The National Pension System, or NPS, is a government-backed retirement planning scheme open to employees in private, public, and unorganised sectors, except the armed forces. Subscribers can invest in the scheme at regular intervals during their earning years and build a corpus over time. Upon retirement, they can withdraw 60% of the corpus as a lump sum and invest the remaining 40% in an annuity. They receive a regular monthly pension based on their annuity performance.
While the NPS scheme returns provide money to lead a comfortable retirement life, one must be concerned about their taxability. The following sections will discuss how they contribute to tax savings.
The Nature of NPS Returns
Pension fund managers (PFMs) oversee the returns of the NPS scheme. Subscribers can select their PFM and diversify their investments across four asset classes: equity, government bonds, corporate bonds, and alternative assets. The returns depend on the chosen PFM and asset allocation. As NPS is a long-term investment, early contributions allow for more financial growth and potentially better returns.
Since market fluctuations affect investment returns, the returns are not fixed. Fluctuating returns can be due to various reasons, including the following:
- Scheme investments depend on markets as fund managers invest the money in debts and equities.
- The return amount depends on the scheme’s performance. Therefore, subscribers must choose their PFM wisely.
- The returns vary depending on the asset allocation chosen by the fund manager.
Tax Benefits of NPS Returns and Contributions
Since 2019, the NPS scheme has attained EEE status. That means its contributions, interest, and returns are tax-free. However, most tax benefits apply to Tier 1 accounts only. Let’s look at the tax benefits that the scheme offers:
● Tier 1 Account Tax Benefits:
Tier 1 accounts offer tax deductions under various sections of the Income Tax Act. They include the following:
Section 80CCD(1): Tax Deduction of up to Rs. 1.5 Lakh per annum for NPS self-contribution
Section 80CCD(1B): Additional tax deduction of up to Rs. 50,000 per year for NPS self-contribution
Section 80CCD(2): 14% and 10% tax deduction for government and private sector employees, respectively, towards their employer’s NPS contributions
● Tier 2 Account Tax Benefits:
Tier 1 account holders can open a Tier 2 account. This account offers more flexibility in terms of contributions and withdrawals. It has no lock-in period, and subscribers can contribute according to their convenience. However, a Tier 2 account offers no tax benefits.
Additional Tax Benefits of the NPS Scheme
Apart from the above tax deductions, the scheme provides additional tax benefits, including the following:
Tax Benefits on Returns from Partial NPS Withdrawals: After continuous investments in a Tier 1 account for three years, subscribers can withdraw 25% of their accumulated corpus for certain reasons. These include home purchase, child’s marriage or education, medical bills, etc. NPS scheme returns from these withdrawals are 100% non-taxable.
Tax Benefits on Returns at Maturity: Upon retirement, subscribers can withdraw 60% of their corpus as a lump sum and invest 40% in an annuity. Section 10(12A) makes the lump sum withdrawals 100% tax-exempted. 40% annuity investment is also tax-free under Section 80CCD(5). However, the income generated from the annuity is taxable.
Tax Benefits for Self-Contributions: The scheme offers significant tax benefits to salaried employees. Sections 80CCD(1), 80CCD(1B), and 80CCD(2) provide tax exemptions of up to Rs. 2 Lakh for self-contributions.
Tax Benefits for Employer Contributions: Employed subscribers can also claim tax benefits on their employer’s NPS contributions. The tax benefits are 10% for private and 14% of the salary for government sector employees.
Tax Benefits for Self-Employed Investors: Self-employed subscribers are also eligible for the following tax benefits:
- 20% of the gross income under Section 80CCD(1), including the overall limit of Rs. 1.5 Lakh under Section 80CCE.
- There is an additional tax deduction of Rs. 50,000 under Section 80CCD(1B), which is over and above the Rs. 1.5 lakh limit under Section 80CCE.
Tips to Maximise Tax Benefits on NPS Scheme Returns
Here are a few strategies to maximise tax benefits on NPS scheme returns:
- Subscribers must allocate their assets according to their investment horizon and risk tolerance. For instance, younger investors can earn more returns by investing in high-risk equity assets.
- Choosing the right Pension Fund Manager is essential to generating better returns and maximising tax benefits.
- Regular contributions benefit subscribers from the power of compounding interest.
- Voluntary contributions, whenever possible, boost the retirement corpus and provide extra tax benefits under Section 80 CCD(1B).
- One must understand tax benefits under various sections of the Income Tax Act to claim all the applicable ones.
- To enjoy tax benefits, opt for a Tier 1 account, as these benefits are not available with a Tier 2 account.
Many people want to save taxes. NPS plays a crucial role in reaching that objective. Open an NPS account now and implement these strategies to maximise the returns and tax benefits. Making the most of an NPS account secures a prosperous retirement.
