Income Tax Benefit with the NPS Scheme

The National Pension System (NPS) is a government-sponsored retirement savings scheme in India designed to provide long-term financial security. Apart from helping individuals build a pension corpus, the NPS offers several attractive income tax benefits. These tax deductions make the scheme even more appealing to those looking to save for retirement while reducing their tax liability.

In this blog, we will explore the various income tax benefits associated with the NPS scheme, including the deductions available under different sections of the Income Tax Act. Additionally, we will look at the historical performance of NPS funds and explain how you can take full advantage of these tax savings.

What is the National Pension System (NPS)?

The National Pension System (NPS) is a voluntary, defined contribution retirement savings scheme regulated by the Pension Fund Regulatory and Development Authority (PFRDA). It is open to all Indian citizens, both in the public and private sectors, and offers two types of accounts:

Tier I Account: A mandatory pension account with restrictions on withdrawals until retirement.
Tier II Account: A voluntary savings account with more flexibility in withdrawals but no additional tax benefits.

The primary objective of the NPS is to create a retirement corpus that can provide a steady income after retirement. While it offers a well-structured retirement plan, the NPS also provides substantial tax benefits under various sections of the Income Tax Act.

Tax Benefits Under Section 80C

The most commonly used section for tax savings is Section 80C, and the NPS qualifies for deductions under this section.

Deduction Limit: You can claim a deduction of up to ₹1.5 lakh under Section 80C by contributing to the NPS Tier I account.
Eligible Contributions: Both employee and employer contributions (if applicable) are eligible for tax deductions under this section.

Example:

If you contribute ₹1.5 lakh to your NPS Tier I account in a financial year, you can claim this amount as a deduction under Section 80C, thereby reducing your taxable income.

Additional Tax Benefits Under Section 80CCD(1B)

To encourage more people to invest in the NPS, the government introduced an additional tax benefit under Section 80CCD(1B), which is over and above the ₹1.5 lakh deduction under Section 80C.

Additional Deduction Limit: You can claim an additional deduction of up to ₹50,000 under Section 80CCD(1B).
Eligibility: This deduction applies to contributions made to the NPS Tier I account, either by the employee or individual subscriber.

Example:

If you contribute ₹50,000 to your NPS account beyond the ₹1.5 lakh limit under Section 80C, you can claim the additional ₹50,000 as a deduction under Section 80CCD(1B). This reduces your taxable income further and allows for more savings.

Section	Maximum Deduction
Section 80C	₹1.5 lakh
Section 80CCD(1B)	₹50,000

By taking full advantage of both sections, you can claim a total deduction of ₹2 lakh from your taxable income.

Employer Contributions: Section 80CCD(2)

For salaried individuals, the employer’s contribution to their NPS account is also eligible for tax deduction under Section 80CCD(2). This section provides additional tax benefits over and above the individual’s contributions.

Deduction Limit: The deduction is allowed up to 10% of the employee’s salary (basic + dearness allowance) for private sector employees and up to 14% for government employees.
Employer’s Contribution: The amount contributed by the employer to your NPS account is not included in the ₹1.5 lakh limit under Section 80C.

Example:

If your basic salary plus dearness allowance is ₹10 lakh, and your employer contributes ₹1 lakh (10% of ₹10 lakh) to your NPS account, you can claim the entire ₹1 lakh as a deduction under Section 80CCD(2), in addition to the other deductions.

Tax Benefits on Maturity of NPS

Upon reaching the age of 60, subscribers are allowed to withdraw a portion of the NPS corpus, while the rest must be used to purchase an annuity.

Lump-Sum Withdrawal: You can withdraw up to 60% of the NPS corpus as a lump sum. The amount withdrawn is entirely tax-free.
Annuity Purchase: The remaining 40% of the corpus must be used to purchase an annuity, which provides a regular pension. The annuity payments are taxed based on the applicable income tax slab rate of the recipient.

Historical Performance of NPS Funds

The NPS offers various fund options, including investments in equities, corporate bonds, and government securities. Below is the historical performance of NPS funds:

Year	Equity Fund (Returns %)	Corporate Bond Fund (Returns %)	Government Bond Fund (Returns %)
2022	11.5%	9.0%	8.0%
2021	15.8%	9.7%	9.1%
2020	8.5%	7.2%	8.8%
2019	10.2%	8.1%	9.5%
2018	7.4%	6.9%	7.8%

The returns from NPS funds have been consistently strong, particularly for equity investments, making it a reliable long-term option for retirement savings.

Tax Exemptions on Partial Withdrawals

Partial withdrawals are allowed from the NPS Tier I account for specific purposes like education, medical emergencies, or home purchase. These withdrawals are tax-exempt up to a certain limit.

Limit: You can withdraw up to 25% of your own contributions, and these withdrawals are tax-free.
Eligibility: The partial withdrawal is allowed only after completing three years of contribution to the NPS account.

Comparison with Other Tax-Saving Instruments

Instrument	Max Deduction (₹)	Lock-in Period	Returns (Approx.)	Tax on Maturity
NPS	₹2 lakh + employer contribution	Until 60 years	8-12% (market-linked)	40% tax-free, annuity taxable
ELSS	₹1.5 lakh	3 years	10-14%	Taxable over ₹1 lakh
PPF	₹1.5 lakh	15 years	7-8%	Fully tax-free
FD (Tax-saving)	₹1.5 lakh	5 years	5-6%	Fully taxable

The NPS stands out due to its dual benefit of long-term retirement planning and substantial tax savings, particularly for individuals looking to secure their post-retirement financial future.

How to Maximize Your Tax Benefits with NPS

Utilize the Full ₹2 Lakh Deduction: Contribute ₹1.5 lakh under Section 80C and an additional ₹50,000 under Section 80CCD(1B).
Leverage Employer Contribution: If you are a salaried individual, ensure your employer contributes to your NPS account to claim further deductions under Section 80CCD(2).
Maximize Long-Term Growth: Choose the right asset allocation between equities, corporate bonds, and government securities to balance risk and return for long-term growth.

Conclusion

The National Pension System (NPS) offers a unique combination of tax-saving opportunities and retirement planning. By maximizing contributions under Sections 80C, 80CCD(1B), and 80CCD(2), individuals can significantly reduce their taxable income while building a robust retirement corpus.

For those seeking long-term financial security with tax benefits, the NPS is an excellent option to explore. Whether you are a salaried employee or a self-employed individual, investing in the NPS can help you achieve financial independence in your retirement years.