With the Union Budget drawing closer, all eyes are on the tax breaks that Finance Minister Nirmala Sitharaman may offer. As almost every budget in recent years has paid special attention to the National Pension System (NPS), tax experts expect announcements related the retirement-focussed instrument this year too. “The budget should enhance the tax deduction offered under section 80CCD(1B) from Rs 50,000 to Rs 1 lakh, to encourage investors to save more for retirement and contribute to NPS. The limit under section 80CCD(2) is 14 per cent of the basic pay for government personnel, but only 10 per cent for private sector employees. It should be raised to 14 per cent for private sector employees, too,” says Amit Maheshwari, Managing Partner, Ashok Maheshwary & Associates.
Given the importance being accorded to the NPS by the central government, it is likely that its structure will only get friendlier in the future. This makes it imperative for you to understand the tax benefits that NPS currently offers.
The most crucial aspect to understand this tax-saving season is the tax relief that you get on contributing to the NPS. If you contribute up to 10 per cent of your salary (basic pay plus dearness allowance), you will be eligible for deduction under section 80CCD (1). For self-employed professionals, the cap is 20 per cent of their gross total income. These deductions are, however, subject to the overall Rs 1.5-lakh limit under the section 80C umbrella.
Then, there is an additional deduction, over and above the Rs 1.5-lakh limit, of up to Rs 50,000 under section 80CCD(1B). This is what prompted Delhi-based IT professional Gopal Bisht to invest in NPS two years ago. “Since there was a separate tax benefit bucket available, I decided to make use of it,” he says.
NPS can deliver the sharpest cut to your tax outgo if your employer lends a helping hand. Employers’ contribution of up to 10 per cent of your salary (basic pay plus dearness allowance) is eligible for tax relief under section 80CCD(2). For government employees, this limit is 14 per cent.
On premature part-withdrawal
While you can access your NPS corpus only when you turn 60, you can withdraw up to 25 per cent of your contribution after ten years under certain specific circumstances. These include the higher education of children, their marriage, purchase or construction of residential house or for treatment of critical illnesses. You can make only three such partial withdrawals during the tenure. You can also withdraw the balance in your account before you turn 60, without tax implications, but the lump-sum amount that can be withdrawn is restricted to 20 per cent. The rest will have to be used to purchase annuities. “Such restrictions make NPS a relatively unattractive product. While the separate Rs 50,000 deduction can help those in the highest tax brackets, those in lower slabs barely have anything to gain.
Given the lack of flexibility, equity investment is a better option for retirement planning,” says financial planner Pankaj Mathpal, Founder, Optima Money Managers. Bisht, for instance, is unhappy about the long lock-in period. “I was enticed by the additional tax benefit, but I am not sure if I want to continue next year,” he adds. On the other hand, it can add value to your retirement planning portfolio. “I am investing the money that I do not need for the near term in the NPS. So, the lock-in period is immaterial. I have made other investments to take care of my liquidity and short-term needs,” says Mumbai-based finance professional Amit Malkar.
Unlike the Public Provident Fund (PPF) and employees’ provident fund (EPF), NPS does has an exempt-exempt-taxed (EET), and not EEE, tax structure. That is, PPF and EPF offer tax benefits at all three stages – contribution, accumulation and maturity. This is not the case with NPS. While it attracts no tax during the contribution and accumulation phases, it is not entirely tax-exempt at vesting. – at maturity, when you turn 60. You can withdraw 60 per cent of the corpus then without paying tax, but the balance 40 per cent will have to be used to purchase annuities from the designated life insurers. Besides the fact that the provision restricts your choice, an anomaly makes this proposition tax-unfriendly. The entire annuity payout that you receive for lifetime will be added to your income and taxed accordingly, making it less tax-efficient than PPF and EPF.
Given the thrust the government has given to the NPS over the years, however, it is likely that the scheme will only get better. Recently, there was talk around allowing systematic withdrawals from the accumulated corpus instead of forcing people to buy annuities. “This move will be helpful as annuities have not gained any popularity. Combined with tax benefits and compulsory savings habit it induces, investing in NPS is a good idea,” says Suresh Sadagopan, Ladder7 Financial Advisories.