The government has made National Pension System or NPS more attractive by announcing new income tax benefits in Budget 2019 for investors in the pension scheme. NPS is a voluntary, defined contribution retirement savings scheme. It is open for both government, private sector employees and the self-employed. Under NPS account structure, there are two sub-accounts – the mandatory Tier 1 account or the pension account, and the Tier II account, an optional account that offers withdrawal flexibility. Withdrawal from Tier I NPS is not allowed till the subscriber reaches the age of 60 or retirement though partial withdrawal and premature exit is allowed in specific cases.
Income tax benefits on NPS accounts
1) Income Tax benefit for NPS under 80CCD (1B): Under this, salaried as well as self-employed NPS subscribers get a deduction for investment up to ₹50,000 in NPS (Tier I account) in a financial year. If you are in the 30% tax bracket, it means a savings of ₹15,600 a year. This is over and above the deduction of ₹1.5 lakh available under Section 80C of Income Tax Act, 1961.
2) Income Tax benefit for NPS under Section 80CCD (1): If you invest in NPS, you can avail a deduction of ₹1.5 lakh under Section 80CCD (1). This benefit is available for both the salaried and the self-employed. But for salaried individuals the maximum deduction allowed under Section 80CCD (1) is 10% of their salary (basic + DA). This limit is 20% of gross income for self-employed.
But you must remember that the total amount of deduction under Sections 80CCD (1) (for NPS), 80CCC (investment in pension plan offered by an insurer) and 80C (PPF, tax-saving FDs, life insurance premium, ELSS etc) is ₹1.5 lakh per year.
3) Income tax benefit for NPS under Section 80CCD (2): This section relates to contribution made by the employer towards employees' NPS account. It is available for both public and private companies.
There is no upper limit for employer’s contribution towards employee’s NPS account but the maximum deduction allowed under Section 80CCD (2) is 10% of employee’s salary in that particular year.
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4) For central government employees, the government in Budget 2019 proposed amending Section 80CCD(2) of the Income Tax Act to allow exemption of employer contribution up to 14% of the salary of central government employees. Last year, the government had approved increasing the contribution to Tier I account for central government employees from 10% to 14%, a move that benefits approximately 18 lakh central government employees covered under NPS. Tax experts say this higher deduction on employer contribution towards employees’ NPS account should be also extended to private sector employees.
In Budget 2019, the government also allowed own contribution by central government employees to Tier II account qualify for income tax benefits under Section 80C, provided the money is locked in for a period of 3 years.
5) In Budget 2019, the government also raised the income tax deduction limit on withdrawal from NPS corpus on retirement or reaching the age of 60 to 60% from 40%. On retirement, a subscriber can withdraw a lump-sum of up to 60% of the NPS corpus fund and balance 40% has to be invested in an annuity plan. In terms of income tax implications, currently only 40% of the corpus fund withdrawn is tax-exempt and 20% is taxable in the hands of the taxpayer. The Budget proposal will make withdrawal from NPS effectively tax-free.