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19 Sep 2017
Don’t lose Big time by not commuting the Additional Pension
Blog, Pension Advice to armed forces officers Sanjeev Govila 0 comment

Additional Commutation of Pension

Dear Friends,

I had written a series of two articles some time back comparing Commutation of pension Vs Non-Commutation, and recommended that everybody should commute pension due to the reasons outlined there. Now, for the officers who have retired on or after 1st Jan 2016, the Govt has given an option to further commute the additional basic pension accruing due to the 7th CPC (Central Pay Commission) recommendations. In this article, I will deal with this dilemma whether the officers who have retired on or after 1st Jan 2016 should opt for further commuting their additional basic pension or not.

Rather than writing a lot of words, I have taken the indicative data of four officers of the ranks of Lt Gen, Maj Gen, Brig and Col, all of whom have superannuated on 1st Aug 2016 at their respective ages of 60, 58, 56 and 54 years of age and compared the effect of additional commutation Vs non-additional commutation. To keep the things simple, I have assumed that all of them have commuted 50% of their pensions earlier. Similalry, while calculating their tax liabilites, I have assumed that they will take full advantage of the Rs 1.5 Lakh exemption limit of IT Sec 80C. In case of officers having tax-free pension due to Diability or Gallantry Awards, the only small difference will be the tax part.

Details of Commutation and Pension as per 6th CPC

The Table 1 below gives out how the four officers of different ranks retiring on the same day and commuting 50% pension would be receiving their pension and would have received the commutation amount. If they have invested their commuted amount prudently, avoiding (or at least not committing much amount to) ‘apparently’ safe investments like bank FDs, PO MIS, Senior Citizen Savings Scheme (SCSS), Insurance etc, they would be patting their backs on their decision to commute their pension – whether goaded by my earlier articles on commutation or their own personal decision to do so.

 

 

Comparison Commuted Vs Not Commuted pension as per Option given by the Govt now

Table 2 below gives out the financials as per 7th CPC for the four ranks now and paints two scenarios – if you do not commute your pension any further beyond what you’ve already done (ie, 50%) under 6th CPC; Or if you decide to avail the option and further commute 50% of the increased basic pension as per 7th CPC.

Don’t lose bigtime by not commuting the additional pension-min

It can be noticed that the so-called shortfall amount can be easily made up if the amount received as additional commuted amount is invested in financial instruments which yield approximately 9.4% average per annum. On a long term basis, a mutual fund portfolio of 35% Equity & 65% Debt can achieve this average return. If an officer wants to be very safe and invest in a 100% safe Debt portfolio and one assumes a very comfortable 7% per annum returns from this portfolio of very high quality Debt Mutual Funds, the commuted amount received can be used to give out additional pension through the Systematic Withdrawal Plans (SWP) route. The advantage of using this mode would be:-

  • The non-commuted pension is fully matched due to additional returns from the portfolio.
  • Taxation would be much less for first three years of SWP pension compared to tax on uncommuted pension since SWP has a component of Principal which is never taxed. Hence, only a part of the pension is taxed compared to uncommuted pension being fully taxed.
  • After three years, indexation benefits kick in into the investment portfolio and rate of interest goes down as per inflation. Most likely, there will be Nil tax after five years on the SWP pension for the next 10 years or so when the commutation is restored back.
  • As the table below shows (Table 3), you will have a substantial amount of money balance after 15 years even while your pension is fully matched for the 15 years of commutation vis-a-vis no additional commutation option.

Invest Commuted AmountWhat should you do if you are retiring shortly?

While the above cases dealt with the additional commutation option that the Govt has given to the officers who have already retired on or after 1st Jan 2016, what should the officers retiring hereafter do? I sincerely believe that if the officer invests his retirement corpus well, including the commuted amount, there is no reason why maximum commutation option of 50% should not be taken by each and everybody. The Table 4 below depicts the same. If you are prepared to invest the retirement corpus in about 35% equity, you do not have to touch your commuted corpus and can earn the same pension as uncommuted option WHILE STILL HAVING YOUR ENTIRE COMMUTED CORPUS INTACT. And if you do not wish to go in for any equity at all, a full debt option, yielding 7% returns only, will also leave you with a large amount of money 15 years later. Thus obviously, non-commutation is only going to make you poorer!

 

 


Summarising,

Why you should definitely commute your pension to the maximum extent allowed?

