In this post, I will discuss tax benefits for NPS and the tax treatment of maturity proceeds. I will discuss if it makes sense to invest in NPS now or if you should invest in NPS for the exclusive benefit of Rs 50,000 under Section 80CCD(1B).
NPS Tax Benefits (Latest)
This part has not been affected by the latest budget. Only contribution to Tier-I NPS account is eligible for income tax benefits. From April 1, 2019, even contribution to Tier II NPS account qualify for tax benefits subject to certain conditions being met.
- Investment up to Rs 1.5 lacs into NPS in a financial year is eligible for deduction under Section 80CCD(1). Please note this deduction comes under the overall ceiling of Rs 1.5 lacs for deduction under Section 80C. In case of an employee, this deduction is additionally capped at 10% of his salary (Basic + DA). In case the subscriber is self-employed, this deduction is capped at 10% of his gross total income.
- Up to Rs 50,000 per financial year for any investments into NPS under Section 80CCD (1B). This deduction is over and above the ceiling limit of Rs 1.5 lacs provided under Section 80C.
- Contribution from the employer up to 10% of Basic Salary + Dearness Allowance is also eligible for deduction under Section 80CCD(2). 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 and limit of Rs 50,000 under Section 80CCD(1B). However, this benefit is available to employees. Self-employed cannot avail this deduction.
Therefore a maximum of Rs 2 lacs can be claimed as deduction for own investment in NPS. Tax benefit on employer contribution is in excess of the aforesaid benefit of Rs 2 lacs. Go through the following post for Common Doubts about NPS. It will help clarify many doubts about NPS investments including tax benefits.
My employer offers NPS. During the last financial year, I made a contribution (employee contribution) of Rs 1 lac in NPS. Additionally, I invested Rs 1 lac in PPF. What is the maximum tax benefit that I can get?
You can get
- Rs 1 lac for PPF investment under Section 80C.
- Rs 50,000 for NPS investment under Section 80CCD(1)
- Rs 50,000 for NPS investment under Section 80CCD(1B)
Section 80CCE caps the amount of tax benefit under Section 80C, Section 80CCC and Section 80CCD(1) at Rs 1.5 lacs.
Do note tax benefit under Section 80CCD(1B) and Section 80CCD(2) is not part of this cap.
An additional point to note is that it is your discretion how you want to show your NPS contribution. For instance, you showed Rs 50,000 under Section 80CCD(1) and Rs 50,000 under Section 80CCD(1B). You could have also shown Rs 60,000 under Section 80CCD(1) and Rs 40,000 under Section 80CCD(1B). You can adjust so as to maximize your income tax benefit.
It is quite possible that your employer may not agree to this and show it as a contribution under Section 80CCD(1) only and deduct excess tax. However, you can claim back this excess tax while filing your income tax return.
NPS: Tax treatment on Maturity or Withdrawal
#1 Withdrawal on retirement
At least 40% of the accumulated wealth in the NPS account needs to be utilized for the purchase of an annuity/pension plan. Remaining 60% can be withdrawn as lump sum.
Annuity purchase: 40% to 100% of the accumulated corpus
Lumpsum: Remaining amount (0% to 60% of the accumulated corpus
40% of the accumulated NPS corpus is exempt from tax at the time of retirement. So, you can withdraw 40% of the accumulated corpus without paying any tax. If you withdraw more than 40%, you will have pay income tax at your marginal income tax rate.
The entire lump sum withdrawal (upto 60% of the accumulated corpus. Minimum: 0%, Maximum: 60%) at the time of maturity is exempt from tax. The change was effected in December 2018.
The amount that you use to purchase an annuity plan (minimum 40%, maximum 100%) is also exempt from income tax. However, the annuity income (pension) shall be taxed in the year of receipt.
If you look at it, you don’t have to pay immediately on exit from NPS. Any amount used to purchase an annuity plan is exempt. Lumpsum withdrawal is exempt to the extent of 60% (but you can’t withdraw more than 60% lumpsum). So, your tax liability will arise when you get annuity payments.
#2 Pre-mature exit from NPS (Exit before Retirement)
At least 80% of the accumulated wealth in the NPS account needs to be utilized for the purchase of annuity/pension. The entire lump sum withdrawal will be taxed (no tax relief in this case). Even in this case, lump sum withdrawal up to 40% 60% will be exempt from tax. However, since PFRDA allows only 20% lump sum withdrawal in case of pre-mature exit, the tax benefit will be limited to 20% only. The amount used to purchase annuity is not taxed. However, annuity income shall also be taxed (as per your income tax slab) in the year of receipt.
#3 Partial Withdrawal from NPS (without exiting the NPS)
Under the revised exit and withdrawal rules for NPS, limited partial withdrawal from NPS is permitted subject to certain conditions.
I am not very sure about tax treatment of such partial withdrawals. As I understand, partial withdrawal shall be taxed in the year of withdrawal as per subscriber’s income tax slab. In Union Budget 2017, such partial withdrawals (to the extent of 25% of own contribution) were made exempt from income tax.
#4 Withdrawal in the event of the death of the subscriber
In the event of the death of the subscriber, the nominee can withdraw the accumulated corpus (in case of All Citizen model). The nominee can opt for annuity payouts too. In the case of government sector NPS, purchase of annuity (at least 80%) is mandatory and remaining can be taken as a lump sum.
The lump sum withdrawal by the nominee shall be exempt from Income Tax. If the nominee uses the amount to purchase an annuity plan, the annuity income will be taxed as per the nominee’s income tax slab in the year of receipt.
