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Everything you need to know about NPS?

NPS tax

Rajesh started working for a private bank last year. He has been looking at various investment options to lead a blissful post retirement life. He is interested in an option that has optimum tax benefits. His colleague Vijay suggested that he check out the National Pension Scheme and tax benefits provided by it.

Read on to know more about National Pension Scheme (NPS) and the income tax benefits of NPS.

What is National Pension Scheme?

The Government of India launched the National Pension Scheme in 2004 as a pension-cum-investment scheme for Indian citizens between the age of 18-65. It is attractive for those who don’t have the comfort of drawing a regular pension post retirement.

NPS is regulated by the Pension Fund Regulatory and Development Authority. It works on a defined contribution model: the subscriber, while employed, is required to contribute to the retirement account on a regular basis; the accumulated corpus depends on the contributions made and income from the investment of such corpus. Withdrawals are permitted for specified reasons. The contributions are invested through pension funds into four major asset classes, namely equity, corporate bonds, government bonds and alternative assets.

A person employed with the Central Government (except for Armed Forces) and Central Autonomous Bodies, on or before January 1, 2004, is mandatorily covered under NPS. Certain state governments have also made NPS mandatory for their employees who have joined on or after a cut-off date.

Types of accounts under NPS

Tier I account:

The primary account, in the nature of pension account, to be opened by a subscriber.

The minimum initial contribution to be made is INR 500. The subscriber is also required to maintain a minimum annual contribution of INR 1,000. In case of government employees, the Central Government contributes 14% of the monthly salary + dearness allowance towards building the corpus. The employee’s contribution towards the corpus is pegged at 10% of the monthly salary + dearness allowance.

No withdrawals are permitted till the subscriber is 60 years. The subscriber has the option to continue deposits until the age of 70 years. Upon maturity, the subscriber can withdraw 60% of the accumulated corpus which is tax free. 40% of the corpus should be mandatorily used to buy an annuity plan which is tax exempt. Income received from annuity is taxable.

There’s an option of deferring the purchase of the annuity plan for three years. For maturity corpus less than INR 2 lakhs, there is no requirement to buy annuity.

Tier I account also allows withdrawals in ten annual instalments till the age of 70 years.

Partial withdrawals: up to 25% of the contribution from Tier I account permitted post three years from account opening. Such withdrawals can be made up to three times during the tenure of the NPS. The withdrawals are tax exempt. It will have to be for higher education or marriage of children, purchase of residential house or treatment of specified illness.

Premature withdrawals: Permitted post three years from account opening; 20% of the corpus can be withdrawn and 80% should be used to buy an annuity plan. Both are taxable.

Tier II account:

This account is a voluntary savings account and can be opened only if the subscriber has a Tier I account. The minimum initial contribution is INR 1,000 and a minimum of INR 250 should be contributed at one time. There are no restrictions on withdrawal of funds from Tier II account except in case of government employees. This account also allows the subscriber to transfer the funds to Tier I account at any time.

Income tax benefits for NPS

For a salaried employee, investment of up to 10% of the salary is exempted from taxable income under Section 80 CCD (1), IT Act, subject to a ceiling of INR 1.5 lakhs. Additionally, INR 50,000 is also deductible from taxable income under Section 80CCD (IB).

Contribution by employer up to 10% of salary is allowed deduction under Section 80CCD (2), IT Act. Government employees will also enjoy tax benefits for contributions made to Tier II account: tax deduction under Section 80C will be applicable but the withdrawal will be permitted after a mandatory lock in of 3 years. The rules are yet to be notified.

No tax benefits for non-government employees.

Is NPS the right plan for you?

It is one of the cheapest investment products in the markets with extremely low processing fees. If you are not keen on actively managing your retirement portfolio, NPS is a safe bet.

However, by choosing NPS, you lose the flexibility of deploying the entire corpus in alternate investments. Withdrawals are also restricted unlike mutual funds which support regular income needs during retirement. The post-tax yield from mutual funds could also be higher than the post-tax income from annuity.