National Pension Scheme (NPS)
The Budget 2024 has introduced significant changes to the National Pension Scheme (NPS), enhancing opportunities for NPS tax saving. Contributions made by private sector employers to the NPS have seen a notable increase in the tax-exempt limit, now raised from 10% to 14% of the employee’s basic salary. This hike is applicable to both private and public sector employees, but only under the new tax regime.
Employees who opt for the new tax regime can now benefit from a higher deduction, up to 14% of their basic salary, for employer contributions to NPS under Section 80CCD(2). This adjustment is aimed at bolstering social security by allowing individuals to save more on taxes and build a larger pension corpus, as highlighted by Shalini Jain, Tax Partner at EY India.
Previously, this benefit was exclusive to central and state government employees.
Improving Social Security Benefits:
In an effort to enhance social security, the deduction of employer contributions to NPS has been proposed to increase from 10% to 14% of the employee’s salary. This provision extends to employees in the private sector, public sector banks, and other undertakings, provided they opt for the new tax regime. Finance Minister Nirmala Sitharaman announced these changes in her Budget 2024 speech.
Current Income Tax Laws on NPS:
The tax benefits for NPS investments, and thus NPS tax saving, vary depending on the chosen tax regime for the financial year. Under the old tax regime, three deductions can be claimed under the Income-tax Act, 1961: Sections 80CCD(1), 80CCD(1B), and 80CCD(2). The new tax regime allows only one deduction under Section 80CCD(2).
Section 80CCD(1):
This section permits a maximum deduction of 10% of salary or Rs 1.5 lakh (whichever is lower) for investments in NPS Tier-I within a financial year. This deduction falls under the overall limit of Rs 1.5 lakh allowed under Section 80C, and is available only under the old tax regime.
Section 80CCD(1B):
An additional deduction of up to Rs 50,000 can be claimed under this section for investments in NPS Tier-I accounts, over and above the Section 80C deduction. This benefit is also exclusive to the old tax regime.
Section 80CCD(2):
This deduction is applicable under both tax regimes and can be claimed if the employer deposits money into the employee’s Tier-I NPS account. The maximum deduction allowed is 10% of salary from the gross taxable income.
Tax Implications on Employer Contributions:
If an employer’s contributions to NPS, Employees’ Provident Fund, and superannuation fund exceed Rs 7.5 lakh in a financial year, the excess amount becomes taxable in the hands of the employee. Additionally, interest earned on excess contributions is taxable.
Maximizing NPS Tax Savings :
Under the old tax regime, an individual can claim a maximum deduction of up to Rs 9.5 lakh through three routes: Section 80CCD(1) (up to Rs 1.5 lakh), Section 80CCD(1B) (Rs 50,000), and Section 80CCD(2) (up to Rs 7.5 lakh) from gross taxable income. Conversely, under the new tax regime, the maximum deduction available is Rs 7.5 lakh under Section 80CCD(2).
NPS Withdrawals and Taxation:
Upon withdrawal, at least 40% of the NPS corpus must be used to purchase an annuity plan from an insurance company, while the remaining 60% can be withdrawn as a lump sum. The lump sum amount is exempt from income tax; however, the annuity income is taxable under the “Income from other sources” category, and standard deduction tax benefits do not apply.
Systematic Lump Sum Withdrawal (SLW):
As of October 27, 2023, the Pension Fund Regulatory and Development Authority (PFRDA) allows NPS subscribers to withdraw up to 60% of their pension corpus through a systematic lump sum withdrawal (SLW) method. This can be done in a phased manner—monthly, quarterly, half-yearly, or annually—up to the age of 75. However, there is no consensus among tax experts on whether withdrawals via the SLW method are tax-free like lump sum withdrawals.
Partial Withdrawals from NPS Tier-I Account:
On January 12, 2024, the PFRDA issued a new master circular outlining conditions for partial withdrawals from NPS Tier-I accounts. Permitted reasons for partial withdrawals include higher education or marriage of children, purchase or construction of a residential house, and other specified circumstances. Up to 25% of the subscriber’s contribution, excluding the employer’s contribution, can be withdrawn, provided the individual has been a member of NPS for at least three years. A maximum of three partial withdrawals is allowed until the NPS account matures.
