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Everything You Need to Know About Tax Benefits of National Pension Scheme (NPS)

Everything You Need to Know About Tax Benefits of National Pension Scheme (NPS)
  • 9th Mar 2021 |
  • 4,151

Albert Einstein was not the last to think that, “the hardest thing in the world to understand is the income tax.” Taxpayers are often burdened with the question of 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 exemptions on taxes, given that the money is duly invested. Considering this, it is important to be aware of the tax-saving instruments that not only provide the benefit of tax exemption but are also a good investment option.

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

What is the National Pension Scheme (NPS)?

We all work to ease our concerns upon retirement, and with adequate financial planning through the NPS scheme, investors 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 NPS scheme is sponsored by the Government of India and was launched in January 2004 for government employees. In 2009 however, this scheme opened up to be availed by the rest of the working population, including those who work in the unorganised sector.

The NPS is regulated and administered by the Pension Fund Regulatory and Development Authority (PFRDA) who defined the scheme as a market-linked voluntary contribution that is managed by professional fund managers. 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. Investors with a low-risk appetite can benefit the most from this scheme. One of the numerous National Pension Scheme benefits is that it is portable across jobs and locations.

What are the Types of NPS Accounts?

The NPS allows systematic and flexible investments via two different types of accounts: Tier 1 account and Tier 2 account. The account opening for the NPS is flowed by the generation of a unique Permanent Retirement Account Number (PRAN) that is issued to every subscriber. Both fund management and contribution to the scheme are made via the PRAN.

  • NPS Tier 1 account: This account comes with a fixed lock-in period until the subscriber reaches the age of 60. An individual can open this account with a minimum deposit of Rs. 500. 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 Rs. 50,000 under Section 80CCD (1B).
  • NPS Tier 2 account: This is a voluntary savings account that allows the subscriber to make withdrawals as and 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?

Ever 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 its popularity. However, it is important to be mindful of the fact 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 for deductions of up to ₹1.5 lakhs. The entirety of 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 that 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 additional ₹50,000 under Section 80CCD (1B). This means that if an individual falls under the tax bracket of 30 per cent, 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 for a deduction of up to 14% of their salary for tax deduction under this section, employees working in the private sector can claim for 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 favourable investment tool for building a retirement corpus owing to its low cost and flexibility.

What are the benefits of the National Pension Scheme?

Apart from the NPS tax benefit, numerous other NPS scheme benefits can be availed by investors. These include:

  • High returns from investment: NPS offers high returns on investment because a portion of the NPS goes to the equities. While this does not come with guaranteed returns, it still promises much higher returns when compared to other traditional tax-saving investments such as the PPF. An investor also has the option to change their fund manager if the performance of their funds is not satisfactory.
  • It allows for flexibility of investment choice: The NPS allows for two investment options acknowledging investment personalities. These investment options can also be switched by the subscriber:
    • 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 as per the investor’s age profile.
    • Active choice: This is a more customised investment option wherein individuals can choose available asset classes in which to invest their funds. 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 that is 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. An investor can choose one of these funds or opt for a combination of them.

  • The Option of making a partial withdrawal: An additional benefit of NPS includes the option to partially withdraw the contributions made to the scheme. It acknowledges the need to withdraw funds to address emergencies and therefore gives individuals partial accessibility to their funds saved over the years. The rules for making a withdrawal are that a maximum of up to 25% of the contribution made to the Tier 1 scheme can be withdrawn. These withdrawals are however subject to certain clauses:
    • At least 10 years’ worth of contributions need to be made, to avail of the partial withdrawal facility o There has to be a minimum gap of five years between two consecutive withdrawals
    • There has to be a minimum gap of five years between two consecutive withdrawals

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