I summarise the benefits of commutation brought out in my two articles earlier below:-

  • The pension is fully taxable while the commuted amount is fully tax-free. If this commuted amount is properly invested, just a fraction of the tax would need to be paid compared to the tax on uncommuted pension while getting the same net pension.
  • With prudent investing without taking any or small risks with a small part of your commuted amount, you can have your same amount of pension vis-à-vis non-comutation while having a large amount with you throughout your life.
  • There would be a large bulk amount available in hand which is a big asset to deal with emergencies, financial goals and responsibility or simply to lead a much better lifestyle.
  • Since commutation is a one-time exercise, the commuted amount per month remains static. So while the pension rises continuously due to DA, pay commissions and now OROP, the commuted amount deduction is continuously reducing to be a smaller proportion of the pension. Eg, when I took my PMR in April 2010, my commuted amount was Rs 19,375 per month which was big proportion of my overall pension. Now it is a very small proportion of my Rs 77,000 net pension.
  • If something untoward happens to you, your family will get the same pension since the Govt disregards the commuted amount paid, irrespective of whether you commuted or not. Clearly, non-commutation in such cases is a big financial loss to the family.

 

If you wish to read our last article on Commutation, it is available here.

For more information, feel free to reach us on, contactus@humfauji.in or call + 011 – 4240 2032, 40545977, 49036836 or

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10 Apr 2017
TO COMMUTE OR NOT TO COMMUTE PENSION - Hum Fauji Initiatives
Blog, Pension Advice to armed forces officers Sanjeev Govila 0 comment

TO COMMUTE OR NOT TO COMMUTE PENSION

Whenever any retiring officer approaches us for advice, invariably the question of whether or not to commute the pension comes up. This article deals with this issue so that all officers, retired or retiring, would be able to make up their mind more knowledgeably.

Before we take a call on the same, a few connected issues need to be understood clearly:-

  1. Basic Pension is exactly half of your last drawn Basic Salary. And Basic Salary is Basic + Grade Pay + Rank Pay.
  2. Whenever commutation is done, only the Basic Pension gets commuted, never the DA received. Thus, after commutation also, the DA is received on full value of Basic Pension.
  3. Commutation can be done of any value from 0% to 50%. However, generally almost all the officers get 50% commutation done, if they go in for it.
  4. Commutation is done based on a factor of commutation set by the Government which depends on the years of service that you’ve put in. To put it more simply, it is the time adjusted Present Value of your future pension.
  5. Pension is restored exactly 15 years after first commuted pension is received by you.
  6. Though not confirmed, probably commutation can still be done within one year of retirement, if the officer has not done commutation and wishes to change his decision.

Now, let us understand the difference between a commuted pension and an uncommuted pension. We’ll understand it by an example.

Case Study

The officer is a Col who has Rs 60,000 of Basic Pay, 8700 of Grade Pay and 6000 of Rank Pay, making it a total of Rs 74,700 of Basic Pay while serving. He will commute 50% of his pension, if he does so. He is in a dilemma what to do. A commutation factor of 8.08 is applicable to him. The DA is 119% at present.

His Basic Pension is = Rs 74,700 / 2 = Rs 37,350.

If he does not commute the pension:-

Monthly Pension received by him = Rs 37,350 + (119% of 37,350) = Rs 81,800.

If he commutes the pension:

Monthly Pension received by him = Rs 18,675 (ie, 37,350/2) + 44,446 (ie, 119% of 37,350) = Rs 63,121.

In addition, he will receive, a bulk commuted pension amount of Rs 19.9 Lakhs (ie, 18,675 X 12 months X 8.88 factor).

Analysis of Commutation Vs Non-commutation:

If you see the calculations above, the difference between commuted and non-commuted monthly pension is about Rs 18,680, which is not much of an additional amount to be received every month. And, he also gets a big sum of Rs 19.9 Lakhs in bulk. He would be able to generate long term returns of anything from 6% – 12% per annum net of tax, depending on where he invests his commuted amount. If he takes up re-employment or corporate job after retirement, for a few years, this small additional monthly amount will anyway not matter much to him. Thus, commutation seems better than on-commutation due to following three reasons:-

  1. Difference between 50% commuted (maximum allowed) and uncommuted pension is not much on a per month basis. As such, for this officer and his wife, living in their own house, Rs 63,000 per month of commuted pension is normally quite adequate.
  2. The bulk amount is quite large. Apart from providing a big financial security, it can be prudently invested to generate the gap amount (between commuted and uncommuted monthly pension) while still retaining the bulk money with you in your kitty.
  3. In case something untoward happens to the officer, the Government pays the same pension to the family of commuted and uncommuted cases, thus effectively ‘forgetting’ the commuted pension bulk amount given to the officer. This is a large welfare measure by the Govt.

