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Tax Benefits - How NPS Helps You Save Income Tax?

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NPS Tax Benefit
March 27, 2024

Table of Content

 

Having no salary or regular earnings once you retire is indeed a scary feeling. From carrying on with the same lifestyle to funding life goals, the need to ensure a steady flow of money in retirement remains a bothering thought. This is where the National Pension Scheme (NPS) can take some of your worries away with its dual advantage. While it helps you create a retirement corpus, there’s a set of NPS tax benefits available while you invest in it during your years of employment. 

To enjoy the advantages in full, it’s essential to have a clear understanding of the NPS features and benefits and the types of accounts they correspond to. 

Understanding Types of NPS Account and Tax Benefits

The National Pension Scheme (NPS) enables you to invest in two types of accounts. The NPS Tier I account aims to provide investors with a regular income after retirement. Contributions made to this account are locked in until the investor reaches 60 years of age.

Meanwhile, in case of NPS Tier II account, there is no restriction on withdrawal & they can be withdrawn anytime. . In order to have a Tier II account one should have an “ACTIVE” Tier I account.

NPS Tier 1 account tax benefits:

Investment in the NPS Tier I account makes you eligible for certain tax deductions under sections of the Income Tax Act, 1961. Here’s a glance at the benefits in the following table and the details thereafter. 

Description

Deduction under Corresponding Income Tax Section

Part of NPS deduction can be claimed for self-contribution up to Rs 1.5 lakh per year

80CCD(1)

Additional deduction up to Rs 50,000 a year can be claimed for self-contribution

80CCD(1B)

Govt. and private sector employees can claim deduction up to 14% and 10% of their salary respectively towards their employers’ contribution to NPS

80CCD(2)

Tax benefits under 80CCD(1): Under section 80CCD(1) of the Income Tax Act, 1961, one can claim tax deductions up to 10% of salary (Basic + DA) subject to maximum of Rs 1.5 lakh per annum towards investment in the NPS Tier I account. 

Tax Benefits under 80CCD(1B): This section allows you to claim an additional deduction of Rs 50,000 over and above the 80C deduction limit of Rs 1.5 lakh for the NPS Tier I investment. That takes the total deduction to Rs 2 lakh per year, for contribution made in NPS.  

Tax Benefits under 80CCD (2): Under this section, employees can claim a percentage of their salary (basic + dearness allowance) for the contribution made by their employers’ to the NPS Tier I account. Yearly claims can be up to 14% of salary for Govt. employees and 10% of salary for their private sector counterparts. 

NPS Tier II account tax benefits:

The NPS Tier II account is a voluntary account for NPS investors which allows regular contributions and withdrawals at any time. But to open this account, having a Tier I account is mandatory. For its voluntary nature, currently, there’s no tax benefit associated with the NPS Tier II account. 

Additional tax benefits under National Pension Scheme (NPS)

Alongside the deductions under sections 80C and 80CCD(1B), investing in NPS entitles you to some additional tax benefits. They are as follows.

  • NPS tax benefit on partial withdrawal: 

    After 3 years of investment in an NPS Tier I account, one is eligible to withdraw 25% of the corpus for specified reasons like a child’s education or marriage, medical requirements etc. This withdrawal is completely tax-free. 

  • NPS tax benefit on maturity:

    On turning 60, an investor can withdraw 60% of the corpus from their NPS Tier I account. The remaining amount should be mandatorily used to buy an annuity plan, which will pay him/her a retirement pension. Both of these are exempt from tax, and investors can use a pension calculator to help estimate their potential retirement income

  • NPS tax benefit on lumpsum withdrawal:

    As the investor turns 60, he/she can withdraw 60% of the total amount accumulated in the NPS Tier I account. This lump sum withdrawal is tax-free under the provisions of section 10(12A). 

  • NPS tax benefit on maturity:

    At maturity of the NPS Tier I account, 40% of the corpus should be used to buy an annuity plan. This is exempted from tax under section 80CCD (5). But remember, the income earned from the annuity plan is taxable. 

Tax Benefits for Employees  

Considered one of the most profitable retirement plans, NPS is also significantly beneficial for salaried employees. While it helps build a corpus, contributions to the NPS Tier I account, entitles the investor for solid tax benefits. 

Tax benefits to employees on self-contribution

For self-contributions to the NPS account, the following deductions are claimable:

  • One is eligible for deductions up to 10% of salary (Basic + DA) with a overall ceiling limit of Rs 1.5 lakh under section 80CCD (1). But, this amount should be included within the total 80C deduction limit of Rs 1.5 lakh allowable under Income Tax Act 1961
  • An additional deduction up to Rs 50,000 u/s 80CCD(1B) can be claimed over and above the limit of Rs 1.5 lakh under section 80CCE. 

Tax benefits to employees on employer’s contribution

Employees gain tax benefits for their employer’s contribution to their NPS account. This amount is 10% of the salary (basic + dearness allowance) for private sector employees and 14% for government sector employees.

