Tax Planning through savings and investments
National pension scheme
Another popular tax saving option is the National Pension Scheme (NPS). It is available to both government and private sector employees. The basic purpose is to help citizens create a retirement corpus and receive a fixed monthly payout so that they can live a comfortable life after retirement.
Any individual can invest in NPS during his/her employment at regular intervals. It provides the option to withdraw up to 60% of the accumulated fund when the depositor attains the age of 60 and invest the rest in an annuity. The amount invested in the annuity is received by the investor as a monthly pension. However, if the depositor wants, he/she can continue the NPS investment till the age of 70 and then make the withdrawal.
This is a safe and long-term option that allows investors to obtain market-linked returns.
Types of NPS accounts
There are two types of NPS accounts:
- Tier 1
- Tier 2.
Tier 1: Tier 1 has a lock-in period till the depositor reaches 60-years. During this time partial withdrawals are allowed under certain circumstances. The contributions made to this fund is tax-deductible under section 80CCD (1) (up to ₹ 150,000) and 80 CCD (1B) (up to ₹ 50,000). This means in a financial year, an individual can invest up to ₹ 200,000 in NPS.
Tier 2: This fund enables voluntary contribution and allows withdrawal whenever they like. NPS Tier 2 however is not eligible for a tax deduction. To open a Tier 2 account, one has to open a Tier-1 account first.
Important aspects for national pension scheme
- Contributions to NPS are mandatory for central government employees up to the age of 60. It is optional for others.
- The maximum deduction is capped at 10% of the salary as per section 80 CCD (1) in the case of salaried employees and up to 20% in the case of self-employed individuals.
- When an individual opts for NPS, he/she is allotted a Permanent Retirement Account Number (PRAN).
- Once an investor retires, he/she gets the option to withdraw a partial amount as a lump sum (maximum 60% of the fund). The rest is invested in an annuity plan from an Annuity Service Provider. Usually, a licensed insurance provider is an annuity service provider.
- The annuity service provider has to be mandatorily empanelled with Home-Pension Fund Regulatory and Development Authority in order to provide annuity service to investors under the NPS scheme.
- Investors have multiple annuity schemes to choose from such as annuity for life, annuity for life with return of purchase on death, and others.
Please note: The returns under the NPS scheme are not guaranteed and are dependent on the performance of the market-linked instrument where the investment is being made – equity, corporate bonds, government bonds, etc.
Premature withdrawal of NPS
As mentioned before, an NPS Tier 1 account matures when the depositor reaches the age of 60. However, if the depositor wants, he/she can stay invested till the age of 70. Moreover, under certain special conditions, depositors in Tier-1 accounts are allowed to withdraw up to 25% of their own contribution, provided the subscriber has stayed invested for at least 3-years.
To make a partial withdrawal from a Tier-1 account, the depositor must submit a withdrawal application along with necessary documents to the National Pension System Trust or the central recordkeeping agency for their approval. However, withdrawals from Tier-2 accounts can be done without any restrictions and limits.
In case the investor passes away and the nominee decides to close the NPS account, then the amount received by the nominee is exempt from taxation.
Please note: The depositor can withdraw up to 25% of their own contribution and cannot withdraw any part of the employer’s contribution.
Tax implications of national pension scheme (NPS)
An investment made into the national pension scheme is tax-deductible under section 80 CCD. In this case, three subsections of section 80 CCD are applicable:
Section 80CCD (1): The provisions under this section provide a tax benefit to all investment made into the NPS scheme by employees in the government, public and private sector as well as self-employed individuals. The maximum limit of such deduction is ₹150,000.
Section 80 CCD (1b): Under this section, taxpayers can claim an additional deduction of ₹ 50,000 for their contributions to the NPS scheme. This section also includes contributions to the Atal Pension Yojana, which we have discussed in detail in the next section.
Section 80CCD (2): Apart from employees, employers can also make contributions into Tier – I NPS accounts. These contributions are allowed in addition to the regular employer contribution into EPF and PPF accounts. However, the maximum contribution is restricted to 10% of the basic salary plus dearness allowance (if applicable).
It is important to note that effective FY 2020-21, the employer’s contribution of more than ₹7.5 lakhs into retirement funds, EPF, NPS, superannuation funds are taxable in the hands of the employee. The interest earned on such a contribution will also be taxed in the hands of the employee.