If the Officer retires after 01 Jan 2016, ie 7th CPC applicable to him:

It is assumed that the 7th pay commission will increase his serving basic pay by 20%. Thus his serving Basic Pay will be Rs 89,640 and hence, Pension Basic Rs 44,820.

If he does not commute the pension, he gets a Pension of Rs 98,156.

If he commutes pension by 50%, his pension will be Rs 75,746. And he gets a commuted amount of Rs 23.88 Lakhs.

Again, even after pay commission effect, the gap between maximum commuted and non-commuted pension is only Rs 22,410 while the officer gets Rs 23.88 Lakhs as bulk if he commutes by 50%.

Our Recommendations

We strongly recommend that all officers should commute their pension to the maximum allowed 50%. If the officers are also able to invest their commuted pension bulk amount wisely and carefully, there is not likely to be any difference (or a minor difference) in their take-home pension even after commutation while still having this large commuted amount with them.

For more information, feel free to reach us on, contactus@humfauji.in or call + 011 – 4240 2032, 40545977, 49036836

26 Mar 2017
Is subscribing to NPS (National Pension Scheme) only for tax saving a smart move?
Blog, Pension Advice to armed forces officers Sanjeev Govila 0 comment

Is subscribing to NPS (National Pension Scheme) only for tax saving a smart move?

Do you buy a car only because it has nice headlights?

Why don’t you buy a house only because there’s a mango tree in front of it?

Why not marry a girl only because she bought your favourite brand of chips from a store?

Outrageous, right? You don’t do any of these. Then why do you take a long financial liability upon yourself just because there’s a small tax benefit that comes with it?

Lately, NPS has become a buzz word amongst fauji circles. The reasons are not far to seek:-

  • Tax season is upon us. You’ve heard that NPS gets you an additional Rs 50,000 of tax saving under Section 80 CCD(1). Then why not?
  • PFRDA (Pension Fund Regulatory and Development Authority) is promoting it hugely through advertisements – last year it was pure mis-selling by calling all its schemes fully safe, and this year the lure is additional tax saving.
  • The NPS schemes in general have performed well due to good Debt and Equity markets in the recent past.

We’ve also been receiving a lot of enquiries from serving, retired and corporate-employed armed forces officers asking us if it is good for them, in light of the additional tax benefit.In fact many of them have taken it already and then are asking us if it is good for them! Let’s see.

Basic Features of NPS

  • NPS is a product specifically made for retirement saving, which is closely regulated and monitored by a Govt agency, PFRDA.
  • There are eight fund managers (ICICI, HDFC, LIC, Kotak, Birla, Reliance, UTI and SBI) who are competing for your money, thus ensuring fair returns since you have the flexibility to shift between fund managers based on performance. Fund management charges are quite low. However, the pension (annuity)will come from Insurance companies which take over your corpus when it is time to get you pension.
  • There are inbuilt checks to ensure you cannot take out money easily at your whims and fancies, thus ensuring you get the power of compounding. You can contribute even beyond 60 years of age till maximum of 70 years.
  • Your contributions are tax exempt under Section 80C (ie, max Rs 1.5L as on today, along with host of other schemes) while your employer can contribute up to 10% of your basic salary if it wishes to. Basically, this part goes to your retirement saving and saves you tax since it does not remain part of your salary.
  • Lastly, there are four types of schemes available – equity (Option E), corporate (C), Govt securities (G) and Alternative investments (Asset Class A). You could do a manual model and choose out of E, C, G or A take the auto allocation (Lifestyle) option which allocates between E, C and G as per your age. The latter has further three sub-choices.
  • The negative points are that the withdrawal rules are tough (which is good in a manner since it is for retirement living), you have to take compulsory annuity (pension) with at least 40% of your own contributed corpus on reaching 60 years of age (relaxable by three years) and that the annuity (ie the pension) is fully taxable. You can withdraw up to 60% of your corpus at the age of 60 but only 40% part is tax-free.If pension is desired between 55-60 years of age, at least 80% of the corpus gets locked to give you pension and you can only withdraw 20% in lump sum on retirement. There is an option to withdraw up to 25% of the corpus earlier too but that is for special circumstances only.

