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All you need to know about the NPS (National Pension Scheme) Tax Benefits
NPS Tax Benefits on Self Contribution
The National Pension Scheme (NPS) is considered to be a boon in the retirement world. It has helped several people secure their money for the future. It is famous for its unique combination of market-linked growth and systematic investment options. But what makes it even more attractive is the tax benefits it offers. In this article, we will break down and explain how NPS can give your money an extra boost through tax advantages.
There are several NPS tax benefits that you can claim on the contributions you make. Here we provide a list of the National Pension Scheme tax benefits you can enjoy:
Section 80 CCD (1)
As a self-employed individual, you are entitled to a tax deduction of up to 20% of your gross income. This tax deduction, however, comes with an important cap. It falls within the overall limit of ₹ 1.50 lakh specified under Section 80 CCE of the Income Tax Act, 1961.
Section 80 CCD (1B)
The NPS income tax benefit does not end with the previous section. As a self-employed individual investing in your NPS, you have the opportunity to go beyond the ₹ 1.50 lakh limit set by Section 80 CCE of the Income Tax Act, 1961. With Section 80 CCD (1B), another NPS deduction section, you can make an additional deduction of up to ₹ 50,000.
NPS Tax Benefits of Investing in Tier 2 Account
When it comes to the Tier 2 account, it is crucial to be aware that, unlike its Tier 1 counterpart, no specific tax benefits are associated with the contributions made here. This means that any money you put into your NPS Tier 2 account does not offer the same NPS tax-saving advantages as contributions to the Tier 1 account.
Moreover, there are no special tax rebates or favourable treatment for the gains that arise from your investments in NPS Tier 2. The gains will be subject to taxation based on your marginal tax rate. In simple terms, any profits you make from your investments in NPS Tier 2 will be treated like any other income, and regular income tax rules will apply.
NPS Tax Benefits for Employer Contribution
Here is a list of NPS tax benefits that you can claim on your employer contributions:
Employer Contribution Tax Benefit for Corporate Model of NPS
Under the corporate model of the NPS, employers can contribute up to 10% of an employee's salary, which includes both basic and Dearness Allowance (DA). This contribution qualifies for an additional tax deduction under Section 80 CCD (2) and is over and above the ₹ 1.5 lakh limit under Section 80 CCE of the Income Tax Act, 1961.
Employer Contribution Tax Benefit under Government NPS
Government employees, whether at the state or central level, enjoy a distinct set of tax benefits within the NPS framework. Here's how it works:
- State government employees:
- State government employees can have their employers contribute up to 10% of their salary (Basic + DA).
- Employees, if they wish, can contribute up to 14% of their salary (Basic + DA).
- The employer's contribution, up to 10%, is eligible for a tax deduction under Section 80 CCD (2) of the Income Tax Act, 1961.
- This deduction is in addition to the ₹ 1.5 lakh tax-saving limit offered by Section 80 C of the Income Tax Act, 1961.
- Central government employees:
- Central government employees, on the other hand, can have their employers contribute up to 10% of their salary (Basic + DA).
- Employees, if they wish, can contribute up to 14% of their salary (Basic + DA).
- The employer's contribution, up to 10%, is eligible for a tax deduction under Section 80 CCD (2) of the Income Tax Act, 1961.
- This deduction is in addition to the ₹ 1.5 lakh tax-saving limit offered by Section 80 C of the Income Tax Act, 1961.
NPS Tax Benefits on Withdrawals and Annuity Purchases
Here are some things you need to know about NPS deduction on withdrawals and annuity purchases:
NPS Partial Withdrawal Tax Benefits
Your NPS Tier 1 account allows you to make partial withdrawals up to three times during your investment tenure, subject to specific terms and conditions. These partial withdrawals are tax-free, up to 25% of the self-contribution you have made. This NPS tax exemption falls under Section 10 (12B) of the Income Tax Act, 1961. So, if you need to tap into your NPS funds, you can do so strategically without incurring tax burdens on a significant portion.
NPS Withdrawal Tax Benefit at Superannuation
As you approach the age of 60, your NPS Tier 1 account enters the phase of superannuation, reaching its maturity. The withdrawals made post-superannuation can amount to up to 60% of your Tier 1 account balance. This entire amount is tax-free, courtesy of Section 10(12A) of the Income Tax Act, 1961.
