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 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 essential to be aware of the tax-saving instruments that provide the benefit of tax exemption and are also a good investment option.
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 it is to start early to save and foster monetary growth.
What is National Pension Scheme (NPS) account?
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 Government of India sponsored the NPS scheme, launched in January 2004, for government employees. In 2009, this scheme was availed by rest of the working population, including those who work in the unorganized sector.
The NPS is regulated and administered by the Pension Fund Regulatory and Development Authority (PFRDA) which defined 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. One of the numerous National Pension Scheme benefits is that it is portable across jobs and locations.
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 maximise 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. But what is tier 1 and tier 2 in NPS? Let’s find out
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).
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 percent, 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.
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 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 can select one of these funds or a mix of them.
- It allows for flexibility of investment choice
The NPS allows for two investment options acknowledging investment personalities. The subscriber can also switch these investment options:
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.
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.
- The option of making a partial withdrawal
An additional benefit of NPS includes the option to withdraw the contributions made to the scheme partially. 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 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.
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).
These limitations apply solely to tier I accounts and not to tier II accounts. Please continue reading for more information on them.
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 get older. 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.
What is Section 80CCD(1B)?
As part of the 2015 Union Budget, the government inserted a new subsection to Section 80CCD. (1B). This was done to improve funding for the NPS and Atal Pension Yojana programs. As a result, employees or self-employed individuals who contribute to the NPS or the Atal Pension Yojana are eligible for an extra deduction of ₹50,000 under Section 80CCD (1B). This deduction is in addition to the Section 80CCD deduction (1). However, while claiming this, ensure there is no claim duplication, i.e., do not claim the identical contribution amounts under both sections.
Consider investing in the NPS plan if the above benefits match your risk tolerance and investment objectives. However, if you are willing to take on more equity risk, several mutual funds are available that appeal to investors from various backgrounds.