Is it for you if you are a Serving Fauji Officer?

Additional Rs 50,000 tax rebate (saves you yearly tax of Rs 15,000 if you’re in 30% tax bracket) may seem great now. But remember, if you’re going to get Govt pension, the NPS pension is likely to be miniscule in comparison, there will be no increase in it once started and there is no tax rebate on the pension, ie, it’ll be fully taxable as on date. Hence, its EET tax regime (EET – Exempt when you contribute, Exempt while it remains invested and taxable when you withdraw) is essentially a tax-deferral scheme – the tax pain happens later and not right now. Even part of lump sum withdrawn amount (41% – 60%) taken by you on retirement is taxable. We’re also not comfortable with Insurance Companies giving you the pension (annuity) since their pension rates are traditionally very low.

A large part of the amount you save is going to get locked up for your entire life, to give you pension. This locked portion is at least 80% of your accumulated funds if you want pension to start between 55-60 years of age (ie, you decide on an early retirement) and 40% if pension is desired after 60 years of age. The only exemption to this rule is that you can withdraw full amount if the total accumulation is less than Rs 2 Lakhs.The lure of saving a bit of more tax is always enticing, but please take care that it should not become a millstone around your neck. And what’s so great if you save a tax of Rs 15,000 in a whole year, if it is cause you a lifelong liability?

Is it for you if you have retiredfrom Armed Forces with a pension?

If you’re above 60 years, you cannot subscribe to NPS. If you’re below that, you have to weigh how much will you be able to contribute in years to come so that it gives you any meaningful pension. A small tax benefit on Rs10-15,000 (depending on whether you’re in 20% or 30% tax bracket) in a whole year should not be the deciding factor. Moreover, if you’re already getting a disability pension which makes the entire Govtpension tax-free, NPS has no benefit for you.

Even if you’ve taken Premature Retirement (PMR) and you’ve qualified for Govt Pension, NPS utility to you is doubtful. However, if you’re employed in a private company and your employer agrees to contribute up to 10% of your Basic + DA as employer contribution (under Section 80CCD(2)), you need to work out how much you actually save in tax since this contributed amount does not remain part of your taxable salary. It will have to be calculated in every individual case and take into account the additional Rs 50,000 80CCD(1) tax benefit also.

We ran a calculation check on NPS Vs Mutual Funds with maximum equity contribution on both for an investing period of 15 years. We feel that equity mutual fund contribution of similar amount will be more beneficial due to the better likely returns and fully tax-free pension got out of ‘Systematic Withdrawal Plan (SWP)’ from mutual funds.

Is it for you if you have retired from Armed Forces but without a pension?

If you’ve retired from the armed forces without earning a pension, it implies that you’re comparatively young. In that case, you can seriously look at NPS and make it as your prime retirement pension tool. However, please do slight active management of your funds by taking Auto Choice – Lifestyle 75 (the 75% equity option). Alternately, if you have the financial discipline, you may go in for Mutual Funds option too to plan a tax-free pension without anybody dictating when should you retire. Retirement Mutual Funds are also an excellent alternative since they’re specifically for this purpose and have a large choice for you. But please go in for funds only with an established track record.

Our Final Take

In general, we feel that:-

  • Investing in NPS for the sake of the additional Rs 10-15,000 tax break will be quite short-sighted. Due to the restrictions on withdrawal of the collected corpus for a very large period of time, it does not seem worth it, if you’re already getting a Govt pension.
  • The EET status makes it tax inefficient to a large extent. You’re only kicking the can down the road.
  • If you’re not getting fauji pension, investing in ELSS (tax saving equity mutual funds) or Retirement Mutual Funds might be a better option. You get 80C benefits when you invest, the accumulation is tax-free and your withdrawals as also pension that you’d take will be fully tax-free. The disadvantage, if you may call it so, is that it would require either an active portfolio management at your end or you hire a good financial planner to do so. But if you do not wish to do any of that, NPS is a good option. Preferably start with Auto Choice (LC75) if you’re young and encourage your employer to also contribute for you.

In case you’re not very familiar with the mutual funds and their benefits, you may go through our blogs and other pages of our website to get an insight into this wonderful investment option.

And do not buy a car only because it has nice headlights?

For more information, feel free to reach us on, contactus@humfauji.in or call + 011 – 4240 2032, 40545977, 49036836 or

Subscribe to our blog for regular financial updates or follow us on  Facebook | Twitter | Linkedin

 

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