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All you need to know about National Pension System (NPS) and its tax benefits

The National Pension System (NPS) is a Government-backed, voluntary, long-term retirement savings scheme in India that offers tax benefits.

  • 8,294 Views | Updated on: Mar 08, 2024

Among the various tax-saving instruments under Section 80C is the National Pension Scheme (NPS), which falls under Section 80CCD of the Income Tax Act. The NPS is an initiative by the Government of India to provide retirement benefits. As this is a tax-saving investment, the golden rule to master is to start early to save and foster monetary growth.

Taxpayers are often burdened with how to save the maximum tax outflow, especially because tax-saving investments are an integral factor in wealth creation. Section 80C under the Income Tax Act permits tax exemptions, given that the money is duly invested. Considering this, it is essential to be aware of the tax-saving instruments that provide the benefit of tax exemption and are also a good investment option.

What is a National Pension Scheme (NPS) Account?

Everyone works to ease their concerns upon retirement, and with adequate financial planning through the NPS scheme, you can rely on a substantial corpus for the post-retirement phase. It helps individuals satisfy their expenses while allowing them to build a corpus via market-linked returns that can be used during their retirement. The Government of India sponsored the NPS scheme, launched in January 2004, for government employees. In 2009, this scheme was availed by the rest of the working population, including those who work in the unorganized sector.

The Pension Fund Regulatory and Development Authority (PFRDA) regulates and administers the NPS, which defines the scheme as a market-linked voluntary contribution that professional fund managers manage. When an individual retires, they can withdraw a part of the corpus in a lump sum and use the remaining, which is at least 40% of the contribution, to buy an annuity to secure a regular income even after retirement.

The NPS scheme holds immense value for those who work in the private sector and require a regular pension after retirement. However, investors with a low-risk appetite can benefit the most from this scheme.

Who Should Invest in the NPS?

The NPS is a useful scheme for anyone who wishes to start planning for retirement early and has a low-risk tolerance. A regular pension (income) in retirement would surely be advantageous, especially for individuals who retire from private-sector jobs.

A systematic investment like this can significantly impact your living after retirement. Salaried people who seek to maximize their 80C deductions may also examine this approach.

What are the Types of NPS Accounts?

The NPS allows systematic and flexible investments via two different types of accounts: Tier 1 accounts and Tier 2 accounts. The account opening for the NPS flows by generating a unique Permanent Retirement Account Number (PRAN) issued to every subscriber. Both fund management and contribution to the scheme are made via the PRAN. Let us find out about Tier 1 and Tier 2 in NPS:

NPS Tier 1 Account

This account comes with a fixed lock-in period until the subscriber reaches the age of 60. It permits only a partial withdrawal with certain conditions. The contributions made towards Tier 1 accounts are qualified for deductions under Section 80CCD (1) and Section 80CCD (1B). This means that an amount of up to ₹2 lakhs can be invested in NPS Tier 1 account, and the entire amount is eligible for a tax deduction, i.e., ₹1.50 lakh under Sec 80CCD (1) and ₹50,000 under Section 80CCD (1B).

NPS Tier 2 Account

This voluntary savings account allows subscribers to withdraw when needed. This account can be opened with a minimum deposit of ₹250. However, the contributions made to the NPS Tier 2 account are not eligible for a tax deduction. It is mandatory to have a Tier 1 account in case you wish to open a Tier 2 account.

What are the Tax Saving Benefits of an NPS Account?

Since the NPS scheme opened to the public in 2009, it has been a popular investment option to save for retirement in India. Apart from the low-cost requirement, the NPS tax exemption has fostered popularity. However, it is essential to remember that tax benefits can only be availed for Tier 1 of the NPS account. Here are some of the tax exemptions that can be availed when someone opts for an NPS scheme:

Tax Benefits Under Section 80C

As investments made in the NPS scheme are listed under Section 80C of the Income Tax Act, a subscriber can claim deductions of up to ₹1.5 lakhs. This amount can be invested in the NPS scheme to avail of the deduction.

