NPS DECODED

 

Claim additional deduction of Rs. 50,000 or more from your income by investing in NPS

 

Investing in NPS

Investment in National Pension Scheme (NPS) has tax benefits under Section 80CCD of Income Tax Act, 1961. This tax-saving option is less explored by investors compared to other popular investments such as PPF and EPF. The deduction under these sections is available to both salaried and self-employed individuals. There are mainly two types of accounts under the NPS which are Tier I and Tier II accounts. All income tax deductions and exemptions are available mainly for Tier I accounts. Hence, for the purpose of our discussion let’s set aside Tier-II Accounts and focus only on Tier I accounts.

The deduction under u/s 80CCD(1) is available for self-employed individuals to the maximum of 20% of Gross income. For salaried employees, the subscriber’s own contribution towards NPS is tax-deductible up to 10% of Salary. Salary for the purpose of NPS contribution is defined as Basic salary plus Dearness Allowance. The deduction u/s 80CCD(1) is available within the maximum limit of Rs 1.5 lakhs u/s 80CCE which states that the total deduction claimed u/s 80C, 80CCC and 80CCD shall not exceed Rs 1.5 lakhs.

An additional deduction for investment up to Rs. 50,000 in NPS is available u/s 80CCD (1B). This is over and above the deduction of Rs. 1.5 lakh available under section 80C of Income Tax Act, 1961. This deduction is available to both salaried and self-employed individuals.

Deduction u/s 80CCD(2) is not available to self-employed individuals. Contribution of an employer towards NPS is eligible for deduction u/s 80CCD (2) up to 14% of Salary for Government employees and 10% of Salary for other employees, without any monetary limit. This deduction is over and above the deduction limit applicable u/s 80CCD(1) and 80CCD (1B) above. For the employer, this contribution can be claimed as a business expense.

NPS however is a complex product compared to PPF or EPF. Hence, let us get a bird’s eye view of this investment product. Anyone who is a citizen of India, non-resident or resident can join the NPS. The applicant must be between the age of 18-65 years on the date of application submission.

The NPS allows a range of investment choices along with a pension fund manager. There are eight fund managers to choose from. There are two investment choices Auto choice or Active choice. Under Auto choice as the name suggests funds are managed automatically by an appointed fund manager as per an investor’s age and risk profile. Under Active choice, individuals are free to decide among available asset classes in which to invest their funds subject to the maximum cap for each Asset class. The contribution amount can be invested in 4 asset classes Equity, Corporate debt, Government Bonds and Alternative Investment Funds.

The subscribers also have an option to switch their investment options as well as change their fund manager. These options are, however, subject to certain constraints.

It is pertinent to note that NPS returns are not guaranteed. The corpus growth continues via market-linked returns. Even the value of corporate and government bonds can react to macroeconomic developments.

Case Study :

Mr. Rahul who is self-employed individual. He has invested Rs. 75,000 in PPF account and Rs. 75,000 in tax saving mutual funds. If he invests Rs. 75,000 in NPS, how much deduction can he claim?

Mr. Rahul can claim the investment in PPF and Mutual Funds u/s 80C which sums up to Rs 1.5 lakhs. The investment in NPS can be claimed either u/s 80CCD(1) and/or 80CCD(1B). However, Section 80CCE restricts the maximum deduction u/s 80C, 80CCC and 80CCD(1) to Rs 1.5 lakhs. Hence, he will not be able to claim the investment of Rs. 75,000 u/s 80CCD(1). He can still claim deduction on investment in NPS u/s 80CCD(1B) up to the maximum limit of Rs. 50,000. So total Deduction Mr. Rahul will be able to claim is Rs 2 lacs (Rs. 1.5 lakhs u/s 80C + Rs. 50,000 u/s 80CCD(1B))

Withdrawal Norms from NPS and its Tax Treatment

Now, we shall discuss the withdrawal/exit from NPS and related taxation. NPS is typically a retirement product and hence the rules are framed such that it returns in form of pension income to retirees and not only available as a one-time corpus. Accordingly, the full corpus accumulated in NPS cannot be withdrawn at one time.

If the subscriber has joined the NPS between 18-60 years, on attaining 60 years or superannuation (as per service rules), at least 40% of the corpus is utilized for the purchase of an annuity and the remaining 60% may be withdrawn as a lump sum. Amount invested in the purchase of annuity and lump sum withdrawal are fully exempt from tax. However, annuity income (Pension) will be subject to income tax as per the investor’s slab. However, the scheme also gives an option to defer the withdrawal up to 70 years of age. Various other options such as deferment of annuity purchase up to 3 years, withdrawal in 10 instalments, a continuation of contribution up to 70 years are also available. If Corpus is less than Rs. 2 lakhs the entire amount can be withdrawn tax-free. If the subscriber has joined the NPS between 60-65 years, the subscriber can exit after the completion of 3 years. Other provisions being largely similar.

Before attaining 60 years or superannuation, an investor in the NPS can avail of premature exit after 10 years from the date of opening the account wherein 20% of the corpus can be redeemed. 80% of the corpus will be utilized in the purchase of an annuity. The redemption amount and amount invested in the purchase of annuity are fully exempt from tax. However, annuity income (Pension) will be subject to income tax as per the investor’s slab. In this case, if the corpus is less than or equal to Rs.1 lakh the entire amount can be withdrawn tax-free. If the subscriber has joined the NPS between 60-65 years and wants to exit before the completion of 3 years, similar provisions as explained above would apply.

The National Pension Scheme also offers the facility of partial withdrawal where in the entire lifetime, the investor is entitled to three partial withdrawals from the account. Partial withdrawal is allowed only in certain specified cases, for example, higher education of children, marriage of children, for the purchase/construction of the residential house, for treatment of critical illnesses, etc. The first partial withdrawal can be done three years after the account is opened. There should be a minimum gap of five years between two withdrawals. Each partial withdrawal should not exceed 25% of the investor’s own contribution to NPS. Partial withdrawal is tax-exempt.

In the case of the death of the investor, the nominee / legal heir can claim the corpus. Full withdrawal by the nominee / legal heir is allowed and remains tax-free. Nominee / Legal heir can opt to purchase an annuity from this accumulated wealth. The pension income would be taxed as per the nominee / legal heir’s income tax slab.

Case Study :

Mrs. Naina started investing in NPS in April 2017 when she was 25 years old. Now, she wants to make a partial withdrawal for the purchase of a Residential house. Her contribution to NPS is Rs. 2,00,000 and accumulated corpus is Rs. 3,00,000. Can she withdraw the amount and will it be taxable?

Partial withdrawal from NPS is allowed after completion of 3 years for specified reasons. Purchase of a residential house is one of the specified reasons as per NPS rules and it’s been more than 3 years since Mrs. Naina opened the NPS account hence she will be able to withdraw 25% of her own contribution to NPS. The total amount she can withdraw is Rs. 50,000 (25% of Rs. 2,00,000 i.e 25% of her own contribution and not the accumulated corpus).