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Using NPS to lower your taxable income


Using NPS to lower your taxable income

The final quarter of FY2018-19 is upon us and most citizens are already planning on how to save on their taxes by investing in various financial products and other instruments that also give them good returns. This is the typical timeline every year when there are phone calls and messages being dispatched to taxpayers regarding investment opportunities in a wide range of financial products with a view towards saving on taxes. Yet, one should always carefully analyse the investment purpose above everything else along with other deductions which are available as per the Income Tax Act. The taxability of the future returns should also be analysed prior to going ahead with an investment.

Returns from investments are key factors when it comes to making investments but people also look at the tax-saving angle. As a result, the choice becomes doubly important in this aspect. From the perspective of paying taxes, investment options may be insurance, pension plans or other instruments which are eligible to earn deductions under Section 80C of the Income Tax Act. Some of these avenues include the PPF (Public Provident Fund), NSC (National Savings Certificate), LIC (Life Insurance Corporation) premium, ULIPs (Unit-Linked Insurance Plans), SSY (Sukanya Samriddhi Yojana), SCSS (Senior Citizen Saving Scheme), ELSS (Equity Linked Savings Scheme) and 5-year bank FDs (Fixed Deposits).

Investments in most of these financial instruments are eligible for tax deductions up to Rs. 1.5 lakh cumulatively under Section 80C. The maturity amount or return from most of these investment options is also tax free. However, it is not the case for NPS or the National Pension Scheme. This is the defined contribution system of pensions that was launched by the Central Government in order to help more people earn pensions after retirement. In the NPS scheme of things, taxpayers can make investments in pension accounts with the choice of taking a portion of the accumulated corpus as a lump-sum amount and the other amount will be invested for securing fixed income every month.

The employer’s contribution is exempted from taxes with regard to a limit of 10% of the salary (basic + dearness allowance). Deduction for the employee’s contribution is also allowed up to 10% of the salary with an overall limit of Rs. 1.5 lakh. In case of self-employed professionals, tax deductions can be availed up to 20% of their gross income within the overall limit of Rs. 1.5 lakh. There is an added deduction for contributions made to the NPS account subject to a maximum investment amount of Rs. 50, 000 in case of both self-employed and employed personnel.

What is overall taxability for the maturity amount?

Under the NPS system, once the contributor reaches the age of 60, he/she can withdraw 60% of the accumulated corpus in the account. 40% of this withdrawn amount is presently exempted from taxation. However, the Government has already proposed exemptions on the entire 60% of the corpus that is withdrawn and this could be implemented from FY2019-20 as per reports. The other 40% of the accumulated corpus has to be mandatorily invested in an annuity plan which provides a monthly pension.

NPS can be used to save on taxes and to maximize tax benefits but do it without compromising your goals. The investment and returns should be in sync with the larger picture. Also take other factors into account. If you invest in medical insurance for your dependent children, yourself and spouse, you can get deductions of Rs. 25, 000 and Rs. 50, 000 as deductions for medical insurance of parents who are above 60 years of age. The cap on the deduction for individual taxpayers who are not senior citizens but with parents who are senior citizens is Rs. 75, 000.

Why NPS?

NPS offers some key advantages to say the least. The lower cost is perhaps one of its biggest USPs. The charge for fund management is just 0.01% of funds which means only Rs. 100 will be required for the smooth management of an amount of Rs. 10 lakhs! This helps in accumulating a sizable corpus since there is a negligible deduction from the returns by way of fund management charges. NPS also offers another key advantage, namely in terms of the corpus’ taxability. Up to 60% of the corpus may be withdrawn in the form of a lump sum amount at the age of 60, the balance amount will be put into an annuity for earning pension post retirement. NPS will be suitable for people who are looking to garner adequate retirement savings but are shaky when it comes to making their own investment decisions.

It suits those who do not wish to actively manage investments made in other channels. Investments are tax deductible up to Rs. 1.5 lakh in NPS under Section 80CCD (1). This is a part of the overall deduction limit of Rs. 1.5 lakh under Section 80C of the Income Tax Act. Under Section 80CCD (1b), the additional tax benefit is Rs. 50, 000 for investing in NPS as brought by the Government in 2016. In case more than 1.5 lakh is paid to the NPS account for a year, the amount which is over and above Rs. 1.5 lakh, can be claimed as a deduction under Section 80CCD (1b).

This helps in maximizing tax savings greatly. Under Section 80CCD (2), the employer’s contribution (over and above the Rs. 1.5 lakh ceiling under Section 80C and additional deduction under Section 80CCD (1b)) is eligible for deduction up to 10% of the basic salary + DA (Dearness Allowance). There is no upper limit on this tax which is deducted and it is only available for employees.

Your Take-Away

NPS can be a good option for maximizing your tax savings if you think that you do not wish to actively manage other investments and yet want a secured income and decent corpus after retirement. This will help you save quite a lot in taxes as you can see above. However, make sure that the investment is fully aligned with your life goals and objectives. Additionally, keep in mind the limitations including the fact that the corpus will only be partly tax free, there is a long lock-in period for funds, no active fund management to speak of and lower returns from annuities for getting pension.







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