What Is The Tax Benefit On NPS Contributions?

The National Pension Scheme (NPS) is a government-backed retirement savings scheme that allows individuals to save for their post-retirement life while benefiting from various tax deductions. The scheme offers an attractive way to reduce taxable income through tax benefits on contributions. Understanding how these tax benefits work can help you maximize your savings for retirement while reducing your overall tax liability.

Tax Benefits on NPS Contributions:

1. Tax Deduction Under Section 80CCD(1):

Tax Benefit:

Contributions to the NPS are eligible for a tax deduction of up to 10% of your salary (for salaried individuals) or 20% of your gross income (for self-employed individuals) under Section 80CCD(1) of the Income Tax Act.

Maximum Limit:

The maximum amount that can be deducted is ₹1.5 lakh in total, which is part of the overall ₹1.5 lakh limit under Section 80C of the Income Tax Act.

Example:

If an individual has a salary of ₹10,00,000, they can claim a deduction of 10% of their salary (i.e., ₹1,00,000) under Section 80CCD(1).

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

Tax Benefit:

In addition to the deduction under Section 80CCD(1), NPS allows an extra tax deduction of ₹50,000 under Section 80CCD(1B). This is over and above the ₹1.5 lakh limit under Section 80C.

No Upper Limit:

The ₹50,000 deduction under Section 80CCD(1B) is in addition to the existing limit of ₹1.5 lakh under Section 80C, which means individuals can avail of a total of ₹2 lakh in tax deductions if they contribute to NPS.

Example:

An individual who contributes ₹50,000 to NPS under Section 80CCD(1B) can claim an additional ₹50,000 deduction, over and above the ₹1.5 lakh limit under Section 80C.

3. Tax Benefits on Employer Contributions:

Tax Benefit:

For salaried individuals, employer contributions to the NPS are also eligible for tax deductions under Section 80CCD(2).

Deduction Limit:

The employer can contribute up to 10% of the employee's basic salary and dearness allowance to the NPS, and this contribution is deductible from the employee's taxable income.

No Upper Limit:

Unlike the contributions made by the employee, there is no upper limit for the employer’s contribution under Section 80CCD(2).

Tax-Free Benefit:

The employer's contribution is not taxable in the hands of the employee.

Example:

If an employee's basic salary is ₹5,00,000 and their employer contributes 10% (₹50,000) to NPS, the ₹50,000 is tax-free and does not count towards the employee’s taxable income.

4. Tax on NPS Withdrawals:

Lump-Sum Withdrawal:

When an individual withdraws their NPS corpus, they can withdraw 60% of the total corpus as a lump sum. 60% of the withdrawal amount is tax-free.

Annuity Purchase:

The remaining 40% of the corpus must be used to purchase an annuity. The amount received from the annuity is taxable as regular income when the pension is paid out.

Example:

If an individual has a total NPS corpus of ₹20,00,000, they can withdraw 60% (₹12,00,000) as a lump sum, which will be tax-free. The remaining 40% (₹8,00,000) must be used to purchase an annuity, and the pension received from this annuity will be taxable as regular income.

Summary of Tax Benefits:

Example:

Let’s consider an example where an individual is contributing to the NPS for retirement:

• Salary: ₹8,00,000 per year
• Employee's Contribution to NPS (Section 80CCD(1)): ₹80,000 (10% of salary)
• Additional Deduction (Section 80CCD(1B)): ₹50,000
• Employer’s Contribution to NPS (Section 80CCD(2)): ₹50,000 (10% of basic salary)

Total Tax Deductions Available:

• Employee contribution: ₹80,000 (under Section 80CCD(1))
• Additional deduction: ₹50,000 (under Section 80CCD(1B))
• Employer contribution: ₹50,000 (under Section 80CCD(2))

The total deduction available would be ₹1,80,000, helping reduce the taxable income by this amount. This is an efficient way to reduce tax liability while contributing towards a retirement corpus.

Conclusion:

The National Pension Scheme (NPS) offers significant tax benefits that can help individuals save more effectively for their retirement. By contributing to the NPS, you can avail tax deductions under Section 80CCD(1), 80CCD(1B), and 80CCD(2). Additionally, the 60% of lump-sum withdrawals at the time of retirement is tax-free, making it an attractive option for tax-conscious individuals. These benefits make NPS one of the most tax-efficient retirement planning tools in India.