Tax incentives for NPS have gotten better and better over the last few years. In 2018, NPS almost became an EEE product. Almost. The entire lump sum withdrawal at the time of retirement (60 years) became exempt from tax. The same was notified in Union Budget 2019 too. In my previous posts on NPS, I have solely focussed on if and how much you must invest in NPS. Here is my latest take on NPS investments.
I have never really talked about the scenario where your employer offers to contribute to your NPS account. What should you do in such cases? The employer contribution to NPS is eligible for additional tax benefit under Section 80CCD (2). And there is no absolute cap on the tax benefit you can get for the employer contribution. The tax savings can be quite substantial. Let’s address this aspect of NPS investments in this post.
Before we go further, let’s do a quick recap of tax benefits for NPS investments.
Tax Benefits for investing in NPS
- For Own contribution to NPS Tier 1 account
- Rs 1.5 lacs under Section 80CCD (1): For your contribution to NPS, the tax benefits have absolute caps. You get tax benefit of up to Rs 1.5 lacs under Section 80CCD (1). This is no exclusive tax benefit and is shared with other Section 80C products such as PPF, EPF, life insurance premium, ELSS, etc. The tax benefit is further capped at 10% of basic salary for employees and 20% of gross income for self-employed.
- Rs 50,000 under Section 80CCD(1B): This is an exclusive tax benefit.
- For own contribution to NPS Tier 2 account
- Up to Rs 1.5 lacs under Section 80C: This benefit is available only to Central Government employees subject to an investment lock-in of 3 years. Poor choice. Don’t invest in NPS Tier 2 account.
- For Employer Contribution to NPS Tier 1 account
- Up to 10% of the Basic Salary (including Dearness Allowance): There is no absolute cap on the tax benefit. Higher your basic salary, the more tax benefit you can get. For the Central Government employees, the percentage is higher at 14%. Clearly, this benefit is available only to salaried employees.
What should you do if your employer offers NPS?
When it comes to NPS investments, your employer can give you three options.
- You must make a choice between EPF and NPS. EPF, in my opinion, is a better product than NPS. Therefore, if you must make a choice between EPF and NPS, stick with EPF. EPF provides the same tax benefits (and even better) than NPS, except for Rs 50,000 under 80CCD (1). For that, if required, you can make a separate contribution.
- You contribute to your NPS account through your employer. Your employer makes a matching contribution. Essentially, both you and your employer contribute to your NPS account.
- Your employer contributes to your NPS account. You don’t have to contribute.
Remember there is no free lunch. Your employer will not pay you anything extra. It will simply restructure your CTC. However, your tax liability will change.
In this post, let’s consider option (2) and (3).
What choice do you have?
If your employer offers NPS and you have no choice but enroll for it, there is little you can do. For instance, if you are a public sector employee, you have no choice. You have to enroll for NPS. Both you and your employer will contribute to the account.
What if you have a choice?
In a few private sector companies, employers are giving such a choice.
I have received feedback from a few readers and some of my clients that their employers are offering NPS. And that is in addition to EPF accounts i.e. your EPF contributions will continue. NPS contribution is over and above EPF.
What should such investors do?
You must understand that tax benefits for own contribution to NPS account are capped at Rs 2 lacs. 1.5 lacs under Section 80CCD (1) and Rs 50,000 under Section 80CCD(1B). If you contribute more, you wouldn’t get any tax benefit. And you may not even get the benefit for the entire Rs 2 lacs. After all, you would have PPF, housing loan repayment, life insurance payments, etc. Therefore, some (or the entire) portion of your Section 80C limit will be covered through other investments.
I have always maintained NPS is no special product. Without any tax benefits, there is no need for NPS in your retirement portfolio. We can easily do retirement planning without NPS. However, with tax benefits, it deserves some attention.
For own contribution, you can invest up to Rs 50,000 per annum in NPS (Tier 1 account) provided
- Your marginal tax rate is 30%.
- You are NOT planning an early retirement.
- You are sure that you wouldn’t need the money till the age of 60.
- NPS is NOT crowding out your other investments.
- NPS is not your major investment for retirement.
If you are making a contribution through your employer, you will likely end up investing more than Rs 50,000. Remember, beyond Rs 50,000, you may not get tax benefits for your contribution. Moreover, (4) and (5) may not hold. Since the employer will also make a matching contribution, (4) and (5) will be under greater pressure.
Unless you have a very high income (especially above Rs 50 lacs, where surcharge kicks in) and high investment ability, opting for both own and employer contribution is unlikely to be a good choice.
What if only your employer contributes?
From your perspective, that is the best scenario. Since you don’t have to contribute, you won’t breach Rs 50,000 for own contribution.
Your employer contribution to your NPS account gives you the tax benefit for the entire amount (your employer won’t contribute more than 10% of your basic).
From the point of view of tax-saving, it can be compelling, especially for those in the highest tax bracket. With surcharge over taxable income over Rs 50 lacs, the tax-savings can be even more substantial.
If you are in 30% tax bracket, by investing Rs 1 lacs (through employer contribution), you end up saving tax worth ~Rs 31,000 (including cess). If your taxable income is above Rs 50 lacs, the saving on Rs 1 lac of investment will be ~ Rs 34,000. The savings will go up if your employer invests more in your NPS account. Remember, this benefit is exclusive too and over and above your other tax-saving investments and expenses.
With such impressive tax benefits, should you sign up if only the employer is contributing?
Remember, the five conditions mentioned in the earlier section must still hold.
If you are in 5% or 20% tax bracket, (4) and (5) are unlikely to hold. Therefore, I wouldn’t advise such investors to opt for employer-only contribution (if there is a choice).
If you are planning an early retirement, remember NPS does not offer much liquidity before the age of 60. If you exit before the age of 60, you must purchase an annuity plan for 80% of the accumulated amount. Only 20% can be withdrawn lumpsum. If you are planning an early retirement, it is not a good idea to have a big portion of your retirement savings in NPS. And that can be the case if your employer contributes to your NPS account.
Even when you are in 30% bracket, if your employer contributes 10% of your basic, NPS can start becoming a substantial investment for your retirement. Therefore, your decision shall be guided by your income level, your investment ability, and your other retirement assets.
A good way to look at it: Your NPS investments shouldn’t be more than 15-20% of your retirement portfolio. This number 15-20% is subjective but I hope you got the idea. A low percentage of retirement assets in NPS will help you retain flexibility.