NPS Scheme Helps You Save Income Tax

Planning for retirement cannot be overlooked, and the National Pension Scheme (NPS) is one of the best ways to ensure you're financially secure during your golden years. 

NPS is a pension scheme launched by the Government of India and regulated by the Pension Fund Regulatory and Development Authority (PFRDA). Initially introduced for government employees in 2004, it was opened to all citizens in 2009. 

Not only does NPS help build a solid retirement corpus, but it also offers attractive tax benefits that you can enjoy while still employed.

Let’s break down how the NPS scheme can help you save on income tax, starting with the key features given below:

• NPS eligibility criteria: Indian citizens between 18 and 70 years of age can open an NPS account.
• NPS account types: NPS offers two types of accounts -

1. Tier 1: Primarily for retirement planning, with tax benefits.
2. Tier 2: For flexible investment planning, requires an existing Tier 1 account.

• Lock-in Period: Tier 1 accounts are generally locked until the age of 60, with partial withdrawals allowed under certain conditions. Tier 2 accounts have no lock-in periods.
• Minimum Investment:

1. Tier 1: Rs. 500 to open an account
2. Tier 2: Rs. 1000 to open an account, Rs. 250 for subsequent investments

• NPS contribution limits: No upper limit, but tax benefits are capped.
• NPS investment options: NPS offers various investment options including equity, corporate bonds, government securities, and alternative investment funds, with the choice of active or auto asset allocation.
• NPS maturity period: The NPS maturity period is generally when the subscriber reaches 60 years of age, although one can continue contributing and remain invested up to the age of 75.

NPS Tax Benefits

The NPS is a retirement savings plan designed to help individuals secure their future while enjoying substantial tax benefits. NPS scheme offers two primary benefits: retirement planning and tax savings.

Under Section 80C of the Income Tax Act, you can claim deductions on your NPS contributions, effectively reducing your taxable income.

Here’s the breakdown of all the tax benefits of NPS under the old as well as new regimes:

Old Tax Regime:

• Section 80C: Deduction up to Rs. 1.5 lakhs (including other eligible investments)
• Section 80CCD(1B): Additional deduction of up to Rs. 50,000
• Section 80CCD(2): Employer's contribution deductible up to 10% of basic salary + DA (overall limit of Rs. 7.5 lakhs including EPF (Employee Provident Fund))

New Tax Regime:

• Only Section 80CCD(2) (employer's contribution) is available for deduction

Understanding Types of NPS Account and Tax Benefits

The NPS account gives you the flexibility to plan your retirement with both Tier I and Tier II options:

• NPS Tier I: You can start a tier I NPS account with as little as Rs. 500, making it an affordable retirement planning tool. This account is primarily aimed at ensuring a regular post-retirement income. Contributions to this account are locked in until the investor turns 60 years old. The contributions can be claimed for tax deductions of up to Rs. 1.5 lakh under Section 80C, and an additional deduction of Rs. 50,000 is available under Section 80CCD(1B).
• NPS Tier II: This voluntary account offers flexibility in terms of withdrawals, but you must have an active Tier I account. Contributions to Tier II accounts do not qualify for tax deductions under Section 80C, except for central government employees under specific conditions.

NPS Withdrawal Rules

Partial Withdrawal:

• Allowed after 3 years of contribution
• Up to 25% of the subscriber's own contribution
• A maximum of 3 withdrawals is permitted during the entire tenure 
• Only for specific purposes (e.g., home construction, children's education or marriage, medical emergencies)

Retirement Withdrawal:

• 60% of the corpus can be withdrawn tax-free as a lump sum upon retirement
• The remaining 40% must be used to purchase an annuity

Note: NPS registration can be done online through the official eNPS website, select banks, or at Points of Presence (PoP) service providers authorised by the PFRDA.

Tax Benefits for Employees

If you're a salaried employee, opening an NPS account offers the following tax benefits:

1. Section 80C Tax Benefits: Like all contributors, you can claim deductions of up to Rs. 1.5 lakh annually on your NPS contributions under Section 80C. This limit includes other eligible investments like PPF, ELSS, and more.
2. Section 80CCD(1B) Bonus: You can claim an additional tax deduction of up to Rs. 50,000 under Section 80CCD(1B) for your NPS contributions.
3. Employer’s Contribution - Section 80CCD(2): Employees can benefit from tax deductions on their employer’s contributions, up to 10% of their basic salary and dearness allowance (14% for central government employees). There is no specific monetary cap under Section 80CCD(2), but the overall exemption, which includes employer contributions to NPS, EPF, and superannuation funds, is capped at Rs. 7.5 lakhs per financial year.
4. EEE Tax Benefits: The NPS follows an Exempt-Exempt-Exempt (EEE) system, providing a triple layer of tax advantages:

• Exempt on Contribution: Your contributions are tax-deductible, reducing your immediate tax liability.
• Exempt on Growth: The returns generated within your NPS account grow tax-free.
• Exempt on Withdrawal: Up to 60% of the corpus can be withdrawn tax-free at retirement. The remaining 40% must be used to purchase an annuity, which is taxable as per your income slab.

