Pre-Book eCA & avoid last-minute rush
Book Now Book Now
  • TrustedTrusted by 1 Million+ Users
  • User Rating4.8 Star User Rating
  • SecureSecure & Safe
20% discount

National Pension Scheme (NPS): Tax Benefits, Features, and Withdrawals

Updated on: 17 Jan, 2023 06:15 PM

What is NPS?

National Pension System (NPS) was introduced for the central government employees on 22nd December 2003 (except for armed forces). NPS is a voluntary contribution scheme that individuals can make regarding their future during their working life. These contributions would accumulate over the years depending on the investment made.
The NPS scheme motivates people to regularly invest a portion in a pension account during their employment. This investment helps you plan your retirement as the subscribers can take out a specific portion of the total amount invested while the remaining amount as a monthly pension is offered to you. (Know More About NPS)
Initially, NPS covered just the central government employee, but now the Pension Fund Regulatory and Development Authority (NPS scheme regulator ) has made it open to all Indian citizens voluntarily. So in today’s time, NPS is open to the public, private, and even the unorganized sectors.
A single item with multiple benefits always attracts us. The same goes for India's most-coveted national pension scheme, NPS. NPS is just not a long-term plan for your retirement; it allows you to save taxes at the same time. NPS tax saving offers you to save taxes within Section 80C or above this limit. NPS tax saving is available for both salaried as well as self-employed individuals.

What are Tier I and Tier II in the NPS tax saving scheme?

Two types of accounts are provided to the investors under NPS, Tier I and Tier II.

Tier I account
Once the NPS account is made, the Tier I account starts. NPS Tier I account is fundamental and is meant for retirement. The minimum contribution of Rs. 500 is required to open an NPS Tier I account after which you get a Permanent Retirement Account Number (PRAN).
The investments made under Tier I account has a locked-in period of 60 years i.e. the age of 60. The contributions are qualified for NPS tax saving benefits under 80CCD (1) and Section 80CCD (1B) of the Income Tax Act, 1961. Under this section, you can invest up to Rs. 2 lakhs and claim a full deduction, i.e., Rs. 1.50 lakh under Sec 80CCD(1) and Rs. 50,000 under Section 80CCD(1B).<
To open a Tier 1 account you need proof of identity, address and age, and fill up the registration form.

Tier II account
NPS Tier II account is an optional account, hence, subscribers need to have Tier I account to open a Tier II account. Also, subscribers need to deposit a minimum contribution of Rs. 1000 to open the NPS Tier II account. This account has flexible rules for exit. Herein the contributions don’t qualify for tax exemption.

A detailed difference between Tier I and Tier II is explained below via table:-

Tier I NPS Tier II NPS
Eligibility Any Indian citizen between 18 & 65 years of age Members of Tier I only can only open Tier II account
Lock-in Period 60 years Nil
Minimum number of contributions in a year 1 Nil
Minimum contribution for account opening Rs. 500 Rs. 1000
Minimum amount for subsequent contribution Rs. 1000 Rs. 250
Tax benefits on Investments – Tax deduction under Section 80C up to Rs 1.5 lakh.
– An additional Rs 50,000 tax benefits under Section 80CCD (1B)
No Tax Benefits
Withdrawal conditions At Maturity Any Time

What is the Tax Deduction for Investment in the National Pension Scheme?

NPS contributions to Tier I accounts are eligible for tax deductions of up to Rs. 2,00,000 per annum via Section 80CCD (1), Section 80CCD (2), and 80CCD (1B). Let us talk about these deductions in detail:-

NPS Deduction under Section 80CCD (1)
This section applies to both salaried and self-employed individuals:-

  • Tax deduction available up to 10% of salary (Basic and Dearness Allowance) under Section 80 CCD (1) not exceeding Rs. 1.5 lakh limit in a financial year.
  • For the self-employed taxpayer, this tax deduction limit is 20% of the gross income since FY 2017-2018 with a maximum limit of Rs 1.5 lakhs for a financial year.

NPS Deduction Under Section 80CCD (1B)

  • The tax deduction under Section 80CCD (1B), both employee and self-employed can claim an additional deduction of Rs. 50,000, this is over and above Rs. 1.5 lakh limit u/s 80C.

NPS Deduction Under Section 80CCD (2)

  • Under Section 80CCD (2), salaried employees get the benefit of the employer contribution. The employer's contribution of 10 percent of salary (Basic + Dearness Allowance) can be claimed as a deduction by the employees in the private sector. This deduction is over and above the limit of Rs 1.5 lakh provided under Section 80C and the limit of Rs 50,000 under Section 80CCD(1B). Further, government employees can claim up to 14%(Basic and Dearness Allowance).

