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June 4, 2021

Know all about NPS and Tax saving

by Mahesh Mara in Income Tax

Know all about NPS and Tax saving

The National Pension System is a voluntary defined contribution pension system in India. The scheme encourages people to invest in a pension account at regular intervals during the course of their employment. After retirement, the subscribers can take out a certain percentage of the corpus. As an NPS account holder, you will receive the remaining amount as a monthly pension post your retirement. Under NPS, an investor can open two accounts:-

  • Tier I account and
  • Tier II account

Tier I account is a non-withdrawable permanent retirement account whereas Tier II is a voluntary withdrawable account. Tier II account can be opened only when you have an active Tier I account. An investor in NPS has two choices to invest in, namely Auto choice and Active choice. In Auto choice, allocation amongst assets is done as per a predetermined formula based on the age of the investor. Under Active choice, the choice of allocation lies with the investor. On retirement, exit or superannuation, at least 40% of the contribution is utilised for the procurement of lifetime pension via the purchase of an annuity. The remaining funds are paid to the subscriber in a lump sum.

What are the benefits of investing under NPS?

Below are the various benefits of investing under NPS:

  • Regulated – NPS is regulated by PFRDA, with transparent investment norms and regular monitoring and performance review of fund managers by NPS Trust.
  • Voluntary – A Subscriber can contribute at any point of time in a Financial Year and also change the amount he wants to set aside and save every year
  • Flexibility – Subscribers can choose their own investment options (Auto choice or Active choice) thus providing the flexibility of choice.
  • Low Deposit – An individual can open an account with initial contribution (minimum of Rs. 500 for Tier I and a minimum of Rs. 1000 for Tier II) at the time of registration. Subsequent minimum contributions as given below are also nominal under this scheme:-
  • Tier I: Minimum amount per contribution – Rs. 500 & Minimum contribution per FY – Rs. 1,000
  • Tier II: Minimum amount per contribution – Rs. 250
  • Option to make partial withdrawal – The NPS fund gives individuals partial accessibility to their funds saved over the years, thus allowing them to meet financial needs before retirement during emergencies.

What are the various tax benefits with respect to NPS under Income Tax Act?

Below are the various tax benefits with respect to NPS under Income Tax Act 1961:

1. Deduction with respect Contribution to National pension scheme u/s 80CCD(1)

This provision defines the rules related to income tax deduction available to individuals for contributions made to the NPS. It is irrespective of the fact whether the contribution has been made by a government employee, private employee or a self-employed individual. The provisions of this section apply to all Indian citizens who are contributing to the NPS and are between the age of 18 to 60 years. This also applies to NRIs. Following are the key provisions of Section 80 CCD (1):  

The maximum deduction permissible under this section is 10% of the salary (basic + DA) or 10% of the gross income of the individual.

From FY 2017-18, this limit has been increased for the self-employed individuals to 20% of the Gross total income with the maximum limit being capped at Rs. 1,50,000/- for a given financial year.

2. Additional deduction with respect to National Pension Scheme u/s 80CCD(1B):

Section 80CCD relates to the deductions available to individuals against contributions made to the National Pension Scheme (NPS) or the Atal Pension Yojana (APY). Contributions made by the employers towards the NPS, also come under this section. NPS is a notified pension scheme from the Central Government. Under section 80CCD (1B), subscribers are allowed up to Rs.50,000 as deductions towards Tier I contributions.

3. Deduction with respect to employers contribution to NPS u/s 80CCD(2):

Section 80CCD (2) refers to a tax benefit for employers with respect to a contribution made to the pension scheme. If your employer contributes to your NPS account, your employer gets a tax benefit under section 80CCD (2).

Contribution of an employer towards Tier I investments is eligible for deduction as follows:

Maximum deduction to employee shall be higher of

  • Employers contribution; or
  • 10%/ 14% of salary

14% for central government contributions and 10% for others. This deduction is over and above the deduction limit applicable u/s 80C.

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