What is NPS - Know about NPS Tax Benefits

One of the most important life goals everyone has is the creation of wealth. This is only possible when one is young and employed. Post retirement, one has to typically live on the savings put away during the years of employment. These savings could be in the form of provident fund, pension and other investments, be it share market investments, fixed deposits, recurring deposits and so on. One such investment vehicle, which is also a great tax saver, is the National Pension Scheme. But what exactly is it?

What is NPS?

The National Pension Scheme or NPS is a social security initiative of the Government of India with a view to encourage citizens to save money for their retirement. This scheme is regulated by the Pension Fund Regulatory and Development Authority (PFRDA). NPS is both, a tax saving vehicle and a market-linked product and the returns accrued depend on the performance of the fund. While the scheme was initially introduced for government employees, it was later extended to all Indian citizens. Through NPS, investors can avail several tax benefits. Let us find out who we can maximize savings with NPS.

How to maximize tax savings with NPS?

Let us look at the various ways to maximize tax savings with NPS

As per Section 80CCD (1) of Section 80 C of the Income Tax Act, an investor can claim deductions of up-to ₹150,000. The deduction claimed needs to be 10% of the basic component of the salary for salaried employees or 20% of the gross annual income of a self-employed individual. It should not, however, exceed the maximum limit of ₹150,000.

As per Section 80CCD (1b), investors can avail an additional tax benefit of ₹50,000. This increases the annual tax benefit on NPS investments to ₹200,000.

As per Section 80CCD (2), salaried employees can claim further tax deduction on 10% of the basic component of their salary + dearness allowance. They can show their employer’s contribution as deduction under Section 36 I (IV). However, the minimum deduction claimed should not exceed 10% of the salary, while there is no cap on the maximum amount. As such, the deduction applicable under Section 80CCD (2) is over and above the ₹150,000 as per Sections 80C and Section 80CCD (1).

Things to Remember

The National Pension Scheme is typically structured into 2 types of accounts

Tier I Account –

This account is designed for retirement savings and is therefore a non-withdrawable account. However, all contributions made in the Tier 1 Account can help you avail tax benefits. You can deposit a minimum of ₹60,000 in this account with ₹500 as the minimum amount deposited at any time.

Tier II Account –

Only those individuals holding a Tier I account can open a Tier II account. Since this is a voluntary account, it is possible for one to withdraw money from it when required. A Tier II account is similar to a regular savings bank account.