The National Pension System (NPS) has become one of the favourite investment instruments for those who are planning for retirement. NPS comes with guaranteed returns, tax benefits, and government backing. Before depositing your money in NPS, it is essential to understand its benefits and how you can maximise them.
In this blog, we will be diving into what NPS is, the new NPS rules, and the tax benefits associated with it.
What Is The National Pension System?
The National Pension System (NPS) is an affordable equity instrument linked to the market that is intended for retirement planning. It was designed to provide citizens with a pension after they retire. It was initially exclusive to central government employees, providing them with a platform to invest and accumulate returns for their retirement.
However, in 2009, the Pension Fund Regulatory and Development Authority of India (PFRDA), which oversees NPS, expanded its reach, thus making it accessible to all Indian citizens. NPS is divided into two accounts and they are Tier I (a mandatory retirement account) and Tier II (a voluntary savings account).
What Are The Key Features Of NPS?
Here are some of the important features of NPS.
Higher Returns – When you invest your money in an NPS account, your money is also allocated to equities along with the other asset classes. Equities can potentially deliver a higher return in the future, which will help your investment earn a good return. The current NPS interest rate ranges between 9% and 12% per annum (as of 2024), making it an appealing long-term investment option.
Flexible Asset Allocation – Investors can choose their asset mix among equity, corporate bonds and government securities.
Minimum Investment Amount – NPS is affordable for investors as the minimum contribution amount is only ₹500. The minimum contribution per year is ₹1000.
Tax Saving – NPS allows you to claim a tax deduction of up to ₹2 lakh. Also, if your employer invests in your NPS account, you can take a deduction of up to 10% of your salary.
Annuity Income – At maturity, when you turn 60 years of age, you only receive 60% of the corpus, and for the remaining 40%, you will have to purchase an annuity plan. This annuity plan helps you to earn regular income as a pension. So, it provides you with a regular source of income after retirement.
Planning for Retirement? Use Our NPS Calculator to See How Your Investments Will Grow!
What Are The Tax Benefits Of NPS?
Below are the tax benefits that one can get when they invest in NPS.
Deduction Under Section 80C
Investments in NPS qualify for tax deductions under Section 80C of the Income Tax Act. Subscribers can claim a deduction of up to ₹1.5 lakh per financial year on their contributions to the NPS Tier 1 account. This deduction is part of the overall ₹1.5 lakh limit under Section 80C, which also includes other investments like PPF, ELSS, and life insurance premiums.
Additional Deduction Under Section 80CCD(1B)
NPS subscribers can claim an additional tax deduction of up to ₹50,000 under Section 80CCD(1B) for their contribution to the NPS. This additional deduction is exclusive to NPS contributions and is over and above the ₹1.5 lakh limit of Section 80C. By taking full advantage of this benefit, an individual can save a total of ₹2 lakh in taxes each financial year.
Employer’s Contribution Deduction Under Section 80CCD(2)
For salaried employees, contributions made by the employer to the NPS are eligible for tax deductions under Section 80CCD(2). This deduction is available over and above the ₹1.5 lakh limit under Section 80C and is capped at 10% of the employee’s salary (Basic + DA). This provision is highly beneficial for salaried individuals as it helps them to receive tax-efficient contributions from their employer.
Also read: Can You Invest in Both PPF and NPS for Tax-Free Returns?
Tax Exemption On Partial Withdrawals
After 3 years of investment, an investor can withdraw up to 25% of the corpus from the NPS Tier 1 account for specific purposes such as medical expenses, children’s higher education, marriage, etc. This NPS withdrawal is exempt from tax.
Tax Benefit On Returns
Returns from the NPS Tier I account are not taxable until maturity. This means that any market-linked returns you earn will not be subject to tax.
Tax Benefit On Maturity
Once an investor turns 60, up to 60% of the corpus can be withdrawn in a lump sum. The remaining 40% has to be used to purchase annuities. Both of these are exempt from tax. For example, if an investor has a total corpus of ₹20 lakhs at 60, up to ₹12 lakhs can be withdrawn. The remaining ₹8 lakh will be used to buy annuities, which will pay retirement pension.
Tax Benefit On Purchase Of Annuity
At maturity, you will have to allocate 40% of your total NPS corpus in annuities. This amount is also exempt for tax purposes under Section 80CCD(5). However, annuity income earned through the annuity plan is taxable as per your income tax slab.
Tax Benefit To Employer’s Contribution
In the 2024 Union Budget, the tax deduction allowed under Section 80CCD(2) was raised from 10% to 14% of the basic pay. This means you can now contribute up to 14% of your basic salary to NPS without having to pay taxes on that amount.
For example, if your basic income is ₹1 lakh, your company can contribute ₹10,000 (10% of your basic pay to the NPS on your behalf, which is tax-free. Now, this deduction will go up to ₹14,000.
Until now, only government employees were entitled to a 14% deduction, but it has now been expanded to include the private sector.
How To Maximise NPS Benefits?
Here are some tips for you to make the most of your NPS benefits.
Maximise Contributions – Take full advantage of the tax benefits by contributing up to ₹2 lakh annually to your NPS account. This includes ₹1.5 lakh under Section 80C and an additional ₹50,000 under Section 80CCD(1B).
Opt For Employer’s Contribution – If you are a salaried employee, it is important to make sure that your employer is contributing to your NPS account under Section 80CCD(2). This is a great way to receive additional tax benefits beyond the ₹2 lakh individual limit.
Choose The Right Asset Combination – Select the appropriate asset allocation between equity, corporate bonds, and government securities based on your risk tolerance and retirement goals. Younger investors can consider choosing a higher equity allocation as it can help them generate better long-term returns.
Defer Withdrawal For Longer Growth – With the exit age extended to 75, you can consider keeping your investments in the NPS for a longer period. This will allow your corpus to grow further and benefit from compounding returns.
Also Read: 10 Best NPS Schemes In India To Invest
NPS New Rules & Tax Benefits – The Conclusion
The NPS is an attractive retirement savings option for individuals of all age groups. NPS offers several benefits, such as higher returns, flexible contributions, and tax-saving benefits, making it a well-rounded solution for retirement planning.
By understanding the tax benefits of NPS, you can ensure a financially secure and comfortable retirement. Retirement planning doesn’t have to be stressful. With the right strategy, NPS can help build your retirement fund and enjoy your golden years without financial worries.
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