Tax
Benefit on NPS Tier 1 and/or 2?
NPS
has two Tiers – 1 and 2.
NPS
Tier 1 is the long term investment, which has restricted withdrawals and meant
primarily for retirement planning. On maturity, you can withdraw maximum of 60%
of corpus as lumpsum and rest has to be used for annuity purchase.
NPS
Tier 2 is for managing short to medium term investment. You can invest and
withdraw anytime as per your wish. This is an optional feature and you are
asked if you need Tier 2 account while opening NPS.
All the tax benefit related to
NPS is available to investment in NPS Tier 1 account only.
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NPS
Tax Benefits:
NPS
tax benefits are available through 3 sections – 80CCD(1), 80CCD(2) and
80CCD(1B). We discuss each below:
1. Section 80CCD(1)
Employee contribution up to 10% of basic salary
and dearness allowance (DA) up to 1.5 lakh is eligible for tax deduction. [This contribution along with
Sec 80C has 1.5 Lakh investment limit for tax deduction]. Self
employed can also claim this tax benefit. However the limit is 10% of their
annual income up to maximum of Rs 1.5 Lakhs.
2. Section 80CCD(1B)
Additional
exemption up to Rs 50,000 in NPS is eligible for income tax deduction. This was
introduced in Budget 2015
3. Section 80CCD(2)
Employer’s contribution up to 10% of basic plus
DA is eligible for deduction under this section above the Rs 1.5 lakh limit in
Sec 80CCD(1). This is also beneficial for employer as it can claim tax
benefit for its contribution by showing it as business expense in the profit
and loss account. Self employed cannot claim this tax benefit.
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Tax
Benefit for Compulsory NPS deduction:
The
earlier pension structure was replaced by NPS in most central and state
government jobs since 2004. So anyone who joined after that has compulsory
deduction for NPS. The deduction is 10% of basic salary and dearness allowance
(DA) and the employer too contributes the matching amount. The confusion for
most employees is how they take tax benefit on their compulsory NPS deduction?
Here is an example:
Amit is a government employee and his
employer deducts Rs 62,000 per annum (which is 10% of basic + DA) from salary
as employee’s contribution in NPS. It also deposits Rs 62,000 per annum as
employer’s contribution in NPS. How and under which section should he claim tax
benefit on NPS?
Let’s
take the easy part first. Employer’s contribution in NPS would be eligible for
tax deduction u/s 80CCD(1).
The
employee has a choice as to which section [80CCD(1) or 80CCD(1B)] he wants to
show his contribution. Ideally he should show Rs 50,000 investment in NPS
u/s 80CCD(1B). The tax deduction on rest Rs 12,000 can be claimed u/s 80CCD(1).
The section 80CCD(1) along with Section 80C has investment limit eligible for
tax deduction as Rs 1.5 lakhs. So he should make additional investment of Rs
1,38,000 in Section 80C to save maximum tax. In all he can save Rs 2 lakhs tax
u/s 80C and 80CCD(1B).
