NPS Tax Benefits: How Salaried and Self-Employed Can Claim Tax Deductions Under Old and New Income Tax Regimes
NPS Tax Benefits: How Salaried and Self-Employed Can Claim Tax Deductions Under Old and New Income Tax Regimes
The National Pension System (NPS) is an investment option that offers numerous tax benefits while helping individuals save for their retirement. Whether you're salaried or self-employed, NPS provides a great opportunity to reduce your tax liabilities and build a secure financial future. However, with the introduction of the new tax regime, understanding how to maximize these benefits can become a little tricky. In this comprehensive guide, we will explore NPS tax benefits in-depth and explain how individuals can claim deductions under both the old and new tax regimes.
What is NPS?
The National Pension System (NPS) is a government-sponsored pension scheme that encourages individuals to save for their retirement. The NPS offers flexibility in terms of contributions, investment choices, and withdrawal options, making it one of the most popular retirement saving tools in India.
- Salaried employees can opt for NPS through their employer, while self-employed individuals can open their own NPS accounts.
- The scheme is designed to provide a steady income post-retirement by contributing to a pension corpus during the working years.
Tax Benefits of NPS Under the Old Tax Regime
1. Deduction for Employee Contribution (Section 80CCD(1))
Under the old tax regime, contributions to NPS can be claimed as a deduction under Section 80CCD(1). This deduction is available for both salaried employees and self-employed individuals. Here's how it works:
- For salaried employees, the total contribution made towards NPS is deductible up to 10% of salary (basic + dearness allowance).
- For self-employed individuals, the deduction is available for up to 20% of gross income.
The maximum deduction under this section is subject to the overall limit of ₹1.5 lakh under Section 80C of the Income Tax Act.
2. Additional Deduction (Section 80CCD(1B))
Apart from the standard deduction under Section 80CCD(1), individuals can claim an additional deduction of ₹50,000 under Section 80CCD(1B). This deduction is available irrespective of the total contribution made under Section 80C.
- This means, a taxpayer can claim a maximum deduction of ₹2 lakh for NPS contributions — ₹1.5 lakh under 80C and ₹50,000 under 80CCD(1B).
- This deduction is above and beyond the limits of 80C and provides a significant opportunity for tax savings.
3. Employer Contribution (Section 80CCD(2))
For salaried individuals, employer contributions to the NPS account are not taxable in the hands of the employee. The employer’s contribution is allowed as a deduction under Section 80CCD(2).
- No upper limit is specified for the employer’s contribution, making it one of the best tax-saving options for salaried employees.
- However, the contribution must be up to 10% of the salary (basic + dearness allowance).
4. Tax-Free Withdrawals (Post-Retirement)
When you retire or reach the age of 60, 60% of the accumulated corpus can be withdrawn tax-free. The remaining 40% must be used to buy an annuity.
Tax Benefits of NPS Under the New Tax Regime
With the introduction of the new tax regime offering lower tax rates and no exemptions like HRA, standard deductions, and tax-saving investments, many taxpayers are confused about how NPS benefits apply. Here’s the breakdown:
1. Employer Contribution (Section 80CCD(2))
The good news is that employer contributions to NPS remain unaffected in the new tax regime. The deduction under Section 80CCD(2) is available, making employer contributions tax-free for the employee, just like in the old regime.
- The employer can contribute up to 10% of the salary (basic + DA), which remains tax-exempt.
However, individual contributions to NPS under Sections 80CCD(1) and 80CCD(1B) cannot be claimed under the new tax regime.
2. No Tax Deductions for Self-Contribution
In the new tax regime, you cannot claim deductions for self-contribution to NPS under Section 80CCD(1) or Section 80CCD(1B).
- This means that only employer contributions are considered under Section 80CCD(2).
- As a result, self-employed individuals or salaried individuals opting for the new tax regime lose the opportunity to claim additional deductions for NPS contributions.
3. NPS Withdrawals and Taxation
Just like in the old tax regime, the 60% lump-sum withdrawal after retirement remains tax-free in both regimes. However, the 40% used to buy an annuity will be taxed as per the individual’s income tax slab.
How to Maximize NPS Tax Benefits?
1. Opt for NPS Early in Your Career
The earlier you start investing in NPS, the more you can benefit from tax savings and compound interest. Starting early helps build a larger corpus and increases your overall retirement savings.
2. Contribute Beyond the ₹1.5 Lakh Limit
While the ₹1.5 lakh limit under Section 80C is applicable for most tax-saving investments, NPS offers an additional ₹50,000 deduction under Section 80CCD(1B). Make sure to contribute up to this limit for maximum tax savings.
3. Plan Your Employer Contributions Wisely
If you are a salaried employee, ensure your employer is contributing to your NPS account. This will allow you to claim tax-free deductions under Section 80CCD(2). This benefit is available regardless of the tax regime you opt for.
4. Consider Your Tax Regime Carefully
When deciding between the old and new tax regimes, consider whether you will benefit more from the NPS deductions offered under the old regime or the lower tax rates of the new regime. For individuals in higher tax brackets, the old tax regime with NPS deductions can result in significant savings.
Do’s and Don’ts for Claiming NPS Tax Benefits
✅ Do’s:
✔ Opt for NPS early to build a larger retirement corpus with tax benefits.
✔ Utilize the ₹50,000 additional deduction under Section 80CCD(1B) for extra tax savings.
✔ Ensure employer contributions to NPS (if salaried) to claim tax-free benefits under Section 80CCD(2).
✔ Choose the right tax regime based on your salary structure and employer contributions.
✔ Plan withdrawals carefully at retirement to maximize tax-free benefits (60% lump sum is tax-free).
❌ Don’ts:
❌ Don't ignore the lock-in period—Tier I NPS funds are locked until retirement, except under specific conditions.
❌ Don't exceed the deduction limits—₹1.5 lakh under 80CCD(1) and ₹50,000 under 80CCD(1B) for self-contributions.
❌ Don't forget annuity taxation—40% of NPS corpus is used for annuity, which is taxable upon withdrawal.
❌ Don't assume NPS is tax-free under the new regime—only employer contributions under 80CCD(2) are tax-exempt.
❌ Don't withdraw before 60 unnecessarily—premature withdrawals may be taxable.
FAQs on NPS Tax Benefits
1. Can I claim both 80C and NPS deductions together?
Yes, NPS (80CCD(1)) falls under the ₹1.5 lakh limit of Section 80C, but you can also claim an extra ₹50,000 deduction under 80CCD(1B) separately.
2. Is NPS taxable on withdrawal?
- 60% of the corpus is tax-free on withdrawal at 60 years.
- 40% must be used to buy an annuity, which is taxed as per your income slab.
3. Can self-employed individuals claim employer contribution tax benefits?
No, Section 80CCD(2) is only for salaried employees whose employers contribute to their NPS account.
4. Can I claim NPS tax deductions under the new tax regime?
Only employer contributions under Section 80CCD(2) are tax-free. Personal contributions under 80CCD(1) and 80CCD(1B) are not allowed in the new regime.
5. Is it mandatory to invest in NPS for tax benefits?
No, NPS is voluntary, but it offers some of the best tax-saving benefits for retirement planning.
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