Tax Benefits Under Section 80CCD (1B)

This additional tax benefit is exclusive to NPS investors. Under this Section, tax deductions can be claimed for investments of up to ₹50,000. This is over and above the deductions you can claim under Section 80C. So, a tax deduction of up to ₹2 lakhs can be claimed by investing in NPS: ₹1.5 lakhs under Section 80C and an additional ₹50,000 under Section 80CCD (1B). This means that if an individual falls under the tax bracket of 30%, they can save ₹62,400 in taxes.

Tax Benefits Under Section 80CCD (2)

This benefit is meant for salaried individuals and can be availed on contributions made by the employer. While government employees can claim a deduction of up to 14% of their salary for tax deduction under this Section, employees working in the private sector can claim a 10% deduction.

Tax Benefits On Returns And The Maturity Amount

NPS tax saving does not conclude at the investment amount. Investors are also free from having to pay taxes on the maturity amount. This is because NPS comes with an exempt-exempt-exempt (EEE) tax status.

The National Pension Scheme tax benefit can help by reducing a significant amount from the subscriber’s taxable income. However, there are more reasons why NPS is a great investment option. It is a good investment tool for building a retirement corpus owing to its low cost and flexibility.

NPS Tax Benefits on Self and Employer Contribution

NPS allows individuals to contribute voluntarily to their retirement savings, providing an additional avenue for building a robust corpus. These self-contributions, made to the Tier-I account, not only support the retirement fund but also come with attractive tax benefits that can significantly enhance one’s financial planning strategy.

Employer contributions to the NPS Tier 1 account are also becoming increasingly common among organizations as they recognize the advantages of offering their employees a comprehensive retirement savings plan. While fostering employee financial security, these contributions also include notable tax benefits.

NPS Tax Benefits on Withdrawals and Annuity Purchases

The National Pension System is a valuable retirement savings tool and comes with a host of tax benefits extending to the withdrawal phase. Understanding the tax implications of NPS withdrawals and annuity purchases becomes crucial as individuals approach their retirement years. Advantages on withdrawals and purchases include:

Partial Withdrawals

NPS allows individuals to make partial withdrawals under specific circumstances. These tax-free withdrawals offer flexibility for individuals to meet financial needs without incurring tax liabilities.

Tax-free Lump Sum Withdrawal

At the time of retirement, individuals can withdraw up to 60% of their NPS corpus as a lump sum. This tax-free lump sum withdrawal provides retirees with a substantial amount to meet immediate financial requirements without any tax implications.

Annuity Purchase and Tax Efficiency

While at least 40% of the NPS corpus must be used to purchase an annuity, the annuity income is subject to taxation. However, the tax liability is spread over the annuity payments received, providing retirees with a more tax-efficient income stream.

Features of the National Pension Scheme

Apart from the NPS tax benefit, numerous features of the NPS scheme make it attractive for investors. These include:

Flexible Investment Choice

The NPS allows for two investment options acknowledging investment personalities. The subscriber can also switch these investment options:

Auto Choice

This is a default option as per the system. The funds invested under this Section are automatically managed by an appointed fund manager per the investor’s age profile.

Active choice

This is a more customized investment option wherein individuals can choose available asset classes to invest their funds in. For Asset Class E Equities, investors can allocate a different percentage of contributed funds to be invested with a maximum capacity of 50%. Other asset classes include Class C, Corporate Debt Securities, wherein the subscriber can invest in fixed-income investments other than government securities. For Class G, the subscriber chooses to only invest in government securities.

Making a Partial Withdrawal with NPS

An additional benefit of NPS includes partially withdrawing the contributions made to the scheme. It acknowledges the need to withdraw funds to address emergencies and gives individuals partial accessibility to their funds saved over the years. The rules for withdrawing are that a maximum of 25% of the contribution made to the Tier 1 scheme can be withdrawn. These withdrawals are, however, subject to specific clauses:

At least 10 years’ worth of contributions must be made to avail of the partial withdrawal facility o. There must be a minimum five-year gap between two consecutive withdrawals. There must be a minimum five-year gap between two consecutive withdrawals.

