NPS Tax Benefit: All about NPS Tax Deduction

NPS Tax Benefit: All about NPS Tax Deduction

Imagine a future where you can sip your morning tea overlooking serene landscapes, knowing that your retirement years are secure. It's a compelling vision, isn't it? Enter the National Pension Scheme (NPS), your gateway to not only building a robust retirement corpus but also enjoying remarkable tax benefits along the way.

With a staggering 4.74 crore subscribers as of September 2021, the NPS has become a beacon of financial stability in India. But what exactly makes it so enticing? It's the perfect blend of flexibility, tax advantages, and the potential for substantial returns that sets it apart from the rest.

In this concise guide, we'll unravel the intricacies of NPS tax benefits, shedding light on the various deductions available and exclusive exemptions at maturity. Join us on this enlightening journey as we explore how the NPS can empower you to create a financially independent future. Let's make every rupee count and embark on a path towards a fulfilling retirement.

What is the National Pension Scheme (NPS)?

The National Pension Scheme, also known as NPS, is a retirement savings program designed to provide financial security and stability during the golden years of one's life. It's a government-initiated scheme that aims to help individuals plan for their retirement and ensure a comfortable lifestyle when they no longer work.

The National Pension System (NPS) was enacted in 2004 by the government and was made available for the general public in 2009. An individual can invest in and create a retirement fund through this voluntary retirement programme, ensuring a monthly income for the rest of their lives.

All Indian nationals between the ages of 18 and 65 may participate in the programme, which is administered by the Pension Fund Regulatory Development Authority (PFRDA). Investors are not permitted to withdraw their money before reaching the age of 60 because NPS is primarily intended for retirement. 

Eligibility Criteria for Availing NPS Tax Benefits

An individual who fulfils the below-listed eligibility criteria can avail of the benefits of the NPS scheme:

  • The applicant must be an Indian citizen (resident or non-resident) or an NRI.
  • Applicant’s age should be between the ages of 18 and 70.
  • The application form's Know Your Customer (KYC) requirements must be followed.
  • According to the Indian Contract Act, one must be able to lawfully sign a contract.
  • Persons of Indian Origin (PIOs), Hindu Undivided Families (HUFs), and Overseas Citizens of India (OCI) are ineligible to enrol on NPS.
  • Since NPS is an individual pension account, a third party cannot open one on their behalf.

What are the Benefits of Investing in NPS?

Individuals unlock the below-listed benefits by investing in the National Pension Scheme:

Retirement Corpus: 

Over time, investing in NPS can help people build a sizable retirement corpus. Regular programme payments assist in creating a sizable amount that may be used in retirement.

Flexibility:

In terms of investment alternatives, NPS offers more flexibility on the contrary to other available schemes. Depending on their level of risk tolerance and financial objectives, subscribers can select from a variety of asset classes, including government bonds, corporate bonds, and equities.

Tax Benefits: 

Contributions made towards NPS are eligible for tax benefits under Section 80CCD(1) of the Income Tax Act. Additionally, the investors get an exclusive tax deduction of up to INR 50,000 is available under Section 80CCD(1B), which provides further incentives for investing in NPS.

Tiered Structure: 

Tier 1 and Tier 2 accounts make up the NPS's tiered organisational structure. While Tier 2 is a discretionary investment account with more withdrawal flexibility, Tier 1 is a required long-term retirement account with some withdrawal limits.

Options for Annuities: 

When retirement time arrives, subscribers of the NPS scheme can use their accumulated funds to buy an annuity from a specific insurance provider. The regular pension income from this annuity ensures financial security in retirement.

Portability: 

NPS enables portability, enabling people to keep using their accounts even if they change jobs or residences. With the help of this instrument, people can smoothly continue funding their NPS account while also maintaining their retirement savings.

Transparency and Regulation: 

The Pension Fund Regulatory and Development Authority (PFRDA) is responsible for the regulation of the National Pension Scheme. This regulatory control guarantees openness, protects the interests of subscribers, and ensures that pension funds are managed properly.

