Claim Additional NPS deduction under Section 80CCD(2)
As you are aware, there are two types of National Pension System (NPS) accounts – Tier I & II.Tier I account is mandatory, whereas Tier II account is optional. Thus, only Tier I account is eligible for tax benefits and is, in the true sense, the core of NPS.
However, normal tax provisions of taxation of profits on sale of investments are applicable when you redeem the units credited in your Tier II account. But all deposits and withdrawals to and from the Tier II account are tax neutral. There are no limits as to number and amount of withdrawals from Tier II account.
Taxation for your contribution to Tier I account:
The Section 80 CCD allows you deduction for contributions made by you or your employer towards NPS account. There are some restrictions on the contribution which you can make towards your NPS Tier I account under this Section. Like if you are employed, you can claim deduction up to 10% of your salary, which comprises basic + DA.
In case you are self-employed, the restriction up to which you can claim tax benefit under Section 80CCD is capped at 10% of your gross total income. Gross total income includes sum of all your incomes computed as per provisions of the income tax laws, before any deduction is allowed to you in respect of various items broadly covered under Section 80C, 80CCC and 80D etc.
However, deductions in respect of interest paid for your housing loan is deducted before arriving at the figure of gross total income for calculating the limit of 10%.
It is important to note that there is an absolute limit of Rs 1 lakh upto which you can claim the deduction under Section 80CCD (1) (for your own contribution towards NPS account).
This limit of Rs 1 lakh covers not only your contribution to NPS, but also coversitems eligible for deduction under Section 80C, like life insurance premium, EPF, PPF, NSC, school fee, investments in equity linked saving schemes, repayment of housing loan etc.
Even payments made by you to life insurance companies for purchase of pension U/S 80 CCC are also covered within the limit of Rs 1 lakh. However, going forward with only contribution to EPF, PPF and NPS qualifying for deduction of Rs 1 lakh under proposed Direct Taxes Code (DTC), NPS will acquire more importance and prominence once the DTC comes into effect.
Tax treatment for contribution made by your employer:
The contributions made by your employer towards your NPS account qualifies for deduction under Section 80CCD (2) without attracting the limit of Rs 1 lakh laid down in Section 80 CCE from the financial year 2011-12.
However, there is only one restriction that only up to 10% of your salary qualifies for deduction without any monetary limit. It works wonders for those in the highest tax bracket, as there is no absolute limit up to which your employer can contribute towards your NPS account for claiming the deduction as long as this is within the limit of 10% of your salary.
Thus, it is advisable to get their salary restructured so as to include 10% component of your salary as contribution to NPS. This will provide a separate window for tax saving and investment.
The point to note here is that the amount of 10% contributed by your employer will be treated as salary under Section 17 and will form part of Form No 16 issued to you. However, the employer will grant you deduction for his contribution under Section 80CCD (2) before deducting any income tax from your salary.
So for all practical purposes employer’s contribution to your NPS account up to 10% of your salary becomes tax free in your hand and gets invested in NPS. Even the provisions under proposed DTC are on the similar lines with regard to tax treatment of employer’s contribution.
Tax treatment when you reach the retirement age:
The contributions made by you and your employer get accumulated in your Tier I account and the value of such corpus depends on factors like quantum of money deposited, the asset classes opted by you for investment and the returns generated by your pension fund manager.
Once you complete 60 years of age, you have to compulsorily purchase an annuity for an amount equal to minimum of 40% of the accumulated balance in your NPS account. The annuity needs to be bought from a life insurance company, which is registered with Insurance Regulation and Development Authority (Irda).
If you wish to withdraw the money before you complete 60 years of age, you can do so, but in that case you will have to purchase an annuity utilising minimum of 80% of the accumulated corpus at the time of withdrawal.
The money that is left after purchase of mandatory annuity, up to the extent of 40% of the accumulated wealth, is exempt from tax and you are free to use it the way you want. Please note that it is not mandatory for you to withdraw the whole corpus left after purchase of mandatory annuity.
You can opt to withdraw the balance amount in a phased manner. However, you need to withdraw a minimum of 10% of your accumulated corpus every year. This account has to be closed once you reach the age of 70 years. This money received by you, either lump sum or in a phased manner, is fully exempt as per the provisions proposed in DTC.
In case of the untimely death of a NPS account holder before completion of 60 years of age, the nominee can withdraw the corpus accumulated at the time of death of the account holder. The money received by the nominee or legal heirs is fully exempt.
The annuity which you receive is taxable on yearly basis.
From the above discussion you will realize that NPS offers you an excellent tool to save your tax and plan for your future as well. It is very tax efficient because you get the tax benefits for the whole amount of your contribution and need to use only 40% of the accumulated wealth for purchase of annuity.
It is pertinent to note that though the annuity is taxable in your hand at the time or receipt, the applicable rate of tax would in all probability be very low as compared to the rate of tax which you are paying now.