Vote for ‘individual retirement accounts'

Perhaps it's time the common man vote for another investment alternative — Individual Retirement Accounts or IRAs. This is not a populist measure but more of a necessity for a country like India.

Need for IRA

There are various investment products available. Some of these investment products are in the nature of retirement benefit plans such as Employee Provident Fund (EPF), Public Provident Fund (PPF), New Pension Scheme (NPS), certain insurance products, among others. For an individual who does not have access to EPF (which would be the majority of us), is there any similar replacement in the capital market? Well, the answer is yes and no.

Let's step back. To incentivise people to save for their retirement, governments have historically provided tax concessions. There are broadly two popular taxation regimes, that is, Exempt Exempt Exempt (EEE) and Exempt Exempt Tax (EET). In both the regimes, the initial investment is eligible for tax benefits and the income accretion is not taxed. In certain regimes, the income is taxed at the time of maturity/withdrawal (such as NPS) and in others, such income is not taxed at all (such as EPF).

For people who do not have access to EPF, the Indian government introduced the NPS. Although NPS is slowly gaining popularity, unlike EPF, there is limited scope of availing tax deduction with respect to initial contribution and at maturity amounts withdrawn could be taxable. Also, investment avenues available to NPS Fund Managers are limited.

Any financial planner would agree that investment avenues for a 25-year old should be different from investment avenues for a 50-year-old. Shouldn't there be more flexibility available to an individual to plan his retirement? Retirement savings, if channelised and invested appropriately, would reduce the pressure on the exchequer to sustain an ageing population.

IRA, as a concept, is borrowed from the US, where it is quite popular. In simple terms, the government allows tax-free accumulation of savings to help plan for retirement. The contributions to IRA schemes, up to certain limits, are eligible for tax deduction (although there could be IRA schemes where investment is not tax deductible). There is a lot of flexibility available in investment avenues. Investments in IRAs could be self-directed and can include investments in stocks, mutual fund units, bank fixed deposits, life insurance policies, and even real estate (with conditions attached)!

IRA for young India

As the objective is to secure funds for retirement, in the US funds in IRAs cannot be withdrawn until 59.5 years. Taxation on accretion of income for IRA investments is deferred till withdrawal.

In certain IRA schemes, where investments are not eligible for deduction at the time of contributions, withdrawal could be exempted. We have a substantially young population which has different investment needs. Although the government is in the mood of phasing out tax deductions (and may be rightly so), it would greatly help if incentives for savings in retirement products (similar to Section 80CCC and Section 80CCD of the Income-Tax Act, 1961) are continued and, probably increased in quantum. Furthermore, if mutual funds are permitted to manage IRA contributions, it would give a significant fillip to the asset management industry.

Just to put things in perspective, assets in IRA plans in the US, which run into trillions of dollars, constitute approximately 27 per cent of the total retirement assets and approximately 20 per cent of assets under management of mutual funds.

It would significantly help if an IRA-styled investment regime is introduced in India ... so, vote for IRAs.

(Nehal D Sampat, Associate Director, Tax & Regulatory Services, PwC India & Shahid Khoja, Manager, Tax & Regulatory Services, PwC India. The views expressed here are personal.)

COMMENT NOW