Everything About National Pension Scheme (NPS) Tax Savings

In India, the NPS is a voluntary and long-term investment plan for retirement under the auspices of PFRDA (Pension Fund Regulatory and Development Authority). Read on to learn what an NPS scheme is and what are its benefits.

What is NPS?

The National Pension Scheme (NPS) is a prominent scheme among the social security initiatives taken by the Central Government. It is one of the best retirement plans.

Except for members of the armed forces, all other employees from the public, private, and unorganised sectors may join this pension scheme.

How to invest in NPS: During employment, people are encouraged to invest in pension accounts regularly. There are 2 types of accounts under the NPS scheme: Tier-I and Tier-II. The Tier-II account is more flexible while the Tier-I account permits restricted withdrawals.

Subscribers can withdraw a maximum of 60% as a lump sum of the corpus upon retirement. The remaining amount must be used to purchase a pension or an annuity plan.

Employees of the Central Government were the only ones covered by the NPS scheme in the past. However, the scheme is currently open to all Indian citizens voluntarily by the PFRDA. This scheme is portable across jobs and locations.

Who Should Invest in NPS?

It is important to note that the NPS is a good option for any individual who wishes to plan for retirement early on and has a low appetite for risk since the equity exposure in an NPS account is restricted.

Undoubtedly, having a regular pension (income) in retirement, particularly if you retire from a private sector job, will be a great blessing in your golden years.

The tax deductions in NPS can also be used by salaried workers who want to maximise their tax savings.

Benefits of National Pension Scheme (NPS)

Listed below are the benefits of National Pension Scheme benefits.

Returns/Interest

Notably, a portion of the NPS is invested in equities, which increases the scheme’s return potential. The returns for this investment are significantly higher than those for other traditional tax-saving investments such as the PPF.

Over the past decade, this scheme has provided an annualised return of 9% to 12%, which has made it one of the most successful schemes in the world. As part of the NPS, you also have the option to change your fund manager if you are unhappy with the fund's performance if you are enrolled in the plan.

Risk Assessment

For the National Pension System, equity exposure is currently capped between 50% and 75%, depending on how the scheme is set up. From the year in which the investor turns 50 years of age, there will be a reduction in the portfolio's equity portion by 2.5% each year in the prescribed range.

Despite this, the cap is fixed at 50% for investors aged 60 and above, regardless of their age bracket. As a result, investors' interest is stabilised because the risk-return equation is more favourable to them. This means the corpus is protected from the volatility in the equity market. NPS offer a higher earning potential than other fixed-income schemes because they have a longer investment horizon.

Regulated

An NPS is regulated by the PFRDA (Pension Fund Regulatory and Development Authority under the Finance Ministry, Government of India) to ensure that transparent norms govern NPS activities. The NPS Trust is responsible for ensuring adherence to the guidelines by conducting regular monitoring.

Flexibility

There is a lot of flexibility with the NPS subscription. A NPS subscriber can contribute to the NPS fund at any time during a financial year and change the amount of their subscription.

You can choose investment options according to your preferences. You can manage your accounts online from anywhere, so you can continue to do so even if you change your city or job.

National Pension Scheme Tax Benefits

The following section explains the NPS benefits for tax:

Employee Tax Benefits for Self-Contribution

NPS subscribers can enjoy tax benefits if they invest in any of the three models - All Citizens (Retail), Corporate, and Government Models. The tax saving benefits of NPS under the Income Tax Act 1961 include the following:

• Section 80 CCD (1): As part of the overall tax saving limit under 80CCE, Income Tax Act, investments made into NPS qualify for tax deductions of up to ₹1.5 lakh.
• NPS Corporate Subscribers: You can claim tax deductions of up to 10% of your compensation (Basic + Dearness Allowance) u/s 80 CCD (2) but not exceeding ₹1.5 lakh in a year.
• Subscribers to Government NPS: The limit for this NPS tax benefit for employees in state governments is 10% of their salary (Basic + Dearness Allowance). In contrast, for employees in central governments, it has been increased to 14% of their salary (Basic + Dearness Allowance). According to the Income Tax Act, this tax benefit is offered under Section 80 CCD (2) and is limited to ₹1.5 lakh in a fiscal year.

• Section 80 CCD (1B): A Retail NPS subscriber may deduct an additional ₹50,000 in a financial year for investments made into their NPS account under this subsection of Section 80C of the Income Tax Act, 1961, over and above the ₹ 1.5 lakh limit under Section 80 C.

Employee Tax Benefits on Employer Contributions

NPS employer contributions are subject to the following limits:

• Corporate NPS Contribution Tax Benefit: Under a corporate NPS model, employers may contribute up to 10% of employees' salaries to NPS accounts. Under Section 80 CCD (2), this deduction is over and above the ₹1.5 lakh limit under Section 80 CCE.
• Employer Contribution - For Government: The government offers tax deductions to state and central government employees. Under current NPS rules, state government employees may contribute up to 10% of their salary (Basic + Dearness Allowance).

In the case of Central Government employees, the maximum employee contribution is 14% (Basic + Dearness Allowance). Section 80 CCD (2) states that this tax deduction exceeds the ₹1.5 lakh limit for tax savings offered under Section 80 C.

Tax Benefits for Self-Employed People

On their contributions to NPS, self-employed individuals can claim tax benefits such as:

• A maximum deduction of 20% of gross income is allowed under Section 80CCD(1), subject to a maximum of ₹1.5 lakh under Section 80CCE.
• Section 80CCD(1B) allows a deduction up to ₹50,000, while Section 80CCE allows a deduction up to ₹1.5 lakh.

Tax Benefit on Annuity Purchase

You must use at least 40% of the NPS Tier 1 scheme amount to purchase annuities or pension plans on maturity. NPS annuities and pension plans can be tax-exempt under Section 80 CCD (5) of the Income Tax Act upon purchase at superannuation. However, the income received from these annuities is taxable at the applicable tax slab rate under Section 80CCD (3).

Corporate/Employer Tax Breaks

For subscribers under the corporate sector, the employer’s contribution to an employee’s NPS account for the latter’s benefit is eligible for tax benefits of up to 10% of the employee’s salary. The salary here includes the basic salary and the dearness allowance. This contribution can be deducted from the taxable income, with a maximum limit of ₹7.5 lakh.

Corporate employers can get tax deductions up to 10% of an employee’s salary on their contributions towards the employee’s NPS account. This deduction should be placed under the ‘Basic Expense’ section in their Profit and Loss account.

Conclusion

As a result of the tax benefits associated with NPS, it can help you reduce your taxable income. However, this should not be your sole reason for investing in it. Because of its low cost and flexibility, it is an excellent product for those looking to build a corpus for their retirement.

Therefore, if the above benefits align with your risk profile and investment goals, you might consider investing in the NPS scheme carefully. While investing, ensurtaxe you check the Pension calculator online to make informed decisions.