NPS is an excellent tool for retirement planning, especially for private sector employees. Many people in the financial advisory space have doubted this product due to its tax inefficiency. They consider NPS Taxation less efficient due non-clarity in guidelines of tax saving NPS. This article is the latest update on tax saving benefits of NPS till date.

Updated: NPS Taxation article updated on 11 Dec 2018. Circular Dated 10 Dec 2018 by Ministry of Finance Link

Our country has evolved in every field including the personal finance sector. The products have evolved based on international practices and to bring parity with other products.

Its counterpart is US 401K plans. The difference in India is that in US many companies manage the 401K plans. But in our country, it is just one body called PFRDA who is managing the NPS structure.

NPS has also evolved in terms of feature and options. But here I am going to talk about tax benefits only.

Tax Saving NPS Benefits for 2017-18 (Till 10/12/2018)

These tax benefits are 2 types:

• Current benefits
• Post Investment Tax Benefits

Let’s see the details below:

NPS Taxation (After 10/12/2018)

Tax exemption limit for lump sum withdrawal on exit has been enhanced to 60%. With this, the entire withdrawal will now be exempt from income tax. (At present, 40% of the total accumulated corpus utilized for purchase of annuity is already tax exempted. Out of 60% of the accumulated corpus withdrawn by the NPS subscriber at the time of retirement, 40% is tax exempt and balance 20% is taxable.)

Tax Taxation post 10 Dec 2018

Entire Proceed in TAX FREE like PPF, EPF or GPF.

Current Benefits of New Pension Scheme

Section 80CCD(1) of Income Tax Act 1961

1. You know for if your employer is a member of and PF trust like EPFO they will deduct 12% of your basic and equally contribute the same amount and deposit in your EPF account. But for nonmembers, NPS offers a solution. Under section 80CCD of Income Tax Act 1961, a salaried individual can contribute up to 10 percent of his salary (Basic+ DA) subject to a maximum of Rs 1.5 lakh in a year in NPS tier-I account to get a tax deduction.

(Remember Employer is not bound to contribute in any manner. An employer can contribute any amount but deduction limit for Income Tax portfolio is capped at 10% of basic only. (Update Post 10 Dec 2018 – The limit is raised to 14%)

Also, the employer can contribute to NPS even if they are contributing to EPF. See point 5 for more clarification)

2. Self-employed investors can deposit up to 20 percent of their gross income in a year subject to a maximum of Rs 1.5 lakh in NPS tier I account to get a tax deduction. This limit was 10 percent

So the benefit is extended to self-employed and professionals too.

Section 80CCD(1B) of Income Tax Act

3. Salaried individuals can get an additional tax deduction of Rs 50,000 by investing in NPS under section 80CCD(1B) of Income Tax Act over and above the limit of Rs 1.5 lakh under Section 80CCD.

4. A self-employed person will also get an additional deduction of Rs 50,000 for investing in NPS under section 80CCD(1B).

(Point 3 & 4: This limit is over the Sec 80 C limit of Rs 1.5 lakhs per year. So additional 50000 deduction helps save more tax. No other product is allowed for this extra deduction)

5. Post 10/12/2018 circular: Government employees under Tier-II of NPS will now be covered under Section 80 C for deduction up to Rs. 1.50 lakh for the purpose of income tax at par with the other schemes such as General Provident Fund, Contributory Provident Fund, Employees Provident Fund and Public Provident Fund provided that there is a lock-in period of 3 years.

Section 80CCD(2) of Income Tax Act

5. Under section 80CCD(2), if an employer contributes up to 10 percent of salary(basic + DA) of an employee to NPS, then that will also qualify for tax deduction. The good thing here is that there is no upper cap on contribution to NPS under this section. One can rework his tax structure and can contribute to NPS through his employer to reduce his tax liability.

Here is an example:

Mahesh is a government employee and his employer deducts Rs 62,000 per annum (which is 10% of basic + DA) from salary as employee’s contribution in NPS. It also contributes Rs 62,000 per annum as employer’s contribution in NPS. How and under which section should he claim tax benefit on NPS?

Let’s take the easy part first. Employer’s contribution in NPS would be eligible for tax deduction u/s 80CCD(1).

The employee has a choice as to which section [80CCD(1) or 80CCD(1B)] he wants to show his contribution.  Ideally he should show Rs 50,000 investment in NPS u/s 80CCD(1B). The tax deduction on rest Rs 12,000 can be claimed u/s 80CCD(1). The section 80CCD(1) along with Section 80C has investment limit eligible for tax deduction as Rs 1.5 lakhs. So he should make an additional investment of Rs 1,38,000 in Section 80C to save maximum tax. In all, he can save Rs 2 lakhs tax u/s 80C and 80CCD(1B).

Benefits of NPS Investments – On Withdrawal

• Tax rules on partial withdrawal: You can partially withdraw from NPS tier I account before the age of 60 for specified purposes. According to Budget 2017, the amount withdrawn up to 25 percent of your contribution is exempt from tax. You should be invested for a minimum of 10 years in the scheme.

Also, note that after the withdrawal the corpus invested will not be effected taxation-wise.

• Tax rules on retirement benefit: After you attain the age of 60, up to 40 percent of the corpus (market value) withdrawn in a lump sum is exempt from tax. Now you can remain invested till 65 also.
• You can withdraw an additional 20 percent after attaining the age of 60 years (Or 65), but that amount will be taxable according to your income slab.
• Minimum 40 percent of the NPS maturity corpus (after attaining the age of 60 years) has to be mandatorily invested in an annuity, which is fully exempt from tax.
• Also, payment made towards the purchase of annuity does not attract GST. This is savings of8% of the corpus.
• The annual income you receive from an annuity will be added to your total income and will be taxable as per your income slab.

Recently the Chairman of PFRDA Mr. Hemant Contractor also said: “NPS Taxation is not fair but can be managed”. This should not stop investors from taking benefit of a low cost, market-linked retirement product. Remember we have a huge working population. Government world over are reducing social security payments or increasing contributions (eg Obama Care). NPS in India can help many have self-sustained retirement life.

Update 30 Oct 2019: Via a notification dated 30/10/2019, PFRDA allowed OCIs (Overseas Citizens of India) will also be allowed to invest in Tier 1 NPS Account. However, like NRIs Tier 2 is still not allowed.

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