Explained: Tax Benefits Under National Pension System (NPS)

National Pension System (NPS), a government-sponsored retirement planning instrument, is regulated by the Pension Fund Regulatory and Development Authority (PFRDA). In NPS, a government employee contributes towards pension from monthly salary along with matching contribution from the employer. The funds are then invested in earmarked investment schemes through pension fund managers, as mentioned on nsdl.com. PFRDA has appointed NSDL (National Securities Depository Limited) as Central Recordkeeping Agency (CRA) for National Pension System. CRA issues Permanent Retirement Account Number (PRAN) to each subscriber and maintain database of each Permanent Retirement Account along with recording transactions relating to each PRAN.

NPS is mandatory to all employees who have joined services of Central Government (except Armed Forces) and Central Autonomous Bodies on or after January 1, 2004.

NPS offers two types of accounts: Tier 1 and Tier 2. While the Tier 1 NPS account is strictly a pension account which doesn't allow withdrawals, the Tier 2 account - known as investment account - is a voluntary saving account associated with the PRAN. 

Tier II account offers greater flexibility in terms of withdrawal, unlike Tier I account. One can withdraw from the Tier II account at any point of time.

Income Tax Act allows benefits under NPS as per the following sections:

1. On employee's contribution: Employee's own contribution is eligible for tax deduction under Section 80 CCD (1) of Income Tax Act up to 10 per cent of salary (Basic + Dearness Allowance). This is within the overall ceiling of Rs 1.50 lakh under Section 80 CCE of the Income Tax Act.

2. On employer's contribution: Up to 10 per cent of Basic and Dearness Allowance (no monetary ceiling) under 80CCD (2). This rebate is over and above 80 CCE limit of Rs 1.50 lakh.

3. Voluntary contribution: Employee can voluntarily invest an additional amount of Rs 50,000 (or more) to the NPS Tier I account and claim tax deduction on the same under section 80 CCD 1(B), subject to a maximum of Rs. 50,000.