Claiming tax benefits related to NPS

Claiming tax benefits related to NPS

The National Pension Scheme is one of the solutions for retirement planning which also provides tax benefits

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The National Pension Scheme (NPS) is one of the ways of saving towards your retirement. You can claim a tax deduction for your contribution as an employee, your employer’s contribution and also your self contribution within the specified limits.

Upon retirement, lump sum withdrawal up to 60% of the corpus is tax-exempt. Therefore, NPS comes with several tax benefits. Let’s understand how you can claim these tax benefits related to NPS. 

Contribution as an employee

An individual in employment can contribute to NPS and save tax within the specified limit of 10% of the basic salary and dearness allowance. This deduction for contribution made as an employee is allowed under section 80CCD(1) and is available within the overall limit of Rs 1.5 lakh under section 80C. Individuals employed with the central government and any other employer can claim the tax deduction for their contributions made in the financial year.

Contribution as an employer

Employees can also claim a tax deduction for their employer’s contribution to NPS and save further taxes. The deduction is available for contributions made by the central government or any other employer. The contribution by the central government is eligible for a tax deduction up to 14% of the basic salary and dearness allowance. The contribution by any other employer is eligible for tax deduction up to 10% of the basic salary and dearness allowance if any. You can claim the deduction under section 80CCD(2) which is over and beyond the limit of Rs 1.5 lakh specified above as per section 80C.

Any contribution made by the employer in excess of the percentages specified above shall not be available for claiming deduction. Note that there is no separate monetary limit for claiming deduction under section 80CCD(2). It is allowed within the overall limit of Rs 7.5 lakh as a maximum contribution which can be made by an employer towards EPF, superannuation and PPF accounts of the employee. 

Self contribution by self employed

An individual who is self-employed can claim a tax deduction for the contribution to NPS. The amount of deduction gets restricted to 20% of the gross total income. The gross total income is calculated as the aggregate of all the incomes earned in a financial year, but before claiming tax deductions for savings and payments. The deduction is under section 80CCD(1) and falls under the overall limit of Rs 1.5 lakh specified in section 80C.

Separately, both a self-employed individual and employee are entitled to claim an additional tax deduction for their additional NPS contribution up to a limit of Rs 50,000 per financial year. The deduction is under section 80CCD(IB) and is in addition to the deduction allowed under section 80C.

Thus, an employee can claim a deduction for their NPS contribution up to Rs 1.5 lakh under 80C, additional contribution of up to Rs 50,000 under section 80CCD(1B), taking their overall deduction for NPS to Rs 2 lakh.

Besides, deduction is also allowed for their employer’s contribution within specified limits. A self-employed can claim a deduction for their NPS contribution up to Rs 1.5 lakh and for additional contribution up to Rs 50,000.

Tax exemption on corpus withdrawals

At the time of retirement, at the age of 60 and above, you are entitled to withdraw a lump sum amount up to 60% of the corpus in a tax-exempt manner.

The balance 40% should be mandatorily used to buy an annuity plan to receive regular pension income. The balance 40% used to buy the annuity plan is also tax-exempt. The pension income you receive from the annuity plan gets taxed as income from other sources based on the income tax slabs applicable to the year of receipt.

All the above tax benefits of deductions and tax-exempt withdrawals are available for subscriptions to Tier 1 account only. Also, your contributions remain locked-in until the age of retirement which is 60 years. NPS does allow partial withdrawals in certain circumstances. However, in order to fully utilise the tax benefits, one should stay invested till 60 years of age.

(The writer is Founder and CEO - ClearTax)