Combine retirement planning with tax saving via NPS, say experts

With premature withdrawal being difficult, opt for it if you won't need the money till retirement

The March 31 deadline for making tax-saving investments for 2022-23 is approaching. One instrument that investors may consider -- both for retirement planning and tax saving -- is the National Pension System (NPS).

NPS offers two accounts. The mandatory tier I account comes with a lock-in period but offers tax benefits. The voluntary tier II account offers complete liquidity but doesn’t come with tax benefits.

Tax benefits on individual contribution

Any individual (resident or non-resident) who has paid any amount in his NPS account is eligible to claim a deduction under Section 80CCD (1) of up to Rs 1.5 lakh.

Naveen Wadhwa, deputy general manager, Taxmann, says, “The aggregate amount of deduction under Section 80C, Section 80CCC, and Section 80CCD can’t exceed Rs 1.5 lakh.”

Section 80CCC deduction is available on contribution to pension funds while Section 80CCD deduction is available on contributions to NPS or Atal Pension Yojana.

Many people exhaust their Rs 1.5 lakh limit due to contributions to insurance policies, Public Provident Fund (PPF), children’s tuition fees, etc. allowed under Section 80C. Wadhwa says, “Such an individual can claim an additional deduction of Rs 50,000 for the contribution to NPS under Section 80CCD(1B).”

When employer contributes to NPS

Section 80CCD (2) applies when an employer contributes to the employee’s NPS account. First, the employer’s contribution is added to the employee’s salary income. The employee can claim a deduction under Section 80CCD (2) up to 14 per cent (for government employees) or 10 per cent (for other employees) of basic pay, plus dearness allowance (DA).

Be aware of the Rs 7.5 lakh limit

Earlier, there was no upper limit on the employer’s contribution that could be claimed as deduction under Section 80CCD (2) as long as it was up to 10 per cent (14 per cent in case of central and state government employees) of the employee’s basic salary and DA. Rahul Charkha, partner, Economic Laws Practice, says, “Due to this, individuals with high salaries were able to claim a large amount of deduction.”

Budget 2020 stipulated that if an employer’s total contribution to Employee Provident Fund (EPF), NPS, and superannuation fund exceeds Rs 7.5 lakh in a financial year, the excess contribution would be taxable in the hands of the employee.

Maneet Pal Singh, partner, I.P. Pasricha & Co, says, “Any interest, dividend, etc. earned on the excess contribution is also taxable.”

Tax benefit for self-employed

When a self-employed individual contributes to NPS, the deduction allowed is lower of the amount contributed by him to NPS or 20 per cent of his gross income (maximum limit being Rs 1.5 lakh).

An additional deduction of Rs 50,000 over and above this limit is allowed under Section 80CCD (1B).

Taxation on withdrawal

At the time of retirement or upon attaining the age of 60 years, NPS subscribers can withdraw up to 60 per cent of the accumulated corpus, tax-free. The remaining 40 per cent must be used to purchase an annuity plan. The pension income received from the annuity plan is taxed at the applicable tax slab.

In case of partial withdrawal, up to 25 per cent of an individual’s contribution is exempted from income tax. The balance is taxed at slab rate.  

Should you opt for it?

NPS is a cost-effective instrument with low fund management and other fees. Unlike in mutual funds, investors get the benefit of tax-free rebalancing here.

Under the All-Citizens Model, investors can take equity exposure of up to 75 per cent and keep it at that level till age 50. Owing to equity exposure, NPS investors can expect to earn better returns than they would from fixed-income oriented retirement instruments.

Subscribers who want control over their asset allocation can opt for the active choice option. They can decide their allocation to equities, corporate debt, government securities, and alternative investment funds. 

Those who want their asset allocation to change automatically with age can go for the auto choice option. Investors also get to choose from a number of pension fund managers.

However, premature withdrawal is difficult. Opt for this scheme if you won’t need the money before retirement.

Taxation of NPS versus PPF
Particulars	NPS	PPF
Contribution/investment	Deduction is allowed under Section 80CCD	Deduction is allowed under Section 80C
Income	Tax-free	Tax-free
Withdrawal-normal	Withdrawal up to 60% of corpus is exempt	Tax-free
Withdrawal-on death of assessee	Tax-free	Tax-free
Partial withdrawal	Exemption limited to 25% of employee's contribution	Tax-free/exempt (depends on certain conditions)
Source Taxmann