The Tier 1 account is covered under EET (Exempt Exempt Taxed) regime
The National Pension System (NPS) is a defined contribution retirement scheme administered and regulated by the Pension Fund Regulatory and Development Authority (PFRDA), Government of India. Any citizen of India aged between 18-65 years as on date of submission of his/her application with the specified institutions (referred as Point of Presence) authorised by the PFRDA can subscribe for NPS scheme. Upon opening of an NPS account, a unique and portable Permanent Retirement Account Number (PRAN) is allotted to the subscriber.
Under the NPS scheme, there are two accounts – Tier 1 (restrictive-withdrawable retirement account) and Tier 2 (voluntary savings account with complete withdrawal flexibility at any time). Withdrawal from Tier 1 account is not permitted till the subscriber attains the age of 60 years or retirement. However, if an individual prefers to exit the NPS (allowed only after 10 years of joining) before retirement or 60 years of age then she will have to annuitise 80 per cent of the corpus and only 20 per cent will be eligible for lump-sum withdrawal.
However, there is a provision for partial withdrawal from Tier 1 account up to 25 per cent of amount contributed by an individual for specified purposes such as child/children’s marriage or higher education, purchasing a house and medical treatment of self/family, subject to fulfilment of certain conditions. The scheme also provides flexibility to subscribers in determining the investment portfolio from pre-specified investment options in terms of debt-equity mix depending upon their investment goals and risk appetite.
There are no income-tax benefits associated with Tier 2 account. On the other hand, the Tier 1 account is covered under EET (Exempt Exempt Taxed) regime wherein contribution to the scheme, return on contributions and specified portion of the withdrawals from the account are exempt from tax. However, payments received from annuities purchased at the end of the scheme are taxable.
Tax deductions available
Section 80CCD(1) of the Income-tax Act, 1961 (the Act) provides that an individual taxpayer who has, during the financial year, paid or deposited any amount in his NPS account, is eligible for claiming a deduction from his total income limited to 10 per cent of his prescribed salary (for salaried individuals) or 20 per cent of gross total income (for self-employed individuals). It is important to note that the contributions made under this section shall be eligible for deduction within the overall limit of Rs 1.5 lakh per annum, which includes popular deduction under section 80C of the Act for various expenditures/tax savings instruments.
An additional deduction of up to Rs 50,000 per annum is allowed for a self-contribution under section 80CCD (1B) of the Act. In other words, when an individual taxpayer has exhausted the limit of Rs 1.5 lakh per annum by making other investments eligible for deduction under section 80C of the Act (apart from NPS), contribution made by her towards NPS can be utilised to claim such additional deduction of Rs 50,000.
Further, the contribution made by an employer to an NPS account of the employee is also eligible for tax deduction in the hands of such employee over and above the deduction eligible for self-contribution. The deduction is available for up to 10 per cent of prescribed salary without any upper limit (14 per cent for central government employees with effect from April 1, 2019). This benefit is not available for self-employed taxpayers.
The term ‘salary’ for the purpose of aforesaid deductions (employee and employer contributions) includes basic salary and dearness allowance, if the terms of employment so provide, but excludes all other allowances and perquisites.
As regards exemption on withdrawal of accumulated corpus at the retirement age, the Finance (No. 2) Act, of 2019 has enhanced the exemption to 60 per cent of the corpus amount (from the earlier limit of 40 per cent) with effect from April 1, 2019. Consequently, upon completing the age of 60 years, an individual can withdraw up to 60 per cent of the accumulated corpus (along with the interest accruals) tax-free and the balance 40 per cent corpus shall be mandatorily utilised for purchasing an annuity plan from a specified life insurance company. Though the amount utilised towards purchasing an annuity plan is tax-exempt, annuity income in the form of monthly pension would be subject to tax at the applicable slab rates in the year of receipt.
In case of an untimely death of an NPS account holder before the completion of 60 years of age, the nominee/ legal heir can withdraw the total accumulated corpus, which is fully tax exempt.
Other relevant aspects worth noting with respect to the NPS scheme are enumerated as under:
- One-time portability is available, which enables transfer of accumulated corpus from an approved superannuation fund of a subscriber (maintained with an existing/earlier employer) to a NPS Tier 1 account, subject to prescribed conditions. As per the relevant provisions of the Act, such transfer would not be taxable in the hands of an individual.
- As per the recently announced draft Employees Provident Fund & Miscellaneous Provisions (Amendment) Bill, 2019, certain provisions are proposed to be introduced under the Employees’ Provident Fund & Miscellaneous Provisions Act, 1952 (EPF Act), which will enable the employees to opt for NPS scheme in lieu of the Employees’ Pension Scheme (EPS) under the EPF Act. An employee who joins the NPS shall be deemed to have exited from EPS under the EPF Act, although such member may join back subsequently, subject to certain conditions. The enabling provisions would be notified by the Central Govt. as and when the draft bill is enacted.
It is suggested that the subscribers should make an informed decision before investing on the basis of their individual financial goals, risk appetite and other relevant factors.(The writer is Partner and Head, Global Mobility Services-Tax, KPMG in India)