The Income Tax Act, of 1961, contains many provisions to save tax and reduce your overall tax burden. If you opt for the old tax regime, you can take advantage of several of these provisions in the form of deductions or exemptions, as applicable to you. One such investment that offers various tax benefits under the Income Tax Act is the National Pension System (NPS), more commonly known by its old nomenclature of National Pension Scheme.
A Closer Look at the National Pension System (NPS)
As a subscriber to the National Pension System, you can invest in specific asset classes till you retire and also enjoy NPS tax benefits. Thereafter, at the end of the investment tenure, you can choose to withdraw 60% of the corpus as a lump sum amount and convert the rest of it into an annuity. This guarantees a steady stream of income once you retire.
There are two types of accounts you can open under the National Pension System, as outlined below.
- Tier-I Account: It is a mandatory annuity -focused account you need to open when you subscribe to this investment scheme
- Tier-II Account: It is an optional investment-focused account that comes with more flexible withdrawal rules
Read further to check out the NPS tax benefits associated with each of these accounts.
Tax Benefits of Investing in the National Pension System (NPS)
The NPS tax benefits are available at the investment stage as well as the withdrawal stage. Here is a closer look at the various NPS tax benefits you can claim as a subscriber.
NPS Tax Benefits u/s 80CCD(1)
As per section 80CCD(1) of the Income Tax Act, 1961, investments made in the National Pension System are deductible from the total income. The maximum amount of deduction is capped at ₹1.5 lakhs (including deductions u/s 80C and 80CCC).
There are also other limits to consider here, as listed below.
- If you are a salaried employee, the maximum deduction should not exceed 10% of the sum of your basic salary and dearness allowance
- If you are self-employed, the maximum deduction is limited to 10% of your income, up to ₹1.5 lakhs
NPS Tax Benefits u/s 80CCD(2)
This NPS tax benefit is applicable to employers, who are subscribers under the corporate sector. The NPS tax benefit under this section pertains to the employer's contribution to the National Pension System. The deduction limit is capped at 10% of the sum of the employee's basic salary and dearness allowance, up to ₹7.5 lakhs.
NPS Tax Benefits u/s 80CCD(1B)
This NPS tax benefit on investments made in the National Pension System is over and above the deduction available u/s 80CCD(1). Here, an additional amount of ₹50,000 is deductible from your total taxable income for contributions made to your NPS Tier-I account.
So, for example, say you have invested ₹1.7 lakhs in your NPS Tier I-account. Of this, you can claim ₹1.5 lakh as a deduction u/s 80CCD(1) and the remaining ₹20,000 as a deduction u/s 80CCD(1B).
However, say you have invested ₹3.1 lakhs in your NPS Tier-I account and ₹60,000 in your NPS Tier-II account. In this case, the maximum cap of ₹1.5 Lakh will be tax deductible u/s 80CCD(1), and the maximum cap of ₹50,000 will be tax deductible under 80CCD(1B), but the Tier-II account investments will not qualify for any deductions.
NPS Tax Benefits on Partial Withdrawal
You can make a partial withdrawal from your National Pension Scheme account before attaining the age of 60. Of the amount withdrawn, 25% is exempt from tax. The remaining 75% is taxable under the head 'income from other sources,' as per the income tax slab rate applicable to you.
NPS Tax Benefits on Lump Sum Withdrawal
At the age of 60, you can withdraw 60% of the accumulated corpus as a lump sum amount. As per the Income Tax Act, this amount is entirely tax-free.
NPS Tax Benefits on Annuity Purchase
The portion of the corpus that is not drawn as a lump sum amount must be converted to an annuity, so you can receive periodic income from the NPS. The amount of the corpus that is used to purchase the annuity is also tax-free. However, the annuity that you will receive year after year will be taxable in the relevant assessment years, as per the income tax slab rate applicable to you.
Conclusion
To maximise your NPS tax benefits, you need to ensure that you invest the maximum sum up to which you can claim tax deductions under each of the sections outlined above. Furthermore, when you are withdrawing your investments, you can also claim tax exemptions. Keep in mind that the NPS tax benefits in the form of deductions and exemptions do not apply to investments in or withdrawals from your NPS Tier II account.