Tax Illustration for Government Employees

(Amounts in Lakhs) Tax Savings through NPS (contribution from employee and employer)
Tax Rates (as applicable) 20% 20% 30%
Salary (Basic + DA) 6.00 8.00 20.00
Allowances 1.00 0.40 2.50
Employer NPS Contribution (10% of Salary) 0.60 1.00 1.50
Total Taxable Salary A 7.60 9.40 24.00
Deductions from Taxable Salary available w.e.f. FY 2021-2022 for NPS Subscriber
Employee Contribution (10% of Salary Deduction under Section 80 CCD (1) B 1.00 0.40 1.00
Employer Contribution (10% of Salary Deduction under Section 80 CCD (2) C 0.50 0.80 0.50
Investment under Section 80 CCD (1B) {Maximum Rs. 50,000 available exclusively under NPS} D 0.40 0.50 1.00
Total Deductions E=B+C+D 1.90 1.70 2
Taxable Salary F=A-E 5.70 7.70 22
Tax (without Surcharge) in Rupees G 27560 69160 491400

Tax Illustration for Corporate Employee

(Amounts in Lakhs) Tax Savings through NPS (contribution from employee and employer) Tax Saving Through NPS (contribution from both employee and employer)
Tax Rates (as applicable) 20% 20% 30% 20% 20% 30%
Salary (Basic + DA) 6.00 8.00 20.00 6.00 8.00 20.00
Allowances 1.00 0.40 2.50 1.00 0.40 2.50
Employer NPS Contribution (10% of Salary) 0 0 0 0.50 0.60 1.20
Total Taxable Salary A 7.00 8.40 22.50 7.50 9.00 23.70
Deductions from Taxable Salary available w.e.f. FY 2021-2022 for NPS Subscriber
Employee Contribution (10% of Salary Deduction under Section 80 CCD (1) B 1.00 0.40 1.00 1.00 0.40 1.00
Employer Contribution (10% of Salary Deduction under Section 80 CCD (2) C 0 0 0 0.50 0.80 1.60
Investment under D 0.40 0.50 1.00 0.40 0.50 1.00
Section 80 CCD (1B) {Maximum Rs. 50,000 available exclusively under NPS}
Total Deductions E=B+C+D 1.40 0.90 1.5 1.90 1.70 3.10
Taxable Salary F=A-E 5.60 7.50 21 5.60 7.30 20.60
Tax (without Surcharge) G 25480 65000 460200 25480 60840 434720

What are the salient features of the NPS tax saving scheme?

Tax savings: The additional deduction of Rs.50,000 is beneficial in the following ways for the tax bracket employees:-

  • Employees in the highest tax bracket of 30% can save approx Rs.16,000 in taxes.
  • Employees in the 20% tax bracket can save approx Rs.10,000, and employees in the 10% tax bracket can make a saving of approx Rs.5,000.

Opting out of EPS: Finance Minister Nirmala Sitharaman has offered the plan to the employees to opt out of EPF and invests in NPS for retirement.

Tax on withdrawal: The contribution of up to Rs.1.5 lakh towards NPS and the interest earned through it is tax-free, but the withdrawn amount is taxable.

Extra tax saving options: The additional Rs.50,000 deduction on NPS has opened more options to investors for saving tax. There is an increase in total deduction under Section 80C and 80CCD of the Income Tax Act to up to Rs.2 lakh. The limit on 80CCD deduction, including NPS contribution, has also been increased from Rs.1 lakh to Rs.1.5 lakh.

Withdrawal Rule: Subscribers can exit from NPS once they reach the age of 60 years (all except government employees). A minimum of 40% of the summed-up pension wealth must be used to purchase an annuity for the subscriber's monthly pension. The rest balance is paid as a lump sum amount. Once the subscriber moves out from NPS, it is the charge of the annuity service providers to provide a regular monthly pension.

Opening an NPS account: Indian citizens from the age range of 18 to 65 years can open their NPS account. The mandatory Know Your Customer (KYC) norms must be fulfilled. After opening the account, a 12-digit unique number called the Permanent Retirement Account Number or PRAN is provided to the NPS account holder.

Online Tracking: Current fund value, as well as other transactions, can be tracked online.

Portability: PRAN (Permanent Retirement Account Number) is a unique number that remains the same throughout. With the NPS tax saving scheme, you have the option of portability across locations and jobs.

Fund options: Under the NPS tax saving scheme, there is a range of investment options, and you can switch from one investment to another or from one fund manager to another. However, the returns are market-linked. You can choose from government bonds, stocks, and other securities. Only 50% is allocated to equity.

Who should invest in the NPS tax saving option?

All individuals who want to plan their retirement should start investing in NPS today. Individuals who retire from a private-sector job and have a low-risk appetite can opt for the NPS tax saving option. Also, individuals who want to do the maximum tax saving can consider options for this scheme.