Early Withdrawal and Exit rules

As a pension program, you must continue to invest until you reach the age of 60. You may, however, withdraw up to 25% for particular purposes if you have been investing for at least three years.

These include children’s marriages or higher education, home construction/purchase, or self/family medical treatment. During your tenure, you may withdraw up to three times (with a five-year interval).

Equity Allocation Rules

The NPS invests in various schemes, including Scheme E-investing in equity. Equities can account for up to 50% of your total investment.

The auto selection determines the risk profile of your investments based on your age. For example, your investments become more steady and less risky as you age. Furthermore, active choice allows you to choose the scheme and divide your investments.

Change the Scheme

You can change your pension system or fund manager if dissatisfied with their performance. This option is available to accounts in both Tier I and Tier II.

Wrapping Up

The National Pension System is a comprehensive retirement savings tool that encourages systematic savings and offers attractive tax benefits. With deductions under Section 80CCD(1) and additional benefits through Section 80CCD(1B) and Section 80CCD(2), individuals can optimize their tax planning while securing their financial future. As the NPS continues to evolve and gain popularity, understanding its nuances becomes essential for individuals navigating the landscape of retirement planning in India.

Key takeaways

  • The National Pension System (NPS) is a voluntary long-term retirement savings scheme in India designed to provide financial security during old age.
  • NPS offers a choice between various investment options, including equity, corporate bonds, and government funds, allowing investors to customize their portfolios based on risk preferences.
  • NPS has a two-tiered structure comprising Tier I, a mandatory long-term retirement account with restrictions on withdrawals, and Tier II, a voluntary savings account with more flexibility in withdrawals.
  • Contributions made to NPS are eligible for tax benefits under Section 80CCD(1) of the Income Tax Act.

FAQs

1

How much amount of NPS is tax-free?

The National Pension System’s (NPS) tax-free component varies based on the withdrawal purpose. At least 40% of the accumulated corpus must be utilized to purchase an annuity, and the remaining 60% can be withdrawn as a lump sum, which is tax-free.

2

NPS under 80C or 80CCD?

NPS contributions fall under Section 80CCD of the Income Tax Act. Individuals can claim deductions for their contributions under Section 80CCD(1), with an additional benefit available under Section 80CCD(1B) for self-contributions.

3

Is NPS worth it for tax benefits?

Yes, NPS is considered worthwhile for tax benefits. Apart from offering deductions on contributions, it provides a tax-efficient structure during retirement, making it an attractive option for long-term financial planning.



4

Elaborate on the NPS tax benefit a corporate NPS subscriber can avail of.

Corporate NPS subscribers benefit from employer contributions, eligible for Section 80CCD(2) deductions. This allows employees to claim deductions on the employer’s contribution, providing an enhanced avenue for tax savings.



5

Is it a good idea to invest in an NPS scheme?

Investing in an NPS scheme is prudent for individuals looking for a disciplined and tax-efficient retirement savings option. The NPS offers a combination of market-linked returns and tax benefits, making it a valuable part of a comprehensive financial strategy.



6

How much NPS exemption in income tax can one expect to receive as an individual contributor?

The Section 80CCD(1) deduction allows individuals to claim up to 10% of their salary (basic plus dearness allowance) or 20% of their gross income, whichever is less. Additionally, Section 80CCD(1B) allows for an extra deduction of Rs 50,000, providing a potential total deduction of Rs 2 lakh.



7

Is the NPS scheme only limited to salaried individuals?

No, the NPS scheme is open to both salaried and self-employed individuals. It caters to a broad spectrum of individuals, offering a flexible and inclusive retirement savings platform.



8

Why is it recommended to purchase an annuity in the NPS scheme?

Purchasing an annuity in the NPS scheme ensures a steady income stream during retirement. At least 40% of the accumulated corpus must be utilized for annuity purchases, providing a structured payout and spreading the tax liability over the annuity payments.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
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Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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