How NPS Investments Can Enhance Your Tax Saving Strategy?

After retirement, a person’s regular salary or income stops, but they still need money to maintain their lifestyle, handle emergencies, and fund retirement goals. To ensure a steady flow of income during retirement, the NPS offers the dual advantage of retirement savings and tax benefits. In addition to building a retirement corpus, it provides tax benefits on investments and withdrawals. The following sections will explore what NPS is and how it can enhance your tax-saving strategy.

What is NPS?

National Pension System, or NPS, is a voluntary scheme for retirement planning. You can invest during your earning years and save money for your retirement life. The contributions accumulate over the period you save. The corpus amount depends on your investment amount and frequency. It aims to motivate people to invest a part of their income for their retirement regularly. Upon retirement, you can withdraw a significant portion of the accumulated corpus and receive a monthly pension from the remaining amount. Moreover, the scheme also offers tax benefits under various sections of the Income Tax Act. Both salaried and self-employed subscribers can avail of these tax exemptions.

Understanding the Tax Benefits for Different Types of NPS Accounts

There are two types of NPS accounts: Tier 1 and Tier 2. The primary purpose of a Tier 1 account is to provide a regular income after retirement, so contributions to this account are locked until then. In contrast, a Tier 2 account offers greater liquidity with no restrictions on withdrawals. However, it's important to note that the tax benefits differ between these account types. Here’s an overview:

• Tax Benefits of a Tier 1 Account:

An NPS Tier 1 account offers certain tax deductions under various sections of the Income Tax Act:

• Section 80CCD(1): Tax Deduction of up to Rs. 1.5 Lakh per annum for NPS self-contribution.
• Section 80CCD(1B): Additional tax deduction of up to Rs. 50,000 per year for NPS self-contribution.
• Section 80CCD(2): Government and private sector employees receive a 14% and 10% tax deduction, respectively, for their employer's NPS contributions.
• Tax Benefits of a Tier 2 Account:

NPS Tier 2 is a voluntary account where you can contribute and withdraw funds anytime. However, you must have a Tier 1 account to open a Tier 2 account. Since it has no lock-in period, its flexibility comes at the cost of tax benefits. The Tier 2 account does not provide any tax benefits.

Additional NPS Tax Benefits

Apart from tax deductions under Sections 80CCD 1, 1B, and 2, NPS investments also provide additional tax benefits under the following conditions:

Tax Benefits on Partial NPS Withdrawals: After investing in a Tier 1 account for three years, you can withdraw up to 25% of your contributions (excluding employer contributions) for specific reasons like buying a home, medical treatment, children’s education or marriage, disability, skill development, or starting a business. These withdrawals are tax-free, with a maximum of three allowed during your subscription.

Tax Benefits on Maturity: When you turn 60, you can withdraw up to 60% of your NPS corpus as a lump sum, tax-exempt under Section 10(12A) of the Income Tax Act. The remaining 40% must be invested in an annuity plan, which is also tax-exempt under Section 80CCD(5). However, any income generated from the annuity is taxable according to applicable income tax rates.

Tax Benefits for Self-Contributions: As a salaried employee, you can claim tax deductions up to Rs. 2 lakh for your NPS contributions. Under Section 80CCD(1), you can deduct up to 10% of your salary (basic + DA) within the Rs. 1.5 lakh limit of Section 80CCE. You can also claim an additional Rs. 50,000 under Section 80CCD(1B), over this limit. Section 80CCD(2) allows you to deduct employer contributions, up to 10% of your salary for private sector employees or 14% for central government employees, in addition to the Rs. 1.5 lakh limit. Using these deductions, you could save up to Rs. 62,400 annually if you are in the 30% tax bracket.

Tax Benefits for Employer Contributions: In addition to self-contributions, employed investors can also claim tax benefits on their employer’s contributions. For private and government sector employees, the benefits are 10% and 14% of their salary, respectively.

Tax Benefits for Self-Employed Investors: Self-employed investors can also claim tax benefits on their NPS account. These include the following:

• Under Section 80CCD(1), you can claim a tax deduction of 20% of your gross income. This includes the overall limit of Rs. 1.5 Lakh under Section 80CCE.
• Under Section 80CCD (1 B), you can claim an additional tax deduction of up to Rs. 50,000, which is over and above the Rs. 1.5 lakh limit under Section 80CCE.

EEE System Benefits in NPS

EEE or Exempt-Exempt-Exempt is a lucrative tax status many investment options have in India. To qualify for the EEE status, a financial avenue must have tax exemptions on contributions, interest gains, and maturity amounts. In 2019, 60% of the lump sum NPS Tier 1 withdrawal became non-taxable. Earlier, only 20% of the withdrawal amount was tax exempted. Since the total lump sum withdrawal became tax-free, the corpus and maturity amounts have become tax-exempt. With these provisions, the NPS has gained the EEE status.

Now that you know about NPS and its tax benefits, you must start investing in the retirement planning scheme to build a corpus and save money on taxes. NPS investments can reduce your taxable income and allow you to enjoy the benefits. If you want to know how to invest in NPS, you can get in touch with a Kotak Bank representative.

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