The national pension system (NPS) is a popular retirement planning instrument in India, because to its market-linked returns and significant tax benefits. This blog tries to demystify and emphasise the tax benefits of NPS.
NPS summary and tax advantages
What is NPS? This is an often-requested question. It is a government-backed retirement tool. NPS provides two types of accounts: Tier I and Tier 2. Tier I is required for all NPS customers, whereas Tier II is optional. This article focuses on the Tier I account and its accompanying tax benefits.
Tier 1 account tax advantages
Section 80CCD(1)
This area enables NPS users to deduct payments to the Tier I account. The maximum deduction allowed under this clause is Rs. 1.5 lakh per fiscal year. This deduction is subject to the total limit of Rs. 1.5 lakh under Section 80C of the Income Tax Act.
Section 80CCD(2)
This is especially beneficial for paid staff. Government employees can deduct their employer’s payment to their NPS account up to 14% of their income (including Basic and Dearness Allowance).
For private sector employees, the deduction is limited to 10% of their pay (Basic + Dearness Allowance). This exceeds the Rs. 1.5 lakh limit under Section 80C.
Section 80CCD (1B)
This section offers another way to save money on your taxes. Subscribers who invest in NPS can claim an extra deduction of up to Rs 50,000. This is above and above the Rs. 1.5 lakh limit under Sections 80C and 80CCD(1).
Combined tax advantages under Sections 80C and 80CCD (1B).
Investing in NPS may allow a subscriber to claim a total deduction of Rs. 2 lakhs, including Rs. 1.5 lakhs under Section 80C deduction (which includes the deduction under 80CCD(1)) and an additional Rs. 50,000 under Section 80CCD (1B). This can result in large tax savings, particularly for those in the higher tax rates.
NPS Tier 2 account
Tier 2 accounts in NPS are optional and provide flexibility in terms of investment and withdrawal. However, unlike the Tier 1 account, the Tier 2 account provides no tax benefits.
Other NPS tax advantages
Partial Withdrawal: After three years of investing, members can withdraw up to 25% of their Tier I payments tax-free for designated purposes such as further education, marriage, or medical treatment.
Tax-free returns
The returns on Tier I investments are not taxed until they are withdrawn or mature.
Maturity advantages
When a subscriber turns 60, up to 60% of the NPS corpus can be taken tax-free. The remaining 40% must be utilised to purchase an annuity plan, which is also tax deductible.
EEE Advantage in NPS
The National Pension System (NPS) is one of the few investment alternatives in India with ‘Exempt-Exempt-Exempt’ (EEE) tax treatment. This classification provides triple tax benefits, making NPS an extremely tax-efficient investment vehicle. Here’s a summary of what EEE includes –
Exempt from donations
Contributions to the NPS are tax-exempt up to the authorised limitations. This includes deductions made under Section 80CCD(1) (up to Rs. 1.5 lakh) and Section 80CCD(1B) (an additional Rs. 50,000). So, donations to your NPS account effectively lower your taxable income, resulting in tax savings.
Exempt from accumulation/gains
The second ‘Exempt’ relates to earnings or gains from your NPS investments. The earnings on your NPS investments are tax-free as they accrue. This implies that as long as your NPS corpus remains invested, any interest, dividends, or capital gains earned will be tax-free. This permits the corpus to expand without the burden of taxes, perhaps resulting in a greater retirement savings.
Exempt from withdrawals
The last ‘Exempt’ refers to withdrawals. When you turn 60, you can take up to 60% of your NPS corpus tax-free. The remaining 40% must be utilised to buy an annuity, which is likewise tax deductible. However, the pension received from the annuity is taxed as income.
Tax benefits for employees
NPS is especially beneficial for paid personnel, providing many options for tax savings –
Employee contribution (Section 80CCD(1))
Employees can claim a tax deduction for contributions to the NPS Tier I account of up to Rs. 1.5 lakh yearly. This amount is under the total cap of Rs. 1.5 lakh under Section 80C of the Income Tax Act. Essentially, this decreases their taxable income, cutting their tax burden.
Employer’s contribution (Section 80CCD(2))
Salaried employees can benefit from both individual and employer contributions to their NPS accounts. This section provides a tax advantage for the employer’s contribution of up to 10% of the employee’s wage (Basic + Dearness Allowance). This exceeds the Rs. 1.5 lakh limit under Section 80C. For government employees, the cap is much higher: 14% of their wage.
Self-contribution (Section 80CCD(1)B)
In addition to the Rs. 1.5 lakh limit under Sections 80C and 80CCD(1), workers can deduct up to Rs. 50,000 for self-contributions under Section 80CCD(1B). This feature boosts NPS subscribers’ tax-saving potential by enabling a total deduction of up to Rs. 2 lakh (combining 80C and 80CCD).
Tax advantages for the self-employed
NPS allows self-employed persons to deduct up to 20% of their gross total income under Section 80CCD(1), subject to the Rs. 1.5 lakh limit under Section 80CCE. An additional deduction of up to Rs. 50,000 under Section 80CCD(1B).
Using the NPS Calculator
An NPS calculator can help you estimate your potential tax savings and future corpus depending on current contributions and other factors.
Real-world examples
Consider a corporate employee earning a basic salary of Rs. 6 lakh and a DA of Rs. 3 lakh. Deductions under Section 80C and 80CCD (1B) can total up to Rs. 2 lakh.
Furthermore, Section 80CCD (2) allows the employee to claim deductions for the employer’s contribution, which can greatly raise the overall deduction amount.
Ending note
NPS is more than simply a tax-saving strategy; it is a smart retirement investment with flexibility, low expenses, and significant tax benefits. It is essential to invest in it for the proper reasons, taking into account both the retirement benefits and the tax advantages.
