The National Pension System (NPS) is a government-backed retirement investment scheme. It provides a structured approach to creating a retirement corpus through regular monthly contributions. One of the key advantages of NPS is the tax benefits it offers.
This blog will discuss the taxation benefits you get when investing in the NPS. Understanding these tax benefits can help you plan your retirement more effectively and optimise your savings.
NPS – An Overview
The NPS is a voluntary retirement savings plan designed to help individuals generate a regular income after retirement. It is governed by the Pension Fund Regulatory and Development Authority (PFRDA) and allows subscribers to invest their contributions in market-linked options.
Another significant advantage of NPS is the tax benefit it offers to the subscribers. Contributions made to NPS can be deducted from taxable income under certain conditions.
Tax Benefits of NPS
The National Pension System is a valuable retirement savings tool and comes with a host of tax benefits extending to the withdrawal phase. Individuals can take advantage of the following tax benefits and reduce their taxable income:
· Tax Benefits Under Section 80C – NPS contributions are covered under Section 80C of the Income Tax Act, which allows investors to claim deductions up to Rs. 1.5 Lakh, reducing their taxable income accordingly.
·Additional Tax Benefits Under Section 80CCD(1B) – This provision allows an additional deduction of up to Rs. 50,000 for investments made in NPS over and above the Rs. 1.5 Lakh allowed under Section 80C, totalling potential deductions of up to Rs. 2 Lakh.
Tax Benefits for Salaried Individuals Under Section 80CCD(2) – Salaried individuals can benefit from tax deductions on employer contributions made to their NPS accounts.
- Central Government or State Government Employer: Up to 14% of their salary (Basic + DA)
- Any other employer:
Under the old tax regime – Maximum deduction of 10% of salary (Basic + DA)
Under the new tax regime – Maximum deduction of 14% of salary (Basic + DA) (This 14% rate has been increased from 10% with effect from FY 2024-25)
Tax Benefits on Withdrawals and Annuity Purchases – Let’s explore the tax benefits associated with withdrawals and annuity purchases, which can assist individuals in making informed retirement savings decisions.
· Partial Withdrawals – NPS allows for partial withdrawals of up to 25% of the accumulated corpus under specific circumstances, such as medical emergencies or purchasing a home. These withdrawals are tax-free under Section 10(12B), enabling individuals to address urgent financial needs without incurring tax liabilities.
· Lump Sum Withdrawal – Individuals can withdraw up to 60% of the accumulated NPS corpus as a lump sum upon retirement (60 years). This amount is entirely tax-free, providing significant financial relief for immediate retirement expenses such as down payments for properties, medical treatments, and travel.
· Annuity Purchases: The amount used to purchase an annuity from the remaining 40% of the corpus after the lump sum withdrawal is also tax-free at the time of purchase. However, the income received from the annuity is subject to regular income tax rates, meaning it will be taxed according to the individual’s applicable income tax slab.
Conclusion
NPS provides various tax benefits that can significantly enhance your retirement corpus. By investing in NPS, you can reduce your taxable income through deductions under Section 80C and 80CCD. Additionally, you can enjoy tax-free withdrawals and annuity income, subject to more efficient taxation. Starting early with your NPS contributions and increasing your investments over time can lead to a larger retirement corpus.