The tax benefits that the National Pension System (NPS) provides to its members are only one of the many perks it offers. Any person who joins NPS is eligible to claim tax advantages.
Tax advantages can be obtained by deducting contributions made to NPS from one’s income tax as well as by taking tax-free distributions from their NPS corpus.
Three different deductions apply to NPS contributions:
Deductions up to the R1.5 maximum
A range of investments and costs are allowed for deductions up to a cap of R1.5 lakh annually under Section 80 CCE of the Income Tax Act. These investments and costs include contributions to pension plans for employees, life insurance premiums, investments in mutual funds that reduce taxes, as well as costs like child-related tuition fees, etc.
Any investment made in an NPS plan is also eligible for a tax deduction under Section 80 CCE, subject to a total annual ceiling of R1,50,000.
“For a salaried employee, the applicable deductible amount will be the investment amount or 10% of the Basic + DA components of compensation. According to Nirav Karkera, Head Research, Fisdom, for self-employed investors, the lower the invested amount or 20% of gross income would be taken into account as the acceptable amount to claim a tax deduction.
A further R50,000 deduction
A special deduction under section 80 CCD is available for investments up to R50,000 made in a given fiscal year (1B). These tax advantages are obtained depending on the investment amount, and a qualifying deduction results in a reduced income tax obligation.
One of the key points is that only investments in NPS Tier 1 plans are eligible for tax advantages. Tier I and II accounts are the two different categories of NPS accounts. Unlike Tier I, which is for retirement savings, Tier II is for personal savings.
An investor is already claiming R1,10,000 (50K+20K+40K) out of R1.5 lakh under 80C if they invest R50,000 in PF, R20,000 in life insurance premiums, and R40,000 in house loan principal in one financial year. “He may spend an additional R40,000 in NPS and still be eligible for the entire R1.5 lakh. According to Nidhi Manchanda, head of training and R&D at Fintoo and financial adviser, he can deposit an additional R50,000 in NPS under 80CCD(1B).
An investor can save up to R62,400 in taxes if he invests exclusively in NPS and gets the entire R2 lakh deduction. “It is crucial to understand that this R2 lakh deduction is only accessible to people who choose the previous tax system. Such a benefit is not possible under the current tax system, according to financial advisor Manchanda.
Investors are advised to use a Tier 1 account since it is the only one that gives all of the tax advantages. The financial advisor continues that investing in Tier 2 accounts is not tax-beneficial.
Employer contribution deductions
The applicable law is Section 80CCD, and tax advantages to workers on employer contributions are also permitted (2). This too exceeds the R1.5 lakh cap. There are tax advantages for self-employed people as well. Self-employed people who make NPS payments are eligible for several perks based on their efforts.
For instance, a deduction of up to 20% of gross income is available. 80CCD is the relevant section in this case (1). According to section 80 CCD(1B) in this case as well, a deduction of up to R50,000 is permitted, according to Nilanjan Dey, Director, Wishlist Capital.
Tax deductions for withdrawal
According to Nilanjan Dey, when an annuity is purchased under Section 80CCD, conditional benefits are accrued (5). Additionally, up to 25% of self-contribution is allowed for partial withdrawal from the NPS, which is tax-friendly. A tax exemption is also generated by lump sum withdrawals, which account for 60% of the total pension.
Tier 1 is a permanent account that cannot be withdrawn from, however, investors may leave the account early if they wait 10 years after entering it.
Before turning 60, investors may withdraw money from their NPS Tier 1 account, but only for certain uses. But any redemption up to 25% of the entire investment value is tax-free, according to Nirav Karkera. According to Nirav Karkera, if redeemed beyond the age of 60, this threshold for tax-free redemption increases to the redemption of up to 40% of the whole amount.
Taxes aren’t applied to money that is redeemed and put into an annuity plan. However, the annuity scheme’s income is taxed. Employees will get a deduction of up to 10% of their salaries if their employers make contributions to NPS. However, the extra 2% will be taxable in the hands of employees if businesses agree to pay 12% of employees’ salaries to NPS. But the bulk of employers only contribute up to 10%.