Did you know that NPS Tax exemption can help you save as much as Rs.62,400 in a financial year. And that the national pension system provides one of the best returns ranging from 6% to 10.2% pa. In this article, we look at major tax implications of NPS, that is the income tax benefit of saving money in NPS as well as the taxation of withdrawing money from NPS and the tax levied on the monthly pension paid out to you as annuity.
What is the National Pension Scheme
NPS is a pension fund as well as an investment scheme from the central government. This is an alternate pension fund that can be used to accumulate a retirement corpus with great returns. Currently available only to Citizens of India (NRIs included), this scheme allows for additional tax deduction provisions such as the below.
Money you add to the NPS account is locked in till you reach the age of 60. Once you pass 60, you can withdraw upto 60% of the NPS amount tax free, the remaining is invested as annuity and this corpus will pay you a monthly pension for the rest of your life.
An NPS account can be opened by you via your Bank or a 3rd party financial provider such as ET Money.
NPS Tax Exemptions
In a financial year, the total amount of tax saving you can get using NPS can work out to Rs.62,400 if you invest wisely. Here are the options and income tax section under which these tax benefits apply.
Rs.1,50,000 under 80C and 80CCD(1)
Though not technically under sec 80C, the Rs.1,50,000 limit permissible under 80CCD(1) is inclusive of the overall limit under section 80CCE. So your investments under 80CCD(1) and section 80C can have a tax break for a overall limit of Rs.1.5 lakhs.
Eg: If you have Rs.70,000 as PF under sec80C and invest Rs.1.5 lakhs under NPS, you only get tax break on Rs.1,50,000 the extra Rs.20,000 you have will be taxed as per your slab rate.
Rs.50,000 savings under 80 CCD (1b)
In addition to the benefits available under section 80CCD of the income tax act, you also have an additional deduction of Rs.50,000 tax free for investments in NPS via Section 80CCD(1b). In total, you can get benefits for Rs.2 Lakhs per year for savings in NPS.
Employer contributions tax free under 80CCD (2)
Apart from the previous two sections, NPS has the possibility for employers to contribute to your NPS account. If you are a government employee, you will get this for sure. If you are a private sector employee, check with your HR or accounts team on if your company allows for this. This would mean you can get an additional 10% of your salary (Basic + Dearness Allowance (DA)) tax free. For Government staff, this limit is 14%.
Employers benefit too, as the 10% they contribute to your NPS account can be deducted as a Business expense for them.
Tax on NPS Tier-2 account
All tax benefits are provided only to money saved under Tier-1 account. There are no tax benefits for investments made in Tier-2 account.
Tax on NPS Withdrawal and Annuity
There are different taxation slabs and rules applied to the money you can withdraw from NPS.
Withdrawal from NPS Tier-I
Tax on Partial withdrawal of NPS investment
You are allowed to partially withdraw money from your NPS account due to various emergencies. This can be upto 25% of your savings in NPS and this amount is tax free.
Tax on withdrawal of lumpsum maturity amount
NPS falls under EEE, as such once you reach the age of 60, your NPS investment matures. At this time, you have an option to withdraw as a lump sum anywhere between 0% to 60% of the maturity amount. This withdrawal will be tax free.
Tax on monthly pension or Annuity
After you reach the age of 60, you will be allowed to invest back a minimum of 40% of your accumulated corpus as annuity. This amount will be used to pay you a monthly pension. There is no tax applied on the pension you receive from NPS.
Withdrawal from NPS Tier-II
Withdrawing money from Tier-II accounts is in itself not taxable. But, money earned in your Tier 2 account is taxable.
You do not get any tax benefits for investments under Tier-II NPS accounts. Tier II account is an alternate savings method that gives you higher returns than a Fixed deposit. So, if you wish you can park your excess funds here than in an FD and enjoy taxable higher returns. Compared to mutual funds, the returns from Tier-II account is a lot more stable and liquid with less fees and 0 withdrawal penalties.
Other Benefits of investing in NPS
Apart from the tax perks, there are some other great reasons to choose investing in NPS:
- Trust: Backed by the Government of India and regulated by the PF Board
- Flexible long term investment Options: You can choose your investment plans. Decide to invest in 75% equity or even 25% equity. You get to decide what risk to accept for your money via the 3 different investment plans available.
- Great returns and works well for beginners looking to invest and fits well into FIRE Strategy.
- Cheapest fees among investment options: NPS fund managers charge about 0.002% as annual fees. This is comparatively cheaper than the 1% Mutual funds managers charge.
- Two tiered accounts, Tier-I for long term investing and retirement planning and Tier-II account as a short term liquid investment.
Some Frequently asked questions on NPS
No NPS scheme does not come under 80C, instead it comes under section 80CCD of the Indian income tax act. However as per section 80CEE, the contribution limit of of both sec80C and sec80CCD cannot exceed Rs.1,50,000 together.
You need to invest 50000 in your NPS Tier-I account. Once invested, you will get a proof of investment. This proof can be used to as investment proof at the time of tax submissions.
Yes it is a great option for saving tax with NPS. In total you can get upto Rs.2,00,000 can be exempted from tax making it a great choice for long term investment.
It is a long term investment and pension fund that is backed by the Government of India. It has great returns and one of the lowest annual fees. Most importantly, you get to save a lot of taxes.