Tax season is around the corner and, like every year, tax payers at the moment are exploring investment options that are tax efficient. One tax saving scheme that is gaining popularity now is the National Pension System (NPS). The government has recently made this scheme entirely tax free and increased its contribution to 14 per cent from 10 per cent.
Launched in 2004 for government employees, the scheme was opened up to all Indian citizens in 2009 and the one thing it has been known for since its introduction is being low cost. Also the NPS offers you tax benefits beyond the prescribed Rs 1.5 lakh limit of Section 80 (C). However, the government’s recent announcement has only enhanced the attractiveness of the scheme. Let’s look at this investment option in detail.
How NPS works
NPS is a long-term tax saving investment instrument that matures once you reach the age of 60. Before maturity, you are not allowed to withdraw more than 20 percent of the NPS fund.
Investment in NPS up to Rs 50,000 in a financial year qualifies for deduction under Section 80 (CCD), which is in addition to the Rs 1.5 lakh deduction allowed under Section 80 (C). Therefore, NPS allows tax benefit under both Section 80(C) and 80(CCD), allowing you a total tax deduction benefit up to Rs 2 lakh.
NPS invests in a mix of debt and equity, and you can choose the ratio of your equity/debt exposure on the basis of your risk appetite. NPS also allows you the flexibility to choose the fund manager out of multiple options.
Why you should consider the NPS this tax season
For one, the government of India has just enhanced the tax saving appeal of NPS. Previously, only 40 percent of the corpus was tax-free. Another 40 per cent was required to buy annuity and the remaining 20 per cent could be withdrawn, subject to tax deductions as per the applicable tax slab. One can now defer withdrawal till the age of 70 or buy annuity with this 20 per cent. Under annuity, there’s no provision for the capital being returned to the investor. instead you get a fixed income till you survive. Annuity is priced basis your longevity. And annuity is entirely taxable in the year of receipt.
Now, the government has relaxed the tax implications on the NPS corpus by making withdrawal up to 60 per cent of the corpus tax-free. The annuity income would remain taxable as per the applicable slab rate.
The fact that NPS allows you to save additionally under Section 80 (CCD) – over and above the prescribed limit of Rs. 1.5 Lakh under Section 80 (C) – makes it is a good option for millennials to invest in and build a large corpus for retirement. NPS also gives investors the flexibility of deciding the debt and equity mix based on your risk appetite.
With a relaxation in tax implications, taxpayers are expected to give NPS precedence over other tax saving schemes such as Equity Linked Saving Schemes (ELSS) and Unit Linked Insurance Plans (ULIPs).
The writer is CEO, BankBazaar. The article has been published in collaboration with BankBazaar. Opinions expressed are those of the author.