To make NPS more tax-friendly, the government has granted tax exemption to 60% of the corpus. This can be withdrawn by individuals on maturity. In terms of taxability, this move is set to bring NPS at par with Public Provident Fund and Employee Provident Fund.
In an effort to make the National Pension System more lucrative for investors and bring it in the same playing field with investments such as PPF and EPF in terms of tax benefits, the government has made NPS withdrawals tax-free. Individuals can now get tax exemption on 60% of the corpus that they withdraw on maturity. The remaining 40% of the corpus is used to avail an annuity. Earlier, tax exemption was only allowed on 40% of the withdrawn amount, while the remaining 20% was taxed.
Before we dive into the tax advantage of NPS, let us first understand the savings scheme in detail.
What is National Pension System?
The National Pension System is a government backed voluntary saving scheme aimed at helping citizens build a corpus that will take care of their needs post retirement. The wealth generated from the scheme is determined on the basis of the investment growth from the contributions made. NPS is controlled and governed by the Pension Fund Regulatory and Development Authority (PFRDA).
An individual can open two accounts under national pension scheme - Tier I and Tier II. Tier I account is a non-withdrawable retirement account. Partial withdrawals, however, may be permitted under special cases. The account matures when the individual reaches the age of 60. Now, while Tier I account is the default account, opened when one opts for the NPS, Tier II, is a voluntary account. There is no lock-in period, which essentially means that the individual can make withdrawals at any moment from Tier II. Often times, the flexibility of Tier II is compared with that of mutual funds. But the expense ratio for mutual funds is much higher than Tier II NPS a/c.
Who can join National Pension System?
Any citizen of India - resident or non-resident - can join the NPS scheme. The individual must be between the ages of 18 years to 60 years. The scheme can be opted for by individuals and employer-employee groups. In case the NPS account is opened by a non-resident Indian, the contributions made are subject to regulations by RBI and FEMA.
Tax Benefits of National Pension System
100% Tax-Free Withdrawals: To streamline the National Pension Scheme, the entire amount from the saving scheme has been exempted from tax. This puts NPS under the ‘EEE’ regime. This is because it gets exemption at contribution, exemption on accumulation and exemption at withdrawal. Previously, 20% of the corpus was taxed at maturity. This included the principal and the gain. Now, no part of the principal shall get taxed on withdrawal. However, it is important to note that the annuity received shall be taxable. The annuity income will get added to the individual’s income and get taxed depending on which income tax slab that taxpayer falls in. Industry experts believe that the move to make withdrawals tax free will make savings scheme more attractive and have a far-reaching effect on the country's pension sector.
Section 80C of the Income Tax Act: An entity can claim tax deduction up to Rs. 1.5 lakhs under Section 80C of the Income Tax Act, 1961, for contribution made by self and contribution of the employer towards the savings scheme. Section 80CCD(1) covers the contribution by self. The maximum deduction an individual can claim under this is 10% of the salary. In case of self-employed taxpayers, this limit is 20% of the gross income. Section 80CCD(2) covers the employer’s contribution. This benefit is not available to self-employed taxpayers.
There is also a facility to claim deduction for additional self-contribution under Section 80CCD(1B) for up to Rs. 50,000. Thus, the overall tax deduction that can be claimed through National Pension Scheme is up to Rs. 2 lakhs.
In another major move, the mandatory contribution to the National Pension Scheme by the central government for employees has been raised from 10% of salary to 14%. The employee’s contribution will continue to remain at 10%, bringing the overall contribution to 24%. Taking into consideration the 18 lakh employees, the additional burden on the government on account of increased contribution would total to Rs. 2,840 crores in 2019-20.
According to a report by The Hindu, the government said “Contribution by the Government employees under Tier-II of NPS will now be covered under Section 80C for deduction up to ₹1.5 lakh for the purpose of income tax at par with the other schemes such as General Provident Fund, Contributory Provident Fund, Employees Provident Fund and Public Provident Fund provided that there is a lock-in period of 3 years.”
Moreover, employees of the central government can now invest up to 50% of their NPS corpus into equity, which will help boost the retirement corpus for the younger employees. The new NPS rules are expected to be beneficial for both employees of the central government as well as the NPS subscribers.