In short, we can say the National Pension Scheme provides individuals with a structured and regulated platform to save for their retirement, offering tax benefits, investment flexibility, and the security of a regular pension income post-retirement.

NPS Tax Benefits

By investing in the National Pension Scheme, investors unlock several NPS tax benefits. Under the NPS scheme, investors get the option to invest in two types of accounts, i.e. Tier I and Tier II. However, it is mandatory for the investors to have a Tier I account, whereas the Tier II account comes as a voluntary option. Individuals also get NPS Tier 1 tax benefits under Section 80C and Section 80CCD(1B). 

The following table showcases the NPS tax benefits towards the annual contributions:

Income Tax Section for the National Pension Scheme Deduction Description
80CCD (1) Subscribers can claim a self-contribution of INR 1,50,000 at maximum as a part of the NPS tax deduction.
80CCD (2) Salaried people may also deduct employer contributions to NPS under this NPS deduction section. The maximum allowed under this clause for privately employed people is 10% of their wage (basic plus dearness allowance), compared to a cap of 14% for government employees. 
80CCD (1B) Subscribers can claim a self-contribution of INR 50,000 at maximum as an NPS tax deduction. 

Note: Only the amount invested towards the Tier I account is eligible for the NPS deductions. 

Additional NPS Tax Benefits

In addition to the annual tax deductions that the scheme subscribers can claim under Section 80C, as well as Section 80CCD (1B), investors can also enjoy some additional benefits in specific cases, including:

On Partial Withdrawal: After the successful completion of three years of investment, the investor has the option to withdraw 25 per cent of the accumulated amount from your NPS Tier I account. However, this amount can be withdrawn only for specific purposes, including medical expenses, education, marriage, etc. Additionally, this withdrawn amount is exempt from tax.

On Returns: The NPS not only provides investors with significant returns but also the returns are non-taxable till maturity time. In simple words, the returns are not subject to taxation.

On Maturity: Once the investor reaches the age of 60, in a lump sum, the investor can withdraw up to 60%. However, the rest 40% needs to be used for purchasing annuities. Both these values are tax exempted. For example, at the age of 60, an investor has a corpus of INR 20,00,000, from which, at maximum, an amount of INR 12,00,000 can be withdrawn. Further, the investor can use the remaining INR 8,00,000 only for buying annuities which will be paying the retirement pension to the investor. 

Post Retirement NPS Withdrawal Rules 

Under the revised guidelines of the National Pension System (NPS), individuals now have the flexibility to withdraw funds from their retirement accounts with certain conditions in place. According to these regulations, you are allowed to take a lump sum payment of up to 60% of your total NPS corpus. The remaining 40% is required to be invested in an annuity plan, ensuring a steady stream of income during your retirement years.

However, if your total corpus is equal to or less than Rs 5 lakh, you have the option to withdraw the entire amount without the obligation of purchasing an annuity plan. This means that if your accumulated fund's amount to, let's say, Rs. 4.5 lakh, you have the freedom to withdraw the entire sum and utilise it as per your needs without any mandatory annuity commitment.

The tax-free withdrawal cap is set at Rs 6 lakh for corpuses greater than Rs 10 lakh. The retiree would have a consistent income stream thanks to the investment of the remaining funds above Rs 6 lakh in an annuity plan.

It's crucial to remember that while annuity payments are taxed depending on the recipient's income band, withdrawals are tax-free. An annuity of Rs. 4 lakhs, for instance, will be taxed at the recipient's personal tax rate. Based on the income band and the number of years for which the annuity payments are provided, the tax obligation is calculated.

These recommendations are intended to give people managing retirement accounts flexibility and options so they can select the best withdrawal method while taking tax consequences into account.

NPS Early Withdrawal or Exit rules

Upon superannuation: When you reach the age of superannuation or turn 60 as an NPS subscriber, it is mandatory to utilise a minimum of 40% of your accumulated pension corpus to purchase an annuity. This annuity provides you with a consistent monthly pension, ensuring a regular income during your retirement years. The remaining funds can be withdrawn as a lump sum amount, giving you the flexibility to use it as per your financial needs.

