Now that retirement products and their design are on the table, it is a good time for the finance ministry to think through the entire retirement landscape at a much more conceptual level
The controversy around Employees’ Provident Fund (EPF) began two weeks back, and not on Monday, when it was announced that the withdrawal rules will change. With effect from 10 February, a labour ministry amendment has capped what you can withdraw from your EPF corpus before you retire. Before 10 February, you could have withdrawn your entire EPF corpus if unemployed for more than two months. Before EPF portability, each time you moved jobs and got a new EPF number, you could clean out your PF money from the previous employer. The new rules allow you to withdraw your contribution and the interest on it before retirement, but the employer’s contribution is locked in till age 58. On Saturday last week, I accidentally stepped into an ongoing conversation about the change in EPF rules on Twitter. Read the debate on my twitter handle @monikahalan on 28 February 2016 around this. People were angry at getting locked into the product and wanted greater flexibility.
If the reaction to withdrawal restrictions was sharp, post-budget the social media outpouring by Middle India was loud and acrimonious. The budget did not give any increase in tax exemptions and deductions, but did the unthinkable—tax the fully tax-exempt EPF corpus at retirement. The announcement put the tax on 60% of the corpus, leaving 40% tax-free. The uproar after the announcement saw some knee-jerk reactions by various parts of the finance ministry. The Twitter handle of Minister of State for Finance, Jayant Sinha, was active till late on Monday night asking for time to sort things out. On Tuesday, revenue secretary Hasmukh Adhia was quoted by Press Trust of India clarifying that the tax was only on the interest on 60% of the contribution and not the full amount. And then, hours later, a Press Information Bureau press release (see it here: http://mintne.ws/1RD5wCV ) took us back to the beginning. According to the release, there are 6 million “highly-paid” private sector employees in EPF who earn more than Rs.15,000 a month and have accepted EPF voluntarily. For those people, the rules around withdrawal will change. At retirement, 40% of the corpus will be tax-free. If the rest, that is 60%, is used to buy an annuity, there is no tax. Income from the annuity will be taxed each year at slab level (no change in this). But if the rich EPF subscriber wants his 60% as a lump sum, there will be a tax on it. The release leaves what will get taxed unclear. If the entire 60% corpus is taxed at a top slab rate of 30.9%, the average tax on the entire corpus comes to 18.54%. If just the interest on 60% of the contribution gets taxed, then the tax will be small. Mint got a confirmation (http://mintne.ws/1RhOnMs) from the revenue secretary that it will be just the interest that will be taxed and not the full 60% corpus. We ran some numbers to see what the tax looks like (http://mintne.ws/1XY01kG). Suppose a person joins in the next fiscal and sees a salary growth of 10% a year for the next 40 years. Assume that EPF interest remains a steady 8% over this 40-year period. Unrealistic, I know, but we need to assume something for a back-of-the-envelope calculation. A tax on the interest corpus at 30.9% works out to an average tax rate of 12% on the entire corpus.
To understand the uproar over the EPF tax and Middle India’s anger, you must understand the role of this forced silent saving in the life of an average salaried person in India. Fathers got their daughters married by breaking their PF before retirement. Sons swindled out their dads’ PF accounts to start businesses. Whatever survived was the money that would go into buying a home and running the house. Often, the money is not enough, but it is a significant lump sum that allows a person some choices in his old age. The fact that this was a forced compulsory saving made the corpus creation automatic and far from the reach of ponzi masters that abound. The almost-religious fervour around EPF needs to be seen in the context of a lack of social security net in India and the dismal state of the public health system. For Middle India, in a cruel world that taxes the honest, the EPF corpus is one true friend.
Now that retirement products and their design are on the table, it is a good time for the finance ministry to think through the entire retirement landscape at a much more conceptual level. One, use insights from behavioural economists to make it an opt-out product, with a default opt-in. This means that you are automatically put into a pension plan unless you opt out. Already for those who are getting a job for the first time and earn a monthly salary above Rs.15,000, the opt-out system exists but remains unused due to companies not allowing it. There is a need to make opt-out effective and on-going. Two, make the National Pension System (NPS) and EPF portable. Right now, this again exists on paper but the road is not clear of clutter yet. Three, develop the annuity market for a viable choice. Today, the annuity market is undeveloped with a poor choice set.
Source : livemint
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