NPS or National Pension System gives a tax deduction on contributions up to Rs 2 lakh per annum. It gives returns of 10-12% over the long term if you invest in equity NPS funds. On maturity, 60% of the NPS corpus is tax free. In this article we will discuss the many benefits of the NPS in detail. If you want an overview of how the NPS works, read our article here.
Before you read the details below, here is a summary of the top benefits of the NPS:
- Contributions to the NPS are tax-deductible up to Rs 2 lakh per annum.
- NPS allows up to 75% investment in stocks (equity).*
- You can choose between 8 different fund managers in the NPS
- Partial withdrawals up to 25% of contributions are tax-free
- You can switch between NPS funds without incurring any exit loads or tax.
- On maturity, 60% of the NPS corpus can be withdrawn tax-free
*Maximum of 50% for Govt Employees as per latest NPS Press Release. Certain changes for Govt employees have been announced but are still being implemented.
In addition the following benefits are available only for government employees in the NPS:
- Tax deduction for contributions to NPS Tier 2 account, with a lock-in of just 3 years.
- 14% government contribution to the NPS account
Tax benefits on investment in the NPS
Investment in the NPS (Tier 1) is tax deductible under Section 80CCD(1) and 80CCD(2) and 80CCD(1B). The three different sections add up to a total deduction of Rs 2 lakh. Out of this Rs 2 lakh, Rs 1.5 lakh comes from 80CCD(1) and (2) and Rs 50,000 is available under 80CCD(1B).
We will first discuss the Rs 1.5 lakh under 80CCD:
All Citizens of India
If you are self employed, up to 20% of your gross income is eligible for tax deduction under NPS with a ceiling of Rs 1.5 lakh per annum. Note that if you are employed but your company is not registered under NPS, you will be treated as self-employed for the purposes of these sections. Similar tax treatment applies to retirees, housewives and other similar categories of individuals. Such persons can open an NPS account under the NPS (All Citizens) Model.
Corporate NPS subscribers
If you have a corporate NPS account, 80CCD(2) refers to your employer’s contributions. These employer contributions are exempt from tax up to 10% of your basic salary + dearness allowance. Section 80 CCD(1) refers to your own (employee’s) contributions. These are tax deductible up to 10% of your salary subject to a maximum limit of Rs 1.5 lakh per annum. Hence for employees, contributions to the NPS are tax deductible up to 20% of their salary + dearness allowance.
Government NPS subscribers
Govt employees get the same benefits as other salaried employees mentioned above. They also get a higher employer contribution (14% of salary) many private sector employees. In addition to the benefits mentioned above, for government employees, it has been announced that NPS Tier 2 will also be eligible for tax deduction under Section 80C up to Rs 1.5 lakh. It will have a lock-in of 3 years.
Rs 50,000 under Section 80CCD(1B)
This deduction is available exclusively for NPS and no other product. It is over and above the Rs 1.5 lakh under Section 80C. It is given only to voluntary contributions to NPS. Hence mandatory employer contributions or deductions from the employee’s salary do not count under this section.
Tax-free NPS returns
While you continue to hold money in the NPS account, your returns are tax free. For example, if you switch between NPS funds (say, equity funds to debt funds) there is no tax on the same. This is quite different from mutual funds in which such transactions are subject to tax.
You can also make partial withdrawals from the NPS account up to 25% of your contributions. These withdrawals can be made on specific grounds such as children’s education, home purchase etc. These withdrawals are tax-free. Three such withdrawals can be made in the lifetime of the NPS account.
NPS Tax benefits on NPS Maturity
On maturity, you can withdraw up to 60% of the NPS corpus tax-free. The balance 40% of the NPS corpus has to be used to buy an annuity. This transaction is also tax-free but the annuity will be taxable each year, after you start receiving it. For example, if you have Rs 10 lakh in the NPS account, Rs 6 lakh will be tax-free on maturity. The balance Rs 4 lakh has to be used to buy an annuity (monthly pension). Under current rates, you will get an annuity of around Rs 28,000 per year on this sum. This annual payment will be taxable at your slab rate but the tax will be spread out over many years.
High NPS Returns
You can invest in 4 asset classes in the NPS – equity, corporate bonds, government bonds and alternative assets. You can decide your own allocation in them subject to a cap of 75% on equities and 5% on alternative assets. Alternatively, you can simply pick one of 3 lifecycle funds – conservative, moderate and aggressive. These funds will automatically decide your asset allocation based on your age. Historically an NPS portfolio with a 50-75% equity component has given returns of 10-12% per annum, on average. These returns are not guaranteed and fluctuate according to market conditions but tend to be around these levels in the long term. You can view historic NPS returns here.
For government subscribers, the choices are slightly different. Earlier such subscribers were compulsorily enrolled in the Central Govt NPS/State Govt NPS Plan which had equity allocation capped at just 15^%. However now they will be given 4 choices – 100% invest in Government Bonds, conservative lifecycle fund (with 25% cap on equity), moderate lifecycle fund (50% cap on equity) and and existing allocation (Govt NPS with 15% cap on equity). The new system was announced by the govt in a press conference in December 2018.
Choice of NPS Fund Managers
You can choose between any of the pension fund managers registered under the NPS. At present there are 8 of them – HDFC, ICICI Prudential, Reliance, Aditya Birla, Kotak, LIC, UTI and SBI. You can also switch between them without incurring any exit load or tax. One switch is permitted each year, between the NPS fund managers.