The National Pension System (NPS) has many advantages, and one of the significant ones is the tax benefits that they offer to employees. Any individual who subscribes to NPS can claim tax benefits.
Tax benefits can be availed both through income tax deduction of the contributions made towards NPS as well as through tax-free withdrawals from one’s NPS corpus.
NPS contributions are eligible for three kinds of deductions:
Deductions within the R1.5 limit
Under Section 80 CCE of the Income Tax Act, a number of investments and expenses are eligible for deductions up to a limit of R1.5 lakh a year. These investments and expenses include contribution towards employee pension funds, life insurance premium, investments in tax saving mutual funds as well as expenses like child’s tuition fee, etc.
Any investment made in an NPS scheme also qualifies as a tax deductible under section 80 CCE subject to an overall cap of R1,50,000 for a particular financial year.
“For a salaried employee, the investment amount or 10% of Basic + DA components of salary will be considered as the eligible deductible amount. For self-employed investors, the lower of invested amount or 20% of gross income will be considered as the eligible amount to claim tax deduction,” explains Nirav Karkera, Head Research, Fisdom.
Additional R50,000 deduction
Apart from this, investments of up to R50,000 in a financial year is separately deductible under section 80 CCD(1B). These tax benefits are availed based on the investment amount and eligible deduction translates to a lower income tax liability.
One of the important things is tax benefits are applicable only to investments in NPS Tier 1 plans. There are two types of NPS accounts- Tier I and II accounts. While Tier I is for retirement savings, Tier II is a voluntary savings account.
If an investor has a PF investment of R50,000, a life insurance premium of R20,000, and a principal repayment of a home loan of R40,000 in one financial year, then he is already claiming R1,10,000 (50K+20K+40K) out of R1.5 lakh under 80C. “He can additionally invest R40,000 in NPS to claim the full R1.5 lakh. He can invest R50,000 more in NPS under 80CCD(1B),” says Nidhi Manchanda, financial planner, head of training, R&D at Fintoo.
Considering if an investor claims a full R2 lakh deduction by investing in NPS only, then he will be able to save tax of up to R62,400. “It is important to know that this R2 lakh deduction is available for taxpayers opting for the old tax regime only. Under the new tax regime, such a benefit is not available,” financial planner Manchanda says.
It is suggested that investors should opt for a Tier 1 account, as only that offers all the tax benefits. No tax benefits are available for those investing in Tier 2 accounts, the financial planner adds.
Deductions of employer’s contribution
Tax benefits to employees on employer’s contribution is also allowed, the relevant provision is Section 80CCD(2). This too is over the limit of R1.5 lakh. Also, there are tax benefits of the self-employed as well. Self-employed individuals who contribute to NPS can secure certain benefits on their own contributions.
For instance, there is a deduction up to 20% of gross income. The pertinent section here is 80CCD(1). “Here too a deduction up to R50,000 -- under section 80 CCD(1B) -- is allowed,” says Nilanjan Dey, Director, Wishlist Capital.
Tax exemptions on withdrawal
Nilanjan Dey said that conditional benefits accrue on purchase of annuity u/s 80CCD(5). Also, partial withdrawal from NPS is tax friendly, subject to provisions as up to 25% of self-contribution. Apart from these two, lump sum withdrawal (60% of accumulated pension) spawns a tax exemption as well.
Tier 1 is a non-withdrawal permanent account, but in case of premature exit, investors can do so only after completing 10 years.
“Investors can redeem from their NPS Tier 1 account before the age of 60 for specific purposes only. However, a redemption of any amount up to 25% of the total invested value is tax-free,” says Nirav Karkera. This threshold for tax-free redemption goes up to a redemption of up to 40% of total
corpus if redeemed after the age of 60, Nirav Karkera explains.
An amount redeemed and invested in an annuity plan is tax-free as well. However, income from the annuity scheme is subject to taxes. In case if employers contribute to NPS, then employees will get a deduction of up to 10% of salary. However, if employers are willing to contribute 12% of employees’ salary to NPS, then the additional 2% will be taxable in employees’ hands. But the majority of employers cap their contribution to 10%.
