NPS Tax Benefits and Exemptions under of Income Tax Act

Content:

WHAT IS NPS?

NPS-deduction

The National Pension Scheme or NPS is a social security initiative by the Central Government. This pension program is open to employees from the public, private and even the unorganized sectors with the exception of those from the armed forces. The scheme encourages people to invest in a pension account at regular intervals during the course of their employment. After retirement, the subscribers can take out a certain percentage of the corpus. As an NPS account holder, you will receive the remaining amount as a monthly pension post your retirement.

NPS is available for both government employees as well as private citizens. NPS is one of the most popular options available to individuals looking to create a corpus for their retirement along with a regular monthly income. NPS Deductions are available under 3 sections which are discussed further.

Who should invest in NPS?

NPS is a good option for anyone who wants to plan for their retirement early on and has a low-risk appetite. A systematic investment like this can result into difference to your life post-retirement. In fact, Salaried persons who want to make the most of the 80C deductions can also consider this scheme as a Tax Saving tool. NPS deductions are now-a-days one of the most used tools for tax savings.

HOW NPS WORKS?

The money deposited in NPS is invested in a variety of securities and investment avenues including equity market. It is widely regarded as one of the cheapest investment options with exposure to equity.

As the returns are directly related to the market performance, there is no guarantee of any particular amount, but over a period of time, returns from NPS are one of the highest in the market.

TYPES OF NPS ACCOUNTS & ELIGIBILITY FOR ADDITIONAL NPS DEDUCTIONS:

(i) Tier 1 Account

This has a fixed lock-in period until the subscriber reaches the age of 60 years. Only partial withdrawal is allowed, with certain conditions. Contributions made towards Tier 1 are tax deductible and qualify for deductions under Section 80CCD(1) and Section 80CCD(1B). This means you can invest up to Rs. 2 lakh in an NPS Tier 1 account and claim a deduction for the full amount, i.e. Rs. 1.50 lakh under Sec 80CCD(1) and Rs. 50,000 under Section 80CCD(1B).

(ii) Tier 2 Account

This is necessarily a voluntary savings account which allows the subscribers to make withdrawals as and when they like. But the contribution made to a Tier 2 account is not eligible for tax deduction. To open a Tier 2 account, you must open a Tier 1 account first.

Contribution to NPS now qualifies under the exempt-exempt-exempt (EEE) mode of taxation wherein the amount contributed to NPS, the income generated and the amount of maturity, are all tax-exempt. As per the latest guidelines, you can withdraw up to 60% of the amount on maturity and need to reinvest the remaining 40% to purchase an annuity that gives you a regular monthly income.

SECTION THAT ALLOWS FOR ADDITIONAL NPS DEDUCTION:

Section 80CCD of the income tax act deals with deductions offered to individuals contributing to the NPS. As per Section 80CCD, until the year 2015, an individual was eligible to claim an income tax deduction of up to Rs. 1 lakh against contributions made to the NPS. In the budget for the year 2015, the government enhanced the maximum amount payable to the NPS to Rs. 1.50 lakh per annum. Additionally, a new sub-section 1B was also introduced, which offered an additional deduction of up to Rs. 50,000/-for contributions made by individual taxpayers towards the NPS.

The additional deduction of Rs. 50,000/- under Section 80CCD(1B) is available to assess over and above the benefit of Rs. 1.50 Lakhs available as a deduction under Sec 80CCD(1). Thereby, raising the maximum limit of exemption to Rs. 2.00 Lakhs with Section 80CCD(1) + Section 80CCD(1B).

NPS DEDUCTION UNDER DIFFERENT SCENARIOS:

Contribution bySectionDeduction AllowedAdditional Note
Employer80CCD(2)10% of salary (no monetary limit)Outside of 80C and 80CCD(1B) limits
Employee80CCD(1)10% of salary, max up to Rs.1,50,000Within Section 80C
Self80CCD(1B)Rs.50,000In addition to 80C and 80CCD(2)

In case your employer is contributing to NPS, and you are also contributing to NPS – you can claim all the three deductions listed above to maximise your tax benefits.

Which are the other tax saving schemes like NPS?

Apart from the NPS, the other popular tax-saving investment options under Section 80C are Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF) and Tax-saving Fixed Deposits (FD). Below table shows the comparison between NPS and these options: 

Investment NameInterestLock-in periodExemption TypeRisk Assessment
National Pension Scheme8% to 10%Till Retirement E-E-EMarket Driven
Equity linked Saving Scheme12% to 16%3 YearsE-E-TMarket Driven
Public Provident Fund8.1%15 YearsE-E-ERisk Free
Fixed Deposits5% to 8%5 YearsE-T-ERisk-Free

So which Option you should go for?

Our recommendation will be that you should consider investing in NPS scheme if the benefits elaborated above match your risk profile and investment goal. However, if you are open to more equity exposure, there are many mutual funds catering to investors from diverse backgrounds available. So you must analyse your risk taking ability and then make your investment decisions.

POINTS TO BE NOTED BEFORE INVESTING INTO NPS:

(i) The additional deduction of Rs. 50,000/- is available only for contributions made to NPS Tier 1 accounts.

(ii) Tier 2 accounts are not eligible to claim the deduction under Section 80CCD(1B).

(iii) The deductions under Section 80CCD(1B) are available to salaried individuals as well as to self-employed individuals.

(iv) You need to produce documentary evidence of the transaction related to the contribution to NPS.

(v) Partial withdrawals are allowed under NPS but are subject to specific terms and conditions.

(vi) The total exemption limit under Section 80CCD(1B) is Rs. 50,000/- and is independent of exemptions under Sec 80 C. Thereby, you can claim a maximum deduction of  Rs. 2,00,000/-.

(vii) In case the assessee dies, and the nominee decides to close the NPS account, then the amount received by nominee is exempt from taxation.

(viii) If partial withdrawals are made from the account, then only 25% of the contribution made is exempt from taxation.

(ix) If the assessee is an employee and decides to close the NPS account or opt out of NPS, then only 40% of the total amount is tax-exempt.

(x) The assessee can withdraw 60% of the entire amount on reaching the age of 60 years as tax-free income. The remaining 40% is also tax-free if it is used to purchase an annuity plan.

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