Tax Exemption for NPS Withdrawals

In his budget speech for 2016, Finance Minister Arun Jaitley has made certain announcements related to the national pension system (NPS). Previously, the NPS was an Exempt-Exempt-Taxable scheme, which meant that withdrawals were taxed at the prevailing tax rates.

When first launched, the scheme was proposed as an Exempt-Exempt-Taxable plan. This means that the amount that would be withdrawn at the time of maturity was liable to taxation at the rates prevalent at the time. However, in Budget 2016, Finance Minister has proposed to give tax exemption on the 40% of the total amount payable at the time of closure or opting out of the NPS. This has made NPS, a very good retirement planning tool.

Any withdrawal before the age of 60 years requires the users to purchase annuities for 80% of the accumulated corpus and withdraw only 20% as a lump sum amount.

To maximize the NPS tax exemption benefits, it is advisable to withdraw the accumulated corpus when you reach 60 years. At this time, you will be able to withdraw up to -40% of the amount as a lump sum and convert the balance to an annuity scheme. In this manner, users can enjoy tax exemption on the 40% of the total amount payable at the time of closure or opting out of the NPS, giving them greater liquidity.

According to the current regulations, individual contribution of up to 10% of the basic salary and dearness allowance or INR 1.5 lakhs; whichever is lower of the two can be deducted from gross income as per section 80 CCD (1) of the Income Tax Act. A person who is self-employed can also take advantage of the NPS tax benefit under section 80 CCD (1) within the overall limit as described by the section 80 CCE. However, the total tax deductions are limited to INR 1.5 lakhs for all investment classes under section 80 CCE and will include investments made under section 80 C of the Income Tax Act.

From the last financial year (2015 – 16), investors were allowed an additional NPS tax exemption of INR 50,000 under section 80 CCD (1B). This benefit excludes the limit of INR 1.5 lakhs under 80 CCE. Therefore, total tax benefits for investing in the NPS, amount to INR 2 lakhs.(assuming that there is no other investment which qualifies for deduction u/s 80C of the Income tax Act).  It is important to bear in mind that these benefits are available only for contributions made to Tier I accounts. Investments made to Tier II do not offer any tax benefit but can be done for benefit of flexibility in withdrawal.

Overview of NPS

The NPS is a voluntary defined contribution pension scheme available for individuals aged between 18 and 60 years. When the scheme was launched, it was categorized as an EET structure, which made it unattractive, as compared to other pension EEE schemes. However, new structure proposed by government attempts to brings it on par with similar plans.

With NPS, subscribers in the highest tax bracket will no longer have to face erosion of their corpus due to the taxability at the time of withdrawal.

For more information and to determine the precise effects of the proposed modifications, it is advisable for you to use an NPS tax calculator that can easily be found online.