In cases where the entire pension corpus is equal to or less than Rs. 5 lakhs, you have the option to withdraw the entire amount in one go. This means you can receive the full sum as a lump sum without any mandatory annuity purchase.

Premature exit: Some restrictions exist if you leave the National Pension System (NPS) before you've reached retirement age or turned 60. An annuity that assures a consistent monthly income must be purchased using at least 80% of the subscriber's total pension corpus. This contributes to monetary security and a consistent income source even after retirement.

For customers with a total corpus of up to Rs. 2.5 lakh, there is an alternative. In such circumstances, they may opt to remove the entire cash in one go. These clauses are intended to guarantee that retirees have a steady source of income during their golden years.

Upon the death of the subscriber: Upon the subscriber's passing, the subscriber's nominee or legal heir would get the whole accrued pension corpus (100%) after the subscriber's passing.

Equity Allocation Rules

The National Pension System (NPS) provides a number of investment plans, including Scheme E concentrating on equity investments. Individuals investing in the NPS have the choice to allocate up to 50% of their investment to stocks.

Both auto choice and active choice are accessible as investing alternatives. Based on your age, the auto-selection option determines the risk profile of your assets. The investments tend to become safer and more stable as you age. This strategy is made to adapt to your evolving investment requirements over time. 

The active choice option, on the other hand, gives you the freedom to choose where to invest your money and how to distribute it among various plans. As a result, you have more freedom and flexibility to customise your investment portfolio to suit your interests and level of risk tolerance. The NPS provides a variety of investment alternatives to assist you in creating a safe and well-balanced retirement portfolio.

How to Open an NPS Account?

The NPS gives people the option to register an account through either online or offline means, and is regulated by the Pension Fund Regulatory and Development Authority (PFRDA). This guarantees that individuals can select the approach to starting their NPS journey that is most convenient for them.

Offline Process

You can manually start an NPS account by going to the Point of Presence (PoP), which can be a bank or another authorised organisation registered with the PFRDA if you prefer the more conventional method. Simply obtain a subscriber form at the nearby PoP, fill it out, and submit it with your KYC paperwork. You may, however, omit this step if you have already finished the KYC procedure with that specific bank.

The PoP will provide you with a PRAN (Permanent Retirement Account Number) once you make the initial deposit, which should be at least Rs. 500, Rs. 250 every month, or Rs. 1,000 per year. You'll be able to log into your NPS account using this number and the password that is included in your welcome package. Please be aware that there is a one-time registration cost of Rs. 125 for this procedure.

Online Process

It now only takes a few minutes to open an NPS account, which is really convenient. By visiting enps.nsdl.com and connecting it to your PAN, Aadhaar, and mobile number, you may quickly register an account online.

You will receive an OTP on your mobile device for verification during the registration process. A PRAN (Permanent Retirement Account Number) will be generated for you after you enter the OTP. Your key to accessing your NPS account and successfully managing your investments will be this unique number.

Types of NPS Accounts

Tier I and tier II are the two main account categories under the NPS. The two account kinds are thoroughly explained in the table below.  

Specifics NPS Tier-I Account NPS Tier-II Account
Status Default Optional
Withdrawals As per the NPS rules and regulations As permitted
Tax exemption INR 2 lakh per annum at maximum (Under 80C and 80CCD) INR 1.5 lakh at maximum for government employees. In the case of other employees, there is no tax exemption.
The minimum contribution to open an NPS account INR 500 INR 1000
Minimum NPS contribution INR 500 monthly or INR 1000 annually INR 250  
Maximum NPS contribution Not Applicable  Not Applicable

Everyone who chooses the NPS plan must have a Tier-I account. Employees of the Central Government are required to contribute 10% of their base pay. The NPS is a voluntary investing option for everyone else.

NPS Interest Rate

The NPS interest rate is not fixed and varies depending on the performance of the underlying assets. As a result, it is not possible to determine the exact return you will receive upon retirement in advance. NPS is designed as a market-linked product, offering you the opportunity to invest in a diverse range of assets, such as equity, government debt, corporate debt, and alternative assets.

