A penny saved is a penny earned. More so, when it comes to saving income tax, especially when a salaried person is investing in a long-term goal like retirement with own or employer’s contribution. It is all about financial discipline and investing diligently for decades. While the current taxation structure of popular retirement schemes for salaried employees, typically operates under the Exempt-Exempt-Exempt (EEE) framework, in reality, a large chunk of your nest egg might be claimed by taxes – not once, but multiple times.
The Exempt-Exempt-Exempt mythExempt-Exempt-Exempt tax status means that there is no income tax on investment in all the three stages of its lifecycle: contribution, accumulation/growth, and withdrawal.
However, there is catch as this works only up to a specific amount as the government sets limits on how much you can save for retirement without paying taxes. What it means is that these retirement products are not completely EEE.
The following table shows the limits to employee as well as employer contribution in all three retirement products:
Employer contributions
Employee Contributions
Whether it is employer’s contribution or your own contribution, both amounts come from your compensation package, but are treated differently for income tax purposes.
“The government treats them differently because employer contributions are considered a perquisite, while employee contributions are personal savings under tax deduction limits,” explains Abhishek Soni, CEO & Co-founder of Tax2win. “However, in reality, both come from your earned salary.”
Triple taxation on common retirement schemes
Once these contribution limits are exceeded, you may get taxed not once or twice but potentially three times and on money you can’t even access.
“Retirement savings are typically locked in for decades, yet in certain cases they face multiple layers of taxation” says Soni.
“Contributions above prescribed limits are taxed upfront. The returns on these excess contributions are then taxed annually, even though the funds cannot be accessed. Finally, at retirement, pension income or annuity payouts may be taxed again,” says Soni.
In the case of NPS, Soni says that while contributions get tax benefits and returns grow tax-free inside NPS, the problem arises at withdrawal. “Only 60% of your NPS corpus can be withdrawn tax-free. The remaining 40% (recently reduced to 20% in certain cases) must be used to purchase an annuity and the pension income from that annuity is taxable every year,” he explains.
“Because a portion of the corpus is mandatorily annuitized and the resulting income is taxed, NPS functions closer to an EET framework rather than a true EEE retirement product,” he clarifies.
This multi-layered taxation typically on higher contributions significantly reduces long-term compounding and undermines the attractiveness of disciplined retirement saving, despite the money remaining inaccessible during the accumulation phase, Soni highlights.
Similar taxation on different retirement schemes
Adding to this complexity is another layer of inequity in how different retirement products are given a similar tax treatment whether they are safe fixed-return products like Employee provident fund or market-linked schemes like NPS that carry real investment risk.
“Market-linked schemes like NPS involve risk and volatility, unlike PF or FD which offer relatively stable returns,” Soni notes. “Taxing accrued returns in both cases in a similar manner ignores this risk difference.”
Why take market risk for potentially higher returns when you’ll be taxed similarly to guaranteed-return products, despite the additional risk you’re assuming?
“This discourages long-term equity-linked retirement investing and pushes people toward safer but lower-return options, which may not be ideal for building a strong retirement corpus,” adds Soni.
Outdated exemption limits on retirement products
These limits were once generous when they were set years earlier. But in the current context, they seem outdated. This is because salaries have grown, and inflation has steadily eroded the purchasing power of money.
“These thresholds no longer reflect only ‘high earners,'” explains Soni. “The ₹7.5 lakh employer contribution and ₹2.5 lakh employee PF limits were set years ago and have lost relevance due to inflation and wage growth. “
If these limits had been adjusted for inflation, they would stand at roughly ₹10–10.5 lakh for employer contributions and ₹3.3–3.5 lakh for employee contributions today, according to Soni. That’s a significant difference and one that affects thousands of working professionals who never considered themselves wealthy.
While we wait for policy reforms, retirement planning requires more strategic thinking today.
“Taxation on contributions and accruals beyond defined thresholds increases the importance of diversification,” suggests Atish Jain, CEO, Choice Connect. “Retirement planning benefits from spreading savings across multiple long-term instruments rather than relying excessively on a single tax-advantaged vehicle.”
This means looking beyond just PF and NPS and at other investment options, understanding the tax implications of each, and planning your contributions carefully to stay within beneficial limits while maximizing growth.
Retirement planning in India faces a fundamental disconnect where the rules haven’t kept pace with economic reality. What was designed to tax only the wealthy now affects middle-income professionals. And what should be rewarded i.e. disciplined, long-term saving gets penalized through multiple taxation layers.