Select Page

Finance Minister, Arun Jaitley, in Budget 2015-16 introduced an additional income tax deduction of Rs. 50,000 for contribution to the New Pension Scheme (NPS) under Section  80CCD (1B).  So a taxpayer in the 30% tax bracket can save up to Rs 15,450 in tax every year. The Budget has not altered any feature of the NPS, the additional deduction is a big incentive for investors.  Note This additional benefit would be available from next Financial year (From Apr 1 2015)What are features of NPS, pros and cons of investing in NPS, returns of NPS, how much tax one saves by investing in NPS, difference between NPS and Mutual Fund,tax on NPS , should you put additional 50,000  and save tax by opening NPS account.

Overview of NPS (New Pension Scheme)

NPS is a flexible retirement savings scheme which offers both a lump-sum amount and monthly pension ie a fixed income to an employee after retirement. NPS was introduced in 2004 for the new government employees but from 2009, it was extended to all on a voluntary basis. Under this scheme, subscribers invest in a fund chosen by them and at the time of retirement they get a lump sum amount depending on the performance of that fund. The returns from NPS are not guaranteed; they are market-linked. NPS has very strict rules on withdrawals and the corpus cannot be taken out before the age of 60. There is a proposal to allow 25% of the corpus to be withdrawn for specific purposes (medical emergency, higher education of children, marriage of daughters, house purchase etc.

The official site for NPS is npscra.nsdl.co.in and www.npstrust.org.in . Detailed explanation of the NPS is covered in our article Understanding National Pension Scheme – NPS

Overview of NPS features are given below.

  • Any resident Indian or NRI aged 18-60 years can open an NPS account at a  a post office, a bank(some branches only) or a distributor, technically called point of presence Service Providers (POP-SP).  You will have to get a Permanent Retirement Account Number (PRAN) to open an NPS account.  As per KYC norms Photo Id proof, Date of birth proof and Address proof are required to be submitted along with application form.
  • The minimum investment is Rs 1,000 in a financial year. The minimum contribution is 500 per transaction. There is a transaction charge of .25% or Rs 20 (whichever is higher) on every transaction.  There is no maximum limit for investments in NPS, though the tax deductions on such contributions are capped.
  • The investor has various investment options available in terms of allocating between different types of funds (E Class Fund, C Class Funds, G Class Funds) or going with predefined allocation called as LifeStage Fund. Investors can choose their asset mix but allocation to equity funds cannot exceed 50%. Lifestage fund For investors who don’t actively track their investment or cannot decide the allocation, the LifeStage Fund is a useful option. Under this, the allocation to equities is defined by the age of the individual. This is the default option to be followed if the investor does not mention the desired asset allocation.
    • E class funds are equity funds and invest in Nifty stocks.
    • The C class funds are debt funds that invest in corporate bonds.
    • The G class funds invest in government securities
  • The scheme is structured into two tiers: Tier-I and Tier II accounts. The Tier-I account is the non-withdrawable account meant for savings for retirement. Tier II account is a voluntary saving account.
Functionality Tier I Tier II
Contribution Minimum Contribution of Rs. 500 per contribution.Minimum Contribution Rs. 6000/- p.a. Minimum Contribution of Rs. 1000 at the time of Account opening.Minimum Contribution of Rs. 250 per contribution.Minimum Balance of Rs. 2000/- at the end of each Financial Year
Withdrawals No withdrawals allowed during vesting period except as per the norms prescribed by PFRDA No limit on Withdrawals
Tax Benefits Triple Tax Benefits are available Triple Tax Benefits are NOT available
  • Investors in the NPS, unlike a pension fund or a ULIP, can choose from different  pension fund managers and even shift from one to another. But you are allowed to switch managers just once in a year. There is no tax implication when you shift from one fund option to another or change a pension fund manager.
  • The NPS is one of the cheapest financial product with an expense ratio of only .01%. There are also other charges , such as the one-time expenses for obtaining a PRAN and opening the account and the transaction charge of .25% or Rs 20 on every contribution.
  • Tier 1 account of  NPS offers tax deductions under various sections(not the Tier 2). These are:
    • Rs 1,50,000 under section 80CCD . 80CCD is part of  investments under Section 80C which includes EPF,PPF,Life Insurance etc.
    • Rs 50,000 under section 80CCD(1b) (Effective from 1 Apr 2015)
    • 10% of Basic Salary + Dearness Account (DA)
  • You can exit the scheme after attaining 60 years of age. You have the option to defer the withdrawal and stay invested in NPS up to 70 years of age however you are not allowed to make further contributions.
  • One  has to compulsorily annuitize 40% of the accumulated pension wealth. Option to annuitize 100% of the corpus is also available.
  • Subscribers can exit from NPS even before attaining the age of 60 by using at least 80 per cent of the accumulated pension wealth for purchase of an annuity for providing for the monthly pension. The balance is paid as a lump sum payment to the subscriber.
  • Accruals from your NPS account are taxable only when you opt out or withdraw from the scheme or on maturity (at the age of 60).
  •  The annuity/pension which you receive is taxable on yearly basis.
  • In case of untimely death of the 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.

How can companies or corporate contribute to NPS?

There are two models under the New Pension Scheme (NPS)

  • All Citizens Model – Available to all citizens of India , explained above.
  • NPS-Corporate Sector Model – Provide NPS benefits to the employees of corporate entities:
    • Employees’ contribution to NPS will be deductible up to 10% of salary subject to overall cap of Rs 1.5 lakh (which includes investments under Section 80C).
    • An additional deduction of Rs 50,000 is also available for any contribution made by employees to NPS.
    • Employer’s contribution will also be available for deduction up to 10% of salary (without any cap).
    •  On resigning, the employee can carry this account with him over to the next employer.