Tax Benefit on Annuity Purchase at Superannuation
At the point of superannuation, NPS rules mandate the use of at least 40% of your Tier 1 account balance for purchasing annuities. However, there is a silver lining here. The purchase of these annuities enjoys NPS tax exemption under Section 80 CCD (5) of the Income Tax Act, 1961. This is a strategic move to ensure a steady income stream during your retirement years.
However, it is crucial to note that while the annuity purchase is tax-exempt, the subsequent income derived from these annuities is subject to taxation based on the applicable income tax slab rate. So, while you savour the tax benefits during the transition, you must keep in mind the tax implications on the income generated from annuities.
FAQs
Elaborate on the NPS tax benefit that a corporate NPS subscriber can avail of.
As a corporate NPS subscriber, you can enjoy significant tax benefits. Under Section 80 CCD (1), you can claim a tax benefit of up to 10% of your basic salary + DA. This falls within the overall limit of ₹ 1.5 lakh under Section 80C. Additionally, you have the opportunity to avail yourself of an extra NPS deduction benefit of ₹ 50,000 under Section 80 CCD (1B). These dual NPS tax benefits not only enhance your tax savings but also make NPS a compelling choice for building a secure financial future.
Is it a good idea to invest in an NPS scheme?
Yes, investing in an NPS scheme is a wise decision. NPS allows you to save specifically for retirement, participate in the market, and tailor the plan to your risk appetite. Moreover, the scheme offers numerous tax benefits. Before making a decision, analyse the scheme to ensure it aligns with your risk profile and meets your investment goals.
Is the NPS scheme only limited to salaried individuals?
No, the NPS scheme is not limited to salaried individuals. Anyone, including self-employed individuals, such as online business owners, shopkeepers, home-based entrepreneurs, freelancers, etc., can opt for NPS and claim tax deductions on investments under Section 80CCD (1) and 80 CCD (1B). NPS caters to a wide spectrum of individuals and offers a flexible and inclusive retirement savings solution.
Why is it recommended to purchase an annuity in the NPS scheme?
Purchasing an annuity in the NPS scheme is recommended because, at the time of retirement, you will have a substantial corpus as your retirement fund. While withdrawing a part of your account is tax-free, it may not generate long-term income.
The NPS allows you to withdraw up to 60% of your Tier 1 account balance at the time of retirement, entirely tax-free. This lump sum withdrawal provides you with financial flexibility and a significant amount to cater to immediate needs or desires. However, you risk exhausting all this money earlier than anticipated and outliving your savings in retirement.
Annuities, on the other hand, provide a regular pension for your golden years, ensuring a higher degree of financial security. For example, with a corpus of ₹ 1 crore, you can withdraw up to ₹ 60 lakh and consider investing the rest ₹ 40 lakh in an annuity plan. This can offer a steady income stream and enhance your overall financial well-being. Annuities not only contribute to financial stability but also offer peace of mind. Knowing that you have a reliable income source in the form of a pension can alleviate concerns about outliving your savings or facing financial hardships in your later years.
I am a salaried individual, but I fall under the lowest tax bracket. Should I invest in the NPS scheme?
The decision to invest in the NPS scheme is not a one-size-fits-all scenario and depends on your specific needs and overall investment portfolio. Before diving into any investment, it is essential to understand your specific financial needs. Are you primarily looking to build a retirement corpus, avail of tax benefits, or diversify your investment portfolio?
Being in the lowest tax bracket means that the direct tax benefits of NPS might be comparatively less significant for you. However, NPS offers a unique combination of market-linked returns, tax benefits, and retirement planning, making it relevant beyond just tax savings.
If you fall under the lowest tax bracket, consulting with a financial advisor is recommended. They can help assess your financial goals and risk tolerance and guide you on whether NPS aligns with your overall financial strategy.
Disclaimer:
Our content given in this article is as per the existing provisions, laws and regulations as per the Income Tax Act, 1961 and Income Tax Rules, 1962 issued thereunder. Tax laws are subject to amendments made thereto from time to time. The benefits / guidance mentioned herewith should not be considered as opinion / view of the Company. We request to seek independent view from your personal tax advisor on applicable tax benefits / guidance under the said article.
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