The government has notified the National Pension System (NPS) tier-II account as eligible for tax deduction under Section 80C. Previously, NPS tier-II had no lock-in, but now such tax-deductible contributions by the government employees will be locked in for three years.
Private sector contributions to the NPS tier-II account will continue to remain free from lock-in but will not get tax deductions. The maximum tax deduction under Section 80C is ₹1.5 lakh per annum, including other products, like life insurance contributions, equity-linked savings scheme (ELSS) funds or even mandatory deductions to NPS tier-I.
The contributions to the NPS tier-I account come in two parts—employer contribution and employee contribution. The 14% central government employer contribution is not bound by the Section 80C limit of ₹1.5 lakh and does not use up the limit. It is not taxable at all. However, employee contribution, which is 10% of basic salary and dearness allowance is mandatory and does come under the ₹1.5 lakh limit.
However, there may be employees whose mandatory contribution does not use up the ₹1.5 lakh limit completely with their NPS tier-I contributions. Such employees can invest in other products such as ELSS funds or life insurance to use up the limit.
The NPS tier-II now gives them one more option. Like ELSS funds, it will have a lock-in of just three years, which is lower than other 80C tax-saving investments. “However, the returns on the NPS tier-II account will be fully taxable at slab rate," said Dhruv Rawani, a Mumbai-based chartered accountant.
In NPS tier-I, the government subscribers can either go for the default NPS Central Government Scheme, which caps equity at 15% or choose a lifecycle fund with equity capped at 50% in the most aggressive lifecycle fund. They can also choose between any of the eight pension fund managers and switch between them once a year. It is unclear whether the same guidelines will be applicable to NPS tier-II under Section 80C. The notification adds that these guidelines will be specified by the sector regulator, the Pension Fund Regulatory and Development Authority (PFRDA).
The investment guidelines are yet to be notified by PFRDA.
A person with knowledge of the matter on condition of anonymity said that a single composite scheme of 80:20, debt equity will be rolled out. "The central government employees can also split their money between multiple fund managers. Also, the employee can choose to continue the account even after three years, as he does not have to withdraw it," the person added.
“I think it is a welcome development because of the short lock-in. The central government employees should seriously consider this deduction," said Deepali Sen, founder of Srujan Financial Advisors LLP. “The taxability of the returns is a downside but I don’t think it affects the investment case for NPS tier-II fundamentally," she added.
The central government employees have to contribute a minimum of ₹1,000 per year to the NPS tier-II account in the first year and ₹250 in the subsequent two years. This account cannot be pledged (borrowed against), assigned or transferred to anyone.