For more details one can read NPS Corporate Broucher(pdf)

What is Annuity?

An annuity is a financial instrument which provides for a regular payment of a certain amount of money on monthly/quarterly/annual basis for the chosen period for a given price. In simple terms it is pension. Pension is taxable.

How much tax would you save if you invest in NPS ?

Tier 1 account of  NPS offers tax deductions under following sections. Please note these deductions are NOT available for Tier 2 account.

  • Rs 1,50,000 under section 80CCD . 80CCD is part of  investments under Section 80C which includes EPF,PPF,Life Insurance etc.
  • 10% of Basic Salary + Dearness Account (DA) under section 80CCD(2). It works when the employer also invests in NPS. Under this Section, an employer can contribute upto 10% of the basic salary plus dearness allowance to the NPS account of an employee. The employer can show his contribution as deduction from the business income under Section 36 I (IV)
  • Rs 50,000 under section 80CCD(1b) (Effective from 1 Apr 2015)

How much tax you save if you open Tier 1 NPS account?

If you open Tier 1 NPS account then your contribution towards NPS will be included in 1.5 lakh limit of 80C which includes your EPF, ELSS, Life insurance etc. By restructuring your salary so that you can contribute to NPS the tax saved (using Income tax calculations for 2015-16)is calculated as shown below.

Description Without NPS With NPS
Salary 25,00,000 25,00,000
Basic (40% of Salary) 10,00,000 10,00,000
NPS Contribution 0 1,00,000
 Deductions
 Under section 80C  1,50,000  1,50,000
 Under section 80CCD  1,00,000
 Total taxable income  23,50,000  22,50,000
 Tax (at 30%)  5,30,000  5,00,000
 Tax with Edu cess at 3%  5,45,900-  5,15,000
 Additional Tax saved 0 30,900

How much tax would you save by investing upto 50,000 Rs ?

From  Apr 1 2015 one can do additional saving of Rs 50,000  under section 80 CCD(1B). This would lead to additional saving as shown in table below. You can use our Income tax calculator

Description Without NPS With NPS
Salary 25,00,000 25,00,000
Basic (40% of Salary) 10,00,000 10,00,000
NPS Contribution 0 1,00,000
 Deductions
 Under section 80C  1,50,000  1,50,000
 Under section 80CCD(2)  1,00,000
 Under section 80CCD(1B) 0   50,000
 Total taxable income  23,50,000  22,00,000
 Tax (at 30%) without Edu cess  5,30,000  4,85,000
 Tax with Edu cess at 3%  5,45,900  4,99,550
 Additional Tax saved  46,350(30,900+15450)

Tax saved in 20% slab is  Rs 14,832

Comparing putting and not putting additional 50,000 in NPS ?

If you do not invest in NPS you have 50000-  tax  amount left,for above example 50000 – 15450 = 34550 Rs left. If you invest this money annually in equity fund which gives returns of 10% for 15 years you would get  10.97 lakh. This would be tax free.

If you put it in NPS and make monthly contribution of Rs 50,000/12 = 4167 the using the Pension calculator of NPS at www.npstrust.org.in/PENSIONCALC/Index.html  then amount you get and  pension  shown in image below. You would get 17.27 lakh on maturity. If you just commit minimum percentage i.e 40% to buying annuity then 6.9 lakh is amount for annuity and 10.36 lakh is withdrawal amount on which you would have to pay tax.  Whenever you withdraw money from the NPS, the returns will be taxed as capital gains. The pension you receive every month would also be taxable. Question is will NPS with only 50% in equity give you the same return as equity fund?

NPS Pension and Annuity Calculator

NPS Pension and Annuity Calculator

How are the returns from NPS?

Will NPS with only 50% in equity give you the same return as equity fund?  You can check the returns of the NPS schemes at www.npstrust.org.in/index.php/navreturns/returns. As on 27th Feb 2015 the returns are as shown in image below. You can see that the returns are market-linked and perform the same way as NIFTY. Remember equity portfolio in NPS is invested in an index,presently Nifty, and is passively managed. An actively managed equity portfolio can give better returns.

NPS returns of equity

NPS returns of equity

What are the differences between NPS and Mutual funds?

 Mutual Funds  NPS (Tier I account)
No limit  depends on investor  Equity limit is restricted to 50%
Wide array of funds to choose from  Only in Funds selected by PFRDA
Can change fund anytime  Can change fund only once a year
No forced discipline unless through SIP If employee then automatically contribution gets deductedElse minimum contribution limit
Tax benefits only in ELSS 80C benefit and if employer contributes his contribution gets 80CCE
Can withdraw anytime Restricted withdrawal
No pension benefit on maturity Forced to take annuity on withdrawal or maturity of 60 years which generates pension

To invest or not to invest  in NPS is the question?

It is not a simple YES/NO answer.  An additional deduction should not be the only reason to invest in the NPS.  Go for it if it suits your risk profile and investment horizon. Also do consider the lock in and liquidity of your investment. Tier I account locks in money till retirement but it ensures that it is used for the original goal. NPS outweighs mutual funds for its low cost and tax exemption. If you aren’t worried about saving taxes, then mutual funds (equity or balanced) make more sense for long-term investors willing to take higher risk for better returns. Remember the additional benefit would be available from  Financial year FY 15-16 (AY 2016-17),i. e, From Apr 1 2015.

Related articles:

Do you have an NPS account? What do you think on NPS? Does it make sense to save additional 50,000 Rs ? Is liquidity factor a major block for investing in NPS? What is making you look at NPS?

Share
Keto Advanced 1500 review