Rs 2 lakh as deduction: How to maximise tax saving with National Pension Scheme

The NPS is used not only to build a sizable retirement kitty but also to reduce your taxable income by an additional Rs 50,000.

Tax season is around the corner and many of us are hunting for investment opportunities to reduce our taxable income by Rs 1.5 lakh and save up to Rs 46,800 on taxes. While there are many tax-saving avenues like Equity Linked Savings Scheme ( ELSS), Public Provident Fund, National Savings Certificate etc, the National Pension Scheme is one such scheme that not only can build a sizable retirement kitty but will also reduce your taxable income by an additional Rs 50,000. 

What is NPS?

The scheme enables users to invest in this pension account during their employment period and allows them to take out a certain sum of the corpus post-retirement. The balance amount can be received by the subscriber as a monthly pension only after retirement.

 

How to maximise tax saving

Anant Singh Ubeja, Senior Associate, SKV Law Offices, explains how one can maximize your tax savings with NPS:

1. Invest under Section 80CCD(1): The contributions to NPS are eligible for tax deduction up to 10% of salary (basic + DA) for salaried individuals and 20% of gross income for self-employed individuals, with a maximum limit of ₹1.5 lakh under Section 80CCE.
2. Additional Deduction under Section 80CCD(1B): One can claim an additional deduction for investment up to Rs 50,000 in NPS which is over and above the limit of Rs 1.5 lakh under Section 80C.
3. Employer's Contribution under Section 80CCD(2): For salaried individuals, the employer’s contribution to NPS up to 10% of salary (basic + DA) is deductible under Section 80CCD(2), and this is over and above the limits under Sections 80C and 80CCD(1B). This does not have an upper cap in terms of amount, but it should not exceed 10% of the salary.

You can get deductions of up to Rs 2 lakh with NPS

Point to note: The Rs 50,000 income deduction is over and above the Rs 1.5 lakh limit provided by others. NPS is now the only investment vehicle which allows you this additional tax deduction under section 80 CCD (1B).

" This means you can invest up to Rs. 2 lakhs in an NPS Tier 1 account and claim a deduction for the full amount. Tier 1 Account (Pension Account) has a fixed lock-in period until the subscriber reaches the age of 60 years. Only partial withdrawal is allowed, with certain conditions additional deduction of Rs 50,000/- is available only for contributions made to NPS Tier 1 accounts. Tier 2 accounts are not eligible to claim the deduction under Section 80CCD(1B)," noted Clear Tax  in a note. 

Example

You u invest Rs. 1.5 lakh under Section 80C (PPF, Tax Saver FD, etc.).

You also contribute Rs. 70,000 annually towards NPS.

You can claim a total deduction of Rs. 2 lakh:

Rs. 1.50 lakh under Section 80C

Rs. 50,000 under Section 80CCD(1B)

How to get started with NPS

Piyush Syal of Value Research explains how one should get started: 

You can visit your nearest bank as both public and private banks act as intermediaries for NPS.But if you are tech-savvy and a DIY investor, open your NPS account by visiting the website of any of the three service providers:

1. Protean (formerly NSDL)
2. CAMS
3. KFintech

Keep the below documents ready and follow the online instructions.

1. A soft copy of your Aadhaar and your signature
2. The mobile phone linked to your Aadhaar (An OTP will be sent to this number)
3. Your bank details and a soft copy of the cancelled cheque

Choosing between 'Auto' and 'Active' investment option

At some point, you will be asked to specify your preferred investment option between 'Auto' and 'Active'.

If you opt for the 'Auto', your investment will automatically be spread across asset classes pre-defined based on your age and the type of fund you choose. There are three fund types:

1. Aggressive lifecycle fund (75-15-10 in equity, g-sec and corporate bonds)
2. Moderate lifecycle fund (50-20-30 in equity, g-sec and corporate bonds) - Default option
3. Conservative lifecycle fund (25-30-45 in equity, g-sec and corporate bonds)

There is lock-in period until retirement age and the mandatory purchase of an annuity with a part of the corpus upon retirement. The returns on NPS are market-linked, especially for the equity component

"Even in the most aggressive option, the maximum that can be allocated to equities is 75 per cent. That too, till the age of 35. After which it decreases each year until it reduces to 15 per cent by age 55. On the other hand, the 'Active' choice allows you to keep 75 per cent of your portfolio in equities, no matter your age. Basically, the equity exposure doesn't automatically reduce with increasing age. Even the most aggressive plan of the 'Auto' choice is too conservative, especially when investing for a long-term goal like retirement.  We suggest going for the 'Active' option and allocating the maximum possible amount - 75 per cent - to equities. The remaining money can be spread equally between g-sec and corporate bonds. This strategy will help accumulate a larger corpus," said Syal.

National Pension Scheme Withdrawal Rules After Retirement (60 years)

At the time of Maturity

1. PFRDA permits NPS Withdrawal, as per which a maximum of 60% can be withdrawn as lumpsum while the remaining 40% is mandatory to be invested in an annuity. This 60% of the corpus is tax-free, while 40% is taxable when the subscriber receives the annuity. Additionally, 100% withdrawal can be made in cases where the corpus amount is less than or equal to five lakh at the time of Superannuation, i.e., attaining the age of 60 years.

Pre-Mature Exist

1. Early withdrawal is allowed, and you can withdraw up to 25% for certain purposes like children’s weddings or higher studies, building/buying a house, or medical treatment of self/family, among others. In the entire tenure, this withdrawal can be made only three times (with a gap of five years). This 25% of the permissible withdrawal is tax-free. 100% withdrawal can be made when the corpus amount is less than or equal to Rs. 2.5 lakh.

NPS is a good investment option if: 

NPS is a good option for investors who are looking for a mix of equity and debt in their retirement savings, with the flexibility to change the asset allocation. It's particularly suitable for individuals who:-

1. Are looking for long-term retirement savings.
2. Want to avail tax benefits.
3. Are comfortable with locking in their investment until retirement age (except for specific premature withdrawals under certain conditions).
4. (Prefer a mix of investment options that include government securities, corporate bonds, and equity.

Old Regime vs New Regime, as explained by Ubeja:

Old Regime allows for a wide range of deductions and exemptions, including those under Section 80C and 80CCD. It’s generally more beneficial for individuals who have significant investments in instruments like NPS, ELSS, insurance, etc. 

Example: Under the old regime, if your taxable income is Rs 10,00,000, and you make a Rs 1,50,000 investment in NPS (and claim the full amount under 80C), plus an additional Rs 50,000 under 80CCD(1B), your taxable income can be reduced to Rs 8,00,000. 

New Regime offers lower tax rates but eliminates most exemptions and deductions, except for the NPS employer contribution under Section 80CCD(2).

Example: If you opt for the new regime with a taxable income of Rs 10,00,000, you would not claim deductions for the Rs1,50,000 or the additional Rs 50,000 contributions to NPS. However, the tax slabs are structured such that for many individuals, the lower rates may result in similar or sometimes better tax savings without needing to make specific investments.