Maximising NPS Tax Benefits: New Guidelines and Best Practices for Taxpayers

NPS is a government-backed voluntary retirement savings scheme open to all Indian citizens aged 18-70.

The National Pension System is more than just a means of retirement saving; it's also a very smart way of reducing your tax income. Tax incentives have been introduced over the years, and the government wants to encourage taxpayers to save for retirement and save some tax.

If you’re wondering how to make the most of the NPS tax benefits or need clarity on the latest guidelines, this post will help. Let’s break it down into simple, actionable steps and explore best practices to maximise your benefits.

Understanding the Basics of NPS and Its Tax Benefits

Before diving into the tax advantages, let’s quickly recap what the NPS is.

What is NPS?

NPS is a government-backed voluntary retirement savings scheme open to all Indian citizens aged 18-70. It allows you to build a retirement corpus by investing regularly in market-linked instruments like equities and bonds.

Types of NPS accounts:

Tier I Account: The account is mostly for retirement savings and gives tax benefits but has withdrawal restrictions.

Tier II Account: A flexible savings account with no tax benefits or withdrawal restrictions.

Key NPS Tax Benefits You Should Know

NPS provides tax-saving opportunities under various sections of the Income Tax Act. Here’s a breakdown:

1. Tax Deduction Under Section 80CCD(1)

• Eligibility: Available to both salaried individuals and self-employed taxpayers.
• Limit:

1. Salaried: Up to 10% of basic salary + dearness allowance.
2. Self-employed: Up to 20% of gross income.

• Overall cap: ₹1.5 lakh (clubbed with Section 80C).

2. Additional Deduction Under Section 80CCD(1B)

• Amount: Up to ₹50,000.
• Why it matters: This is over and above the ₹1.5 lakh limit under Section 80C. By using this, you can reduce your taxable income by ₹2 lakh in total.

3. Employer Contribution Under Section 80CCD(2)

• What’s covered: Employers can contribute up to 10% of an employee’s basic salary + dearness allowance to their NPS account.
• Tax benefit: This contribution is deductible from the employee's taxable income without any upper limit.

4. Tax-Free Maturity Proceeds

From April 1, 2019, the entire 60% lump sum you withdraw at retirement is tax-free, making NPS a more lucrative investment option.

New Guidelines for NPS Tax Benefits

The government occasionally updates NPS rules to enhance its appeal. Here are the latest guidelines:

1. Taxation on Partial Withdrawals

• You can make partial withdrawals (up to 25% of your contributions) tax-free for specific purposes, such as children’s education, marriage, buying a house, or medical emergencies.

2. Revised Annuity Purchase Rule

• At maturity, 40% of your corpus must be used to purchase an annuity (a regular pension). The income from the annuity remains taxable under your applicable slab rate.

3. Tier II Tax Benefits for Central Government Employees

• Central government employees can now claim tax benefits on contributions to their Tier II account under Section 80C, provided they have a lock-in period of three years.

4. Enhanced Ease of Account Opening

• The government has simplified the process of opening an NPS account through Aadhaar-based eKYC and online platforms, making it more accessible to taxpayers.

Best Practices to Maximise NPS Tax Benefits

Knowing the rules is one thing, but applying them effectively is another. Here’s how you can maximise your NPS tax benefits:

1. Utilise the Full ₹2 Lakh Deduction

Make sure you claim both:

• ₹1.5 lakh under Section 80C (including NPS contributions).
• An additional ₹50,000 under Section 80CCD(1B).

For example, if your annual taxable income is ₹8 lakh, contributing ₹2 lakh to NPS could bring your taxable income down to ₹6 lakh, significantly reducing your tax liability.

2. Get Your Employer to Contribute

If you’re a salaried individual, ask your employer to contribute to your NPS account under Section 80CCD(2). This contribution not only enhances your retirement savings but also reduces your taxable income without eating into your personal 80C limit.

3. Plan for Tax-Free Withdrawals

To maximise tax efficiency:

• Use the 40% annuity purchase to secure regular income during retirement.
• Withdraw the remaining 60% lump sum, which is tax-free, at the time of retirement.

4. Start Early to Build a Bigger Corpus

The earlier you start, the more time your investments have to grow. A disciplined approach over decades can yield significant returns, thanks to the power of compounding.

5. Choose the Right Fund Allocation

NPS offers two investment choices:

• Active Choice: You can decide the allocation between equities, corporate bonds, and government securities.
• Auto Choice: The allocation adjusts automatically based on your age.

If you’re young, consider a higher equity allocation (up to 75%) to maximise returns over the long term.

6. Avoid Over-Contribution Elsewhere

Remember, the ₹1.5 lakh limit under Section 80C includes other investments like ELSS, PPF, and life insurance premiums. Prioritise NPS contributions if you’re planning for retirement and want to claim the additional ₹50,000 under Section 80CCD(1B).

Who Should Consider NPS?

While NPS is a great tool for many, it’s particularly beneficial for:

• Young professionals: Starting early ensures you build a significant corpus while enjoying tax benefits.
  
• Self-employed individuals: They can invest up to 20% of their gross income and enjoy a higher deduction limit.
  
• Salaried individuals: Employer contributions offer additional tax savings and a hassle-free way to build retirement funds.

How to Open an NPS Account

Opening an NPS account is simple and can be done online or offline through leading banks such as ICICI Bank:

1. Online:

• Visit the official websites of major banks such as ICICI Bank.
• Complete KYC using Aadhaar or PAN.
• Select your investment preferences (Active or Auto Choice).
• Make the initial contribution (minimum ₹500 for Tier I).

2. Offline:

• Visit a Point of Presence (PoP) like ICICI Bank branch.
• Fill out the registration form and provide KYC documents.
• Make the initial contribution.
• You’ll receive a Permanent Retirement Account Number (PRAN) once your account is set up.

Conclusion

The National Pension System (NPS) isn’t just a retirement planning tool—it’s a tax-saving powerhouse that offers unmatched flexibility and growth potential. By understanding the latest guidelines and adopting best practices, you can maximise your tax benefits while building a secure financial future.
Whether you’re just starting your career or are already planning for retirement, NPS offers a smart, efficient way to save taxes and grow your wealth. So, why wait? Open your NPS account today and take control of your financial future.