Tax benefits to the self-employed

Even if you are self-employed, you can always invest in an NPS account and earn certain tax benefits. These are: 

  • Up to 20% of the gross income can be claimed for deduction under section 80CCD(1), within the overall limit of Rs 1.5 lakh under section 80CCE.
  • An additional Rs 50,000 is available for deduction under section 80CCD(1B) which is over and above the limit of Rs 1.5 lakh under section 80CCE. 

Benefits of the EEE system in NPS

A lucrative tax status for investment avenues in India is EEE or exempt-exempt-exempt. To get the EEE status, a financial instrument must:

  • Qualify for tax deduction from the annual income or salary up to the investment amount
  • Offer tax-free gains or interest on the investment
  • Have a tax-free maturity amount

Since the 2019 Union Budget, the entire 60% lumpsum withdrawal upon maturity of the NPS Tier I account is not taxable. Earlier, only 20% withdrawal of the corpus was eligible for exemption. Now with the total lump sum withdrawal being tax-free, both the corpus building and maturity benefit to an extent are exempted. This has helped NPS gain the EEE status. 

Understanding NPS tax benefits through an example

So, how do tax benefits work in NPS? Let us consider the following instance.

Suppose A is a private sector employee who earns a basic salary of Rs 6 lakh and Rs 3 lakh as dearness allowance per year.

He can therefore claim a deduction of Rs 90,000 (10% of basic + dearness allowance) for his contribution to the NPS u/s 80 CCD (1).

Additional tax deduction up to ₹50,000 under section 80 CCD(1B) over and above the overall ceiling of Rs. 1.50 lakh under Sec 80 CCE can be claimed.

Here's a table for better clarity:

Components

Amount

Basic salary

Rs 6 lakh

DA

Rs 3 lakh

Deductions under 80CCE (existing deductions like PF, Life Insurance, etc)

Rs 1.50 lakh

 

Out of Rs 90,000 contributed in NPS

Additional Deductions under 80CCD(1B) –

 

Rs 50,000

Total claimable deduction

Rs 2.0 lakh

Total Taxable Income

Rs 7 lakhs

FAQs on National Pension Scheme Tax Benefits

Q: What are tax benefits on withdrawals and annuity purchases?

Upon maturity of the NPS scheme, 60% of the corpus can be withdrawn as a lump sum. The remaining 40% needs to be used in buying an annuity plan. Both of these are tax-free though the incomes from the annuity plan will be taxable. Moreover, after 3 years of investment, a partial withdrawal of 25% can be made from the accumulated fund. This is tax-free as well.  

Q: What are the tax benefits of investment in the NPS Tier-II account?

The NPS Tier II account is a voluntary one where one can make regular investments or withdrawals. As of now, there are no tax benefits available to this account. 

Q: How much amount of NPS is tax-free?

A total deduction of Rs 2 lakh can be claimed for the NPS investment clubbing the provisions of sections 80CCCE & 80CCD (1B)  

Q: Is NPS available only for salaried individuals?

No, even the self-employed can invest in NPS. 

Q: What are the NPS tax benefits for Corporates/ Employers?

Corporates or employers of NPS holders can earn a tax benefit for contribution to the employee’s accounts. This amounts to 10% of the salary (basic +DA) which can be claimed as business expense under section 36 (1)(iv)(a). 

Q: Is NPS tax-free on maturity?

Yes, NPS is tax-free on maturity. One can withdraw up to 60% of the corpus as a lump sum. The rest has to be spent on purchasing an annuity plan. Both are exempted from tax.   

Q: Can I completely withdraw my accumulated pension wealth without annuitization?

Yes, if your accumulated pension wealth is equal to or less than a sum of five lakh rupees.

Conclusion

The National Pension Scheme is designed as an investment opportunity to secure one’s retirement. Upon maturity, the investor can get a lump sum from the corpus accumulated while the rest takes care of the monthly retirement pension through an annuity plan. But what makes NPS even more attractive is the array of tax benefits at every stage of the investment. Alongside, the low cost of building a retirement fund is a big reason to invest in it. 

Annuity Service Providers: 

PFRDA is a statutory body set up by the Government of India to regulate and develop the pension sector in India. An annuity pension is a type of pension in which the pensioner receives a fixed monthly income as per terms and condition of the plan

The relationship between PFRDA and ASPs (Annuity Service Providers) is that PFRDA is the regulator of the National Pension System (NPS), and ASPs are the entities that provide annuity services to NPS subscribers. When an NPS subscriber reaches the age of 60, they are required to annuitize at least 40% of their pension wealth. They can do this by purchasing an annuity from an ASP that is empanelled by PFRDA

You can select any of the annuity schemes offered by Annuity Service Providers (ASPs) registered with IRDAI and empaneled with PFRDA. HDFC Life is one of the registered ASPs for annuity issuance and further servicing.

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ARN – INT/ED/03/24/10047

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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#Tax benefits & exemptions are subject to conditions of the Income Tax Act, 1961 and its provisions.

#Tax Laws are subject to change from time to time.

#Customer is requested to seek tax advice from his Chartered Accountant or personal tax advisor with respect to his personal tax liabilities under the Income-tax law.

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