NPS (New Pension Scheme or National Pension System) has drawn attention of many investors since it got a few exclusive tax benefits. With the financial year drawing to a close, the interest has got even stronger.
NPS is a relatively new product. Taxation of maturity proceeds of NPS has been a subject matter of great speculation over the last year. Rules for partial withdrawal and lump sum withdrawal and investment guidelines have also been revised during the last year.
It is not easy for investors to keep track of developments unless they are regular visitors to PFRDA website. During my interaction with clients and readers of the blog, I realize there are a lot of aspects where there is still some confusion. I thought of covering such aspects in this post.
In this post, I will clarify a few misconceptions that investors have about investments in NPS.
Myth 1: NPS provides pension
NPS only helps you accumulate wealth. At the time of retirement, you use the accumulated wealth to purchase annuity plan (or a pension plan) from an insurance company. Your NPS fund manager has no role to play in providing you annuity income. Your pension will be paid by the insurance company. You can see the list of empanelled annuity providers on PFRDA website.
So, the money you invest in NPS goes to the NPS fund manager. He invests the money as per your choice of funds. The returns in NPS are market linked and are not guaranteed. Your money accumulates till the time you retire. At the time of retirement, you must purchase an annuity from the insurance company for up to at least 40% of the accumulated amount.
The remaining amount can be taken out in 10 annual installments till such time you turn 70. The amount that you choose not to convert to annuity continues with the fund manager till the time you withdraw it.
Myth 2: Investment in Tier-II account of NPS is eligible for tax benefits
All the tax benefits, annuity restrictions, exit and withdrawal rules are applicable to NPS Tier-I account only. NPS Tier-II account is like an open ended mutual fund. You can take out the money at any time. The tax benefit is only for investment in Tier-I NPS account.
Must Read: NPS Revised Exit and Withdrawal Rules
Myth 3: You can get tax benefit under Section 80CCD(1) for investment in NPS up to Rs 1.5 lacs
Yes, you can. But there is a cap. In case of an employee, this deduction is additionally capped at 10% of his salary (Basic + Dearness Allowance). In case you are self-employed, this deduction is capped at 10% of your gross total income.
Hence, if your salary (Basic + DA) is Rs 4 lacs, the maximum tax benefit under Section 80CCD(1) is limited to Rs 40,000 per financial year.
Of course, you can still seek relief under Section 80CCD(1B) for an additional Rs 50,000 tax benefit. Hence, the tax benefit for investment in NPS (own contribution) is capped at Rs 90,000 per financial year in your case.
Myth 4: Any contribution by employer to your NPS account is exempt from tax
Again not true. Contribution from the employer up to 10% of Basic Salary + Dearness Allowance is eligible for deduction under Section 80CCD(2). If your employer contributes more, the excess amount is taxable in your hands as salary. Therefore, higher your salary, greater the tax benefit.
Do note there is no upper cap (in terms of amount) on this tax deduction. This deduction is over and above the ceiling limit of Rs 1.5 lacs provided under Section 80C. However, this benefit is available to employees. Self-employed cannot avail this deduction.
Continuing with the above example, the contribution from your employer up to Rs 40,000 in a financial year will be exempt from tax.
Therefore, total exempt contribution is as follows:
- Up to Rs 40,000 under Section 80CCD(1). Own contribution
- Up to Rs 50,000 under Section 80CCD(1B). Own contribution
- Up to Rs 40,000 under Section 80CCD(2). Employer contribution
Therefore, in this specific case, the total tax benefit for NPS investment in the financial year is capped at Rs 1.3 lacs per annum.
Do note, even after these investments, you still have option to invest up to Rs 1.1 lacs for tax benefits under Section 80C (in products such as PPF, ELSS etc). Benefit under Section 80CCD(1B) and Section 80CCD(2) is not included under Section 80C cap of Rs 1.5 lacs.
Myth 5: Your entire money gets invested in equities
This is not true either. PFRDA has put strict cap on the amount of your corpus that can be invested in equities. For Government Sector subscribers, the cap on equity investments is 15%. For other subscribers (all citizens model), the cap on equity investments is 50%. You can review the investment guidelines for Government Sector NPS and All Citizens model here. This can change in the future. However, till such time that happens, do moderate your return expectations.
These were the common doubts that I have encountered. If you have any other doubts about NPS, do leave your query in the comments section.
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