National Pension System: All You Need To Know About Tax Benefits

Types of NPS accounts

Under NPS there are two types of accounts, and they are:

NPS Tier 1 Account

This account comes with a fixed lock-in term until the age of 60 years is met by the subscriber. Even partial withdrawal, under certain circumstances, is permitted. Tier 1 contributions are tax-free and are liable for deductions according to Section 80CCD(1) and Section 80CCD (1B). This implies that in an NPS Tier 1 account you can contribute up to Rs. 2 lakh and seek an exemption for the entire sum, i.e. Under Sec 80CCD(1) Rs. 1.50 lakh and Sec 80CCD(1) Rs. 50,000 under Section 80CCD (1B).

NPS Tier 2 Account

It is basically a voluntary savings account that makes it easy for subscribers to withdraw corpus at the time of emergencies. The contribution rendered to the Tier 2 account, however, does not apply for a tax exemption. You must first open a Tier 1 account to open a Tier 2 account. Contributions to NPS now fall under the exempt-exempt-exempt (EEE) tax category, all of which are tax-exempt from the amount contributed to NPS, the income collected and the amount of maturity. You can withdraw up to 60 percent of the amount on maturity, as per the current guidance, and need to reinvest the remaining 40 percent to buy an annuity that provides you a monthly income benefit. 

Contribution towards NPS by an employee

Under the defined cap of 10 per cent of the basic salary plus dearness allowance, an employee can contribute to NPS and seek tax deductions. This exemption is permitted under section 80CCD(1) for contributions made as an employee and is valid under section 80C under the total cap of Rs 1.5 lakh. The tax deduction can be received by individuals employed by the central government and any other employer for their contributions made during the fiscal year. 

Contribution towards NPS by an employer

Employees can also seek a tax break on the contribution of their employer to NPS and take benefit on additional taxation. For contributions rendered by the central government or any other employer, a tax benefit is applicable. The central government contribution is liable for a tax deduction of up to 14% of the basic salary plus dearness allowance. A tax exemption of up to 10% of the basic salary plus dearness allowance, if any, is available for the contribution of any other employer. Under section 80CCD(2), which is over and above the cap of Rs 1.5 lakh stated above, as per section 80C, you can request a deduction. The claim for deduction shall not be made eligible for any contribution made by the employer in lieu of the amounts set out above. Remember that, under section 80CCD(2), there is no additional cap for seeking deductions. It is permitted as a cumulative contribution under the total cap of Rs 7.5 lakh that can be rendered by an employer against the employee's EPF, superannuation and PPF accounts respectively.

Contribution towards NPS if self-employed

For the NPS contribution, an individual who is self-employed can seek a tax deduction. The deduction threshold is limited to 20 percent of the overall gross income. The tax benefit is within the scope of section 80CCD(1) and comes within the total cap of Rs 1.5 lakh referred to in section 80C. Individually, both a self-employed individual and an employee are allowed to claim an additional tax exemption up to the maximum of Rs 50,000 per financial year for their additional NPS contribution. The exemption is made under section 80CCD(IB) and is permitted under section 80C in relation to the tax benefit. An employee can therefore seek an exemption of up to Rs 1.5 lakh under 80C for their NPS contribution, an additional contribution of up to Rs 50,000 under section 80CCD(1B), making their total exemption to Rs 2 lakh for NPS. Consequently, the exemption is also permissible under defined limits for the contribution of their employer. A self-employed individual can seek a deduction of up to Rs 1.5 lakh for their NPS contribution and up to Rs 50,000 for an additional contribution.

Tax benefits on withdrawals

You are allowed to withdraw a lump sum of up to 60 per cent of the corpus in a tax-free manner at the time of death, at age 60 and over. The 40 percent balance can be used to obtain an annuity plan for the purpose of earning monthly pension payments. The 40 percent balance used to purchase the annuity contract is tax-free as well. Based on the income tax slabs applied to the year of receipt, the pension income you earn from the annuity scheme is taxed as income from other sources.