Once you have chosen your desired asset mix and fund manager, your investment will be allocated to specific schemes that focus on these four asset classes. This allows for a well-diversified portfolio that aims to optimise returns over the long term.

Furthermore, NPS provides the flexibility to have two types of accounts - Tier I and Tier II accounts. These accounts have different characteristics and may offer varying returns. It is important to stay updated with the current NPS interest rates for both Tier I and Tier II accounts to make informed decisions regarding your investments.

NPS Tier 1 Returns:  

Asset Classes Ten-Year Returns (in per cent) Five-Year Returns  (in per cent) One-Year Returns  (in per cent)
Equity (Class E) 10.45 to 10.86% 13.11 to 15.72% 15.33 to 18.81%
Corporate Bonds (Class C) 10.05 to 10.64% 9.27 to 10.15% 12.46 to 14.47%
Government Bonds (Class G) 9.57 to 10.05% 10.29 to 10.88% 12.95 to 14.26%
Alternate Assets (Class A) Not Applicable  Not Applicable  3.98 to 16.73%

NPS Tier 2 Returns:  

Asset Classes Ten-Year Returns (in per cent) Five-Year Returns  (in per cent) One-Year Returns  (in per cent)
Equity 10.35 to 10.58% 13.05 to 15.83% 15.19 to 17.92%
Corporate Bonds 9.86 to 10.60% 9.55 to 10.17% 12.71 to 16.36%
Government Bonds 9.59 to 10.07% 10.40 to 12% 12.61 to 13.42%

NPS Calculator

The NPS calculator is like a handy companion that helps you envision your financial future and plan for a comfortable retirement. It's a tool that takes into account your personal details like age, investment amount, and expected rate of return to provide an estimate of how your NPS contributions could grow over time.

Imagine sitting down with a financial advisor who understands your goals and helps you map out your retirement savings journey. That's what the NPS calculator does. It considers various factors and investment options within NPS, such as equities, government bonds, and corporate bonds, to provide you with a realistic projection of the potential returns on your investments.

By using this calculator, you can make well-informed decisions about how much to contribute to your NPS account and how to allocate your investments wisely. It's like having a crystal ball that helps you see the future value of your savings and adjust your financial plans accordingly.

Frequently Asked Questions (FAQs)

How much tax deduction can I claim under NPS?

At maximum, you can claim a 14% tax deduction under the NPS tax benefit provision.

How is the equity allocation decided in NPS?

NPS users have the choice between two investment options: Active Choice and Auto Choice. The subscribers have the freedom to actively choose the NPS asset allocation (and ratio between various assets/schemes) based on their understanding of the Active choice. Up until the age of 50, one may have a maximum of 75% in equity (scheme E). After that, the upper cap on equity exposure is reduced by -2.5% annually.

Three life cycle (LC) funds, where the equity allocation is already capped at 75%, are available for the auto choice option. The subscriber must select one of the three life cycle fund options—LC 25, LC 50, OR LC 75—under auto choice.

What is the maximum limit for tax deduction under NPS?

The maximum limit for tax deduction under NPS is INR 1.5 lakh.

Can I change my fund manager or investment option in NPS?

You can alter your NPS fund manager or investment choice, yes. You can alter your investment selection (Active/Auto), your allocation between schemes (E, C, or G), and your pension fund manager (PFM), online by visiting the NPS website for the CRA (Central Record Keeping Agency) or offline by delivering the paper application to your Point of Presence. Additionally, you can switch the fund manager and the investment option online or through PoP. You can alter your investment scheme four times a year and your fund manager once a year with NPS’s flexibility.

How is the interest earned on NPS investment taxed?

The interest earned on the NPS investment is non-taxable.

Can I withdraw from NPS before retirement? If yes, what are the tax implications?

You can take withdrawals from NPS prior to retirement. You must use at least 80% of the total NPS corpus to buy the annuity if you want to leave the NPS before the age of 60 (such as in the case of voluntary retirement or early retirement). Only the remaining corpus of 20% or less is eligible for tax-free lump sum withdrawal. If an NPS subscriber passes away prior to retirement, the nominee may withdraw the entire accumulated money in one single sum.

Urban Money