Even though you can go through rest of the portion of this post too, it may not be as useful since the entire lump sum withdrawal is now exempt from tax. The portion relied on many subtleties of NPS to get beneficial tax treatment. However, now that the entire lump sum withdrawal is exempt from tax, you don’t have to worry about these lesser-known aspects of NPS. For more on if you should invest in NPS, refer to this post.
You are 25. You put Rs 50,000 per annum in NPS for exclusive tax benefit under Section 80CCD(1B).
- You make all contributions on April 1.
- Your NPS contributions earn 10% p.a. till the time you retire.
- Annuity rate at the time of retirement is 6% p.a.
- You have no other source of income other than NPS withdrawals or annuity income.
- During retirement, you do not avail of any tax benefits under Section 80C, 80D etc.
- Ignored surcharge and cess.
By the time you turn 60, your NPS would have grown to Rs 1.49 crores by the time you retire. Minimum 40% of the accumulated corpus has to be used to purchase annuity (pension).
Let’s consider various options at your disposal.
- 40% withdrawn as lump sum. Remaining 60% used to purchase annuity
40% of the accumulated corpus is exempt from income tax. So, your lump sum withdrawal of Rs 59.6 lacs is exempt from income tax.
You use remaining Rs 89.4 lacs to purchase annuity.
At 6% annuity rate, you will get Rs 5.36 lacs per annum for life.
At present income tax rates and slab, your tax liability per annum will come out Rs. 27,325.
For senior citizens, the minimum basic tax exemption limit is Rs 3 lacs.
If you had invested for tax benefits under Section 80C or availed any other tax benefit, your tax liability would have been lower.
- 60% withdrawn as lump sum. Remaining 40% used to purchase annuity
You make lump sum withdrawal of Rs 89.43 lacs. The entire amount is exempt from tax. Out of this, Rs 59.6 lacs is exempt from income tax. You will have to pay income tax of Rs 7.14 lacs on the remaining lump sum withdrawal amount.
You use Rs 59.6 lacs to purchase annuity. You will receive annual pension of Rs 3.57 lacs. At this level of annual income, you will have to pay income tax of Rs 700 per annum (after accounting for tax rebate of Rs 5,000 per annum under Section 87A).
- 40% lump sum withdrawal, 40% annuity, 20% staggered withdrawal
In a notification on October 29, 2015, PFRDA clarified that the lump sum amount can be withdrawn in up to 10 annual installments till the age of 70. Please note the installments need not be equal. This is applicable to both Government Sector NPS and All Citizens model (including corporate sector NPS). You can download the circular (Clarification of deferred withdrawal of lump sum) from PFRDA website.
Let’s see how you can use this information.
40% lump sum: Rs 59.6 lacs exempt from income tax.
40% annuity: Rs 59.6 lacs used to purchase annuity. Gives an annual income of Rs 3.57 lacs.
20% staggered: You withdraw remaining Rs 29.8 lacs in 9 annual installments i.e. Rs 3.31 lacs per year for 9 years. (To simplify calculations, I have assumed that Rs 29.8 lacs will not grow in the interim. However, in reality, you will earn returns on the balance corpus)
For nine years, you will have income of Rs 6.89 lacs (Rs 3.57 lacs + Rs 3.31 lacs). On this amount, you will pay income tax of Rs 57,800 per annum.
After nine years, you will have income of only Rs 3.57 lacs per annum. On this, you will have to pay income tax of Rs 700.
So, you can see you are not really paying too much tax. Tax exemption on 40% lump sum withdrawal makes NPS a really sweet deal from tax perspective. Moreover, you can optimize your tax liability by staggered withdrawals.
As I had mentioned in one of my earlier posts on NPS, if you can somehow manage a lower marginal tax rate at the time of withdrawal (after retirement), you can actually save some money by investing in NPS. With these examples, it appears you can do that without much difficulty.
I will stop short of telling what you should do. You must decide on your own. Do keep in mind the assumptions taken. And there are a number of them. If you invest more, you may end up with a much larger corpus. Or if the return is higher or lower, the maturity corpus will be higher or lower. Your strategy will depend on your final corpus, your financial needs and tax rules at the time of your retirement.
Should I invest in NPS for extra Rs 50,000 tax benefit?
I have issues with NPS. The issues are with respect to rigidity in the NPS. Premature withdrawal and exit opportunities are limited. There is a mandatory purchase of annuity. If you exit before retirement, you will have to use 80% of the amount to purchase an annuity plan. Moreover, PFRDA wants to make turn it into a product that means everything for everyone. I am not comfortable with such approach.
As I have mentioned in many of my earlier posts, your investment decisions should not be driven by tax benefits alone.
However, if you consider only the taxation angle, the case for NPS investment is really strong. For the benefits under Section 80CCD, you have alternatives in other Section 80C investments such ELSS, PPF etc. In fact, if you have investment discipline, you can probably do better with a mix of ELSS and PPF.
The benefit of Rs 50,000 under Section 80CCD(1B) is exclusive to NPS. As I have shown, you may not have to pay too much tax at the time of retirement (if the corpus is not too big).
If tax benefit is the only criterion, go ahead and subscribe to NPS for the additional tax benefit of Rs 50,000 under Section 80CCD(1B). The investors in the highest income tax bracket stand to gain the most.
In my opinion, you can consider subscribing to NPS if:
- Your marginal tax rate is 30%. AND
- Investment in NPS does not crowd out investment for other goals. AND
- You don’t plan to invest more than Rs 50,000 per annum. AND
- You are sure you won’t need this money before the age of 60 or superannuation. AND
- You are not planning to take an early retirement.
The post was first published in March, 2016 and has been updated since.