principle to the government as an employer too and end the era of entitlement.
Second: Make all contributions to retirement products tax deductible. Treat the accumulated corpus like any other investment corpus for taxation of capital gains, dividends and interest. Exempt the principal withdrawal at maturity from tax. If someone saved Rs 2 lakh a year for 30 years at 10% p.a., the end value would be close to Rs 3.3 crore, of which Rs 60 lakh would be the original contribution (18%).
Let it go without tax. Use that handle to encourage saving. Do not set artificial limits about how much one needs for retirement. Open those floodgates and help the teeming millions that love saving taxes. The availability of large sums for long-term projects and the end of the entitlement era are huge benefits well worth the cost. Do not crowd 80C with useless products that mean nothing with regard to retirement benefit.
Third: Open up the market for retirement products. Let the NPS, SPF, EPF, insurance companies and mutual funds fight for the taxpayer's attention. The focus should be on performance. Let PFRDA take charge. The products should be well diversified, low cost, transparent and professionally managed. They should impose long-term commitment of funds, and penalise or prohibit early withdrawals.
PFRDA should ensure that only the best products remain in the approved list. The investment committee of the PFRDA should be ruthless in its evaluation and inspire the trust of millions in its choice of approved products. No PSU leaning or funding of pet projects of the government with taxpayers' money.
Fourth: Do not bother with what someone does with their money after retirement. Moreover, don't ask them to buy a poor quality annuity. Stop patronising the public and let them choose a world tour with their spouse if they so wish. In reality, most will guard and protect their corpus and tamely pass it on to their kids. That is why this Budget, which tinkers with proviso to Clause 12 of Section 10, falls so woefully short.
(The author is Chairperson, Centre for Investment Education and Learning)