Decoding Taxation on National Pension Scheme (NPS)
Article originally published in Gujarati Mid-day newspaper on May 11 and May 25, 2021. The original article is published in a 2 part series. Here is the English transcript of Part 1
Claim additional deduction of Rs 50,000 or more from your income by investing in NPS
Investment in National Pension Scheme (NPS) has tax benefits under Section 80CCD of Income Tax Act, 1961. This tax-saving option is less explored by investors compared to other popular investments such as PPF and EPF. The deduction under these sections is available to both salaried and self-employed individuals. There are mainly two types of accounts under the NPS which are Tier I and Tier II accounts. All income tax deductions and exemptions are available mainly for Tier I accounts. Hence, for the purpose of our discussion let’s set aside Tier-II Accounts and focus only on Tier I accounts.
The deduction under u/s 80CCD(1) is available for self-employed individuals to the maximum of 20% of Gross income. For salaried employees, the subscriber’s own contribution towards NPS is tax-deductible up to 10% of Salary. Salary for the purpose of NPS contribution is defined as Basic salary plus Dearness Allowance. The deduction u/s 80CCD(1) is available within the maximum limit of Rs 1.5 lakhs u/s 80CCE which states that the total deduction claimed u/s 80C, 80CCC and 80CCD shall not exceed Rs 1.5 lakhs.
An additional deduction for investment up to Rs. 50,000 in NPS is available u/s 80CCD (1B). This is over and above the deduction of Rs. 1.5 lakh available under section 80C of Income Tax Act, 1961. This deduction is available to both salaried and self-employed individuals.
Deduction u/s 80CCD(2) is not available to self-employed individuals. Contribution of an employer towards NPS is eligible for deduction u/s 80CCD (2) up to 14% of Salary for Government employees and 10% of Salary for other employees, without any monetary limit. This deduction is over and above the deduction limit applicable u/s 80CCD(1) and 80CCD (1B) above. For the employer, this contribution can be claimed as a business expense.
NPS however is a complex product compared to PPF or EPF. Hence, let us get a bird’s eye view of this investment product. Anyone who is a citizen of India, non-resident or resident can join the NPS. The applicant must be between the age of 18-65 years on the date of application submission.
The NPS allows a range of investment choices along with a pension fund manager. There are eight fund managers to choose from. There are two investment choices Auto choice or Active choice. Under Auto choice as the name suggests funds are managed automatically by an appointed fund manager as per an investor’s age and risk profile. Under Active choice, individuals are free to decide among available asset classes in which to invest their funds subject to the maximum cap for each Asset class. The contribution amount can be invested in 4 asset classes Equity, Corporate debt, Government Bonds and Alternative Investment Funds.
The subscribers also have an option to switch their investment options as well as change their fund manager. These options are, however, subject to certain constraints.
It is pertinent to note that NPS returns are not guaranteed. The corpus growth continues via market-linked returns. Even the value of corporate and government bonds can react to macroeconomic developments.
Question :
I am a self-employed individual. I have invested Rs. 75,000 in PPF account and Rs. 75,000 in tax saving mutual funds. If I invest Rs. 75,000 in NPS, how much deduction can I claim?
Answer :
You can claim the investment in PPF and Mutual Funds u/s 80C which sums up to Rs 1.5 lakhs. The investment in NPS can be claimed either u/s 80CCD(1) and/or 80CCD(1B). However, Section 80CCE restricts the maximum deduction u/s 80C, 80CCC and 80CCD(1) to Rs 1.5 lakhs. Hence, you will not be able to claim the investment of Rs. 75,000 u/s 80CCD(1).You can still claim deduction on investment in NPS u/s 80CCD(1B) up to the maximum limit of Rs. 50,000. So total Deduction you will be able to claim is Rs 2 lacs (Rs. 1.5 lakhs u/s 80C + Rs. 50,000 u/s 80CCD(1B))