Tax benefits for NPS contribution

After having discussed the withdrawal rules for National Pension System (NPS) last week, this let us discuss income tax benefits available for contributions made by you to your NPS account.  Though you can open Tier I and Tier II account under the NPS, the tax benefits are available only in respect of contributions made to your Tier I account and the discussion  which follows relates to Tier I account only.

Tax benefits for own contribution to NPS account

Only Individuals who are Indian Citizen can open an NPS account. Salaried as well as self employed both can open an NPS account and claim the tax benefits in respect of contribution made to their account under Section 80 CCD(1) for contribution made by them. The maximum contribution which is eligible for tax benefit under Section 80 CCD(1) is restricted to 10% of salary for an employee. For self employed this limit is higher at 20% of the gross total income i.e.  10% of aggregate of all the taxable income from all the sources before deductions under Chapter VIA like Section 80C, 80D, 80G, 80GG, 80TTA, 80TTB etc. The reason for allowing self employed a higher deduction of 20% is that for salaried the employer in all likelihood contributes 10% of the salary to the NPS account of the employee. In terms of absolute amount it is restricted to one lakh and fifty thousand rupees along with all the other eligible items under Section 80 C and 80CCC like LIP, ELSS, ULIP, NSC, EPF, PPF and contribution for an annuity plan and other items like NPS etc.

Due to so many eligible items being clubbed together within the overall limit of one lakh fifty thousand rupees,  the limit gets exhausted with mandatory items like EPF, school fee, Life insurance premium, principal prepayment of home loan etc. and thus leaving  no scope for majority of individual tax payers to contribute and claim tax benefits in respect of NPS. So in order to incentivise taxpayers to save for their retirement through NPS, the government has introduced an addition tax benefits for contribution towards NPS account upto fifty thousand under Section 80CCD(1B). This benefits is over and above the benefit of one lakhs and fifty thousand rupees  available for NPS along with other eligible items under Section 80 CCE. So for those who were not able to claim the benefits in respect of NPS contribution due to the limit of one lakhs and fifty thousands getting exhausted with other items get the benefit. Even people who have been contributing only to NPS will now be able to claim the benefit upto two lakhs rupees for their own contribution towards NPS account.

It is interesting to note that you can have an NPS account and claim the tax benefits under Section 80 CCD(1) and 80CCD(1B) even when you are regularly contributing towards your employee provident fund account. Moreover you can open your NPS account at your own even when your employer does not have NPS in its organisation.

Tax benefits in respect of contributions made to NPS by the employer in case of salaried

In addition to the contribution made by you to your own NPS account which is eligible for tax benefits under Section 80CCD(1) and 80CCD(1B) as explained above, you are also eligible to claim tax benefits for contribution made by your employer to your NPS account upto 10% of your salary under Section 80 CCD(2).

Unlike the contribution made to your EPF account by the employer which is not treated as your income, the contribution made by the employer towards your NPS account is initially treated as your income and included in your salary and then the same is allowed as deduction under Section 80 CCD(2) within the overall limit of 10% of salary.

Please note that there is no absolute monetary limit for claiming the deduction in respect of employer’s contribution to your NPS account. This provision can be used as an excellent tool for tax planning if you are in higher tax brackets. For example an employee who has an annual salary of Rupees one crore will be entitled to claim the deduction for the contribution made by the employer to his NPS account upto ten lakhs rupees in a year. This will effectively save 30% of the amount contributed by the employer. This will help you defer and reduce your tax liability.

It may please noted that while calculating 10% of the salary your entire CTC (Cost to the Company) is not taken into account but only your basic salary is considered. The dearness allowance will also be treated your salary if your employment conditions provide this to be part of your salary for computing your retirement benefits.

Balwant Jain is a tax and investment expert and can be reached on jainbalwant@gmail.com, @jainbalwant on twitter.