This Article is From Nov 06, 2016

Three NPS Benefits That Can Bring Down Your Income Tax Burden

Three NPS Benefits That Can Bring Down Your Income Tax Burden

NPS has been mandatory to all employees joining central government (except Armed Forces) since 2004.


  • New Pension Scheme help save towards retirement and is also tax-friendly
  • Investor in 30% bracket can save Rs 15,500 by investing Rs 50,000 in NPS
  • Only initial investments in NPS eligible for tax deductions
The New Pension Scheme or NPS can not only help save towards your retirement but is also tax-friendly. NPS has been mandatory to all employees joining central government (except Armed Forces) since 2004 but the additional tax deduction of Rs 50,000 introduced in the Budget 2015-16 helped in putting the investment scheme into the spotlight.

Under NPS, there are two types of accounts - tier I and tier II. The tier I account is non-withdrawable till the age of 60, except in specific situations. The tier II account is a voluntary savings account. Subscribers to tier II accounts can withdraw the money whenever they want.

Broadly, the tax benefits offered on investment in tier I accounts in NPS can be categorised into three parts:

1) On self-contribution, under Section 80CCD(1B) of the Income Tax Act, the maximum deduction offered is Rs 50,000. Investors can contribute more than the Rs 50,000 limit but the maximum tax deduction allowed is Rs 50,000. This means an investor in the 30 per cent tax bracket can save around Rs 15,500 under Section 80CCD(1B) by investing Rs 50,000 in NPS. This benefit is also applicable for self-employed people.

This is over and above the limit of deduction available under Section 80CCD(1). This is an exclusive tax deduction available only for investment in NPS and not available for any other investment.

2) If you are contributing to NPS via salary deductions, your own contribution is eligible for tax deduction under Section 80 CCD(1) of up to 10 per cent of salary (basic + dearness allowance). This is within the overall ceiling of Rs 1.50 lakh under Section 80C of the Income Tax Act. Under Section 80C, other investments such as NSC, PPF and principal repayment of home loan quality for tax benefits. So investors can split their NPS contributions for claiming the combined tax benefit of Rs 2 lakh under Section 80C and 80CCD(1B).

3) Employees also get tax deduction for the contribution made by the employer under Section 80 CCD(2) of up to 10 per cent of salary (basic + DA).

Self-employed individuals are also eligible for tax deduction of up to 10 per cent of gross annual income under Section 80CCD(1), subject to the limit of Rs 1.5 lakh under overall Section 80C.

Other things to know

Remember that only initial investments in NPS under Section 80 CCD are eligible for tax deductions. At the age 60, one can withdraw a maximum of 60 per cent and the balance 40 per cent has to be mandatorily annutised or invested in a pension plan. However, 40 per cent of the NPS-accumulated corpus is exempted from income tax.

If funds from the accumulated corpus are reinvested in an annuity or pension plan, no income tax has to be paid on the funds invested. But the earnings from the annuity are taxable under respective income tax brackets.

Manoj Nagpal, CEO of Outlook Asia Capital, says an "investor should not just invest in NPS just based on the initial tax deferment. One has to invest with a view of building a retirement corpus."

Mr Nagpal, however, points out that some aspects of taxation regarding investment in NPS still need clarity. For example, "NPS tier II taxation on withdrawal needs to be clarified by tax department", he adds.