How to open an NPS account to avail the tax benefits?

To avail of the NPS tax saving benefits, first, you need to open an NPS account. The NPS account can be opened both online and offline.

  • To go for offline mode, an investor will need to visit a Point of Presence (PoP) appointed by the PFRDA. PoP connects individual investors or corporate entities with the NPS infrastructure. PoP collects documents for KYC requirements and collects investments. The initial investment for Tier I is Rs. 500. For Tier II, it is Rs. 1000. Once the investment is made, the investor will receive PRAN along with the username and password to operate the NPS account.
  • To go for online mode, visit the official site and enter the PRAN number and password. Then, enter the captcha and click on the ‘submit’ button. You can now access your E-NPS account. Also, E-NPS accounts can be accessed using the internet banking facility of your bank.

Individuals can contact (1800110708) if any issue persists, which is the National Pension helpline.

How much tax is required to pay at the time of withdrawal?

  • At the time of Maturity
    PFRDA permits NPS Withdrawal, as per which a maximum of 60% can be withdrawn as lumpsum while the remaining 40% is mandatory to be invested in an annuity. This 60% of the corpus is tax-free, while 40% is taxable when the subscriber receives the annuity. Additionally, 100% withdrawal can be made in cases where the corpus amount is less than or equal to five lakh at the time of Superannuation, i.e., attaining the age of 60 years.
  • Pre-Mature Exist
    Furthermore, an early withdrawal is allowed in which you can withdraw up to 25% for certain purposes. These purposes can be children’s weddings or higher studies, building/buying a house, or medical treatment of self/family, among others. In the entire tenure, this withdrawal can be made only three times (with a gap of five years). This 25% of the permissible withdrawal is tax-free. 100% withdrawal can be made when the corpus amount is less than or equal to Rs. 2.5 lakh.

Frequently Asked Questions

Q- How much can I invest in the NPS tax saving scheme?

Investment up to Rs. 2,00,000 per annum makes you eligible to claim Rs. 1,50,000 tax deduction under Section 80C and an additional Rs. 50,000 under Section 80CCD(1B).

Q- Is NPS returns tax-free?

60% of the corpus is tax-free, and the remaining 40% is kept aside to receive a regular pension.

Q- Which section covers the NPS tax saving scheme?

The NPS scheme is covered under Section 80CCD.

Q- Who can open the NPS account?

Indian citizens and Non-residential Indians (NRIs) can open an NPS account.

Q- What is the maximum deduction limit allowed under Section 80CCD (1)?

The maximum amount allowed as a deduction under Section 80CCD (1) is 10% of the salary, including Dearness Allowance for salaried individuals and 20%of the total gross income for self-employed individuals.

Q- Is the NPS tax saving scheme available only to salaried individuals?

NPS scheme deductions under Section 80CCD (1) are available to both salaried and non-salaried individuals.

Q- What is the total amount of tax savings that can be done by availing NPS scheme?

A total of Rs.2 lakh can be claimed under NPS in the financial year. Over and above Rs.1.5 lakh, you can avail and an additional tax benefit of Rs.50,000 that can be claimed under Section 80CCD(1B).

Q- Can NRIs opt for the NPS tax saving scheme?

Yes, the introduction of the PRAN (Permanent Retirement Account Number) has given even NRIs (non-resident Indians) the option of subscribing to the Nation Pension scheme. First, though, they have to meet some criteria.

Q- Can I invest more than Rs. 50,000 in the NPS scheme?

Ideally, you should not invest more than Rs. 2 lakh as the following tax deductions apply to the National Pension Scheme.:-an individual can invest Rs. 1.5 Lakhs in Tier 1 for tax exemption under Section 80CCD(1), a part of 80C and Rs. 50 thousand in Tier 1 for tax exemption under 80CCD(1B).

Q- Why is it recommended to buy an annuity in the NPS scheme?

Withdrawal of up to 60% at retirement is tax-free, but this will not generate long-term income. Hence the purchase of annuities is recommended to get a regular pension every month.

Q- I am not provided with an NPS account by my employer. Can I still open an NPS account?

Yes, you can still open an NPS account and claim a deduction for contributions made to your NPS account up to Rs. 1.50 lakhs under Section 80CCD(1). Moreover, you can also claim an exclusive deduction of Rs. 50,000/- under Section 80 CCD(1B) over and above Rs. 1.50 lakhs for contributions made towards your NPS account.

CA Abhishek Soni
CA Abhishek Soni

Abhishek Soni is a Chartered Accountant by profession & entrepreneur by passion. He is the co-founder & CEO of Tax2win is amongst the top 25 emerging startups of Asia and authorized ERI by the Income Tax Department. In the past, he worked in EY and comes with wide industry experience from telecom, retail to manufacturing to entertainment where he has handled various national and international assignments.