The EEE System

The EEE tax benefits make the NPS an attractive long-term investment. Here’s how:

1. Higher Returns: Tax-free growth within the NPS can potentially yield higher returns compared to taxable investments.
2. Long-Term Savings: The EEE system encourages sustained investment, allowing your savings to grow into a substantial nest egg over time.
3. Financial Security: Partial tax-free withdrawals at retirement provide peace of mind and financial security.

Understanding NPS Tax Benefits Through a Real-Life Example

If you want to gain a deeper understanding of National Pension Scheme details, you must see things from a real-life perspective.

Let's assume Raj earns Rs. 15 lakhs annually (Rs. 12 lakhs as basic salary + Rs. 3 lakhs as allowances). By contributing to the National Pension Scheme, Raj can reduce his taxable income and pay less tax. Here’s how:

1. Deductions Under Section 80C:

Raj can contribute up to Rs. 1.5 lakhs annually to the NPS scheme, which is eligible for a tax deduction under Section 80C. This reduces his taxable income to Rs.13.5 lakhs.

2. Additional Deduction Under Section 80CCD(1B):

By contributing an additional Rs. 50,000 to NPS, Raj can claim an extra tax deduction under Section 80CCD(1B), further lowering his taxable income to Rs. 13 lakhs.

3. Employer’s Contribution Under Section 80CCD(2):

Raj’s employer can contribute up to 10% of his basic salary (up to Rs. 1.2 lakh) into his NPS account, which is not considered part of his taxable salary. This reduces his taxable income to Rs. 11.8 lakh.

Summary of Raj’s Taxable Income:

At Raj's salary level, the government typically taxes him at 31.2% (including cess rate).

By reducing his taxable income by Rs. 3.2 lakhs through NPS contributions, Raj saves approximately Rs. 99,840 in taxes (3.2 lakhs * 31.2%).

Key Points:

1. These savings assume Raj isn’t investing in other tax-saving schemes.
2. The calculations are based on the old tax regime; different rules apply under the new tax regime.
3. It’s always advisable to consult a tax expert for personalised advice.
4. Conclusion: By investing in the NPS scheme, Raj not only saves for retirement but also significantly reduces his tax liability.

Challenges of Withdrawing from NPS and the Personal Loan Alternative

While the National Pension Scheme offers numerous benefits, there are some things to keep in mind when it comes to withdrawals.

Restrictions on Early Withdrawals

If you withdraw your savings before turning 60, you can only take out up to 20% of the corpus as a lump sum, which will be taxed according to your income tax slab. The remaining 80% must be used to purchase an annuity, providing regular income. There are no additional penalties, but restrictions apply. Partial withdrawals are permitted after three years, limited to 25% of your contributions and only for specific reasons, such as medical emergencies, children’s education, or marriage.

The Personal Loan Alternative

If you need access to funds before retirement, a personal loan might be a practical option to avoid the restrictions on NPS withdrawals. Unlike NPS, personal loans provide immediate funds without strict conditions on usage. You can also choose a repayment schedule that suits your budget and financial situation. 

While personal loans generally don't qualify for tax deductions, there are specific circumstances where they can provide tax benefits. For instance, if you use a personal loan for home renovation, repair, or construction, the interest paid can be claimed as a deduction under Section 24(b), up to Rs. 2 lakhs per year.

However, it's essential to remember that a personal loan comes with its own interest charges. It's wise to thoroughly assess your financial situation before taking on this commitment.

Conclusion

The NPS scheme is an excellent tax-saving, long-term retirement plan, but early withdrawals are subject to restrictions and may have tax implications. If you need immediate funds without affecting your NPS investment, consider a personal loan from SMFG India Credit. You can conveniently apply online for funds of up to INR 30 lakhs* at interest rates starting from as low as 13%* per annum, with a flexible repayment tenure of up to 60 months*. Contact us or visit your nearest branch for personalised assistance from our expert representatives.