NPS Tax Benefits & Maturity Taxation (Updated 2023)

Most people, till now have been investing in NPS for tax benefits. But if you look at the NPS Tax Benefits (2023) under New tax vs Old tax Regime, then you will realize that NPS is a lot more than just a tax-saving instrument. At the core of it, NPS is a pure retirement savings product, many people invest in it for the sole reason of getting an extra Rs 50,000 tax benefit in NPS.

There is nothing wrong with taking tax benefits if available. But as I wrote earlier in investment planning is more important than tax planning, the reason to invest in NPS should be more than just tax saving.

You need to pick the right product for the right financial goal first. Then comes the maximization of tax savings.

With that said, this post discusses the latest tax benefits for NPS and how are the NPS maturity proceeds and premature withdrawals are tax treated. So what you will read about the following in the post is

• What are the NPS Tax benefits for FY 2023-24?
• How is maturity proceeds of NPS taxed?
• And other NPS taxation related aspects.

So let’s get to it straight away:

NPS Tax Benefits Under Old Tax Regime (Latest 2023)

• Up to Rs 1.5 lakh investment in NPS is eligible for deduction under Section 80CCD(1) in a financial year. This comes under the overall Rs 1.5 lakh limit of Section 80C.
• If you are an employee contributing to NPS, then the above deduction is capped at 10% of salary (Basic + DA). If you are self-employed, then it is further capped at 20% of the gross annual income.
• In addition to the above benefit of Rs 1.5 lakh, an additional deduction of up to Rs 50,000 in a financial year is available for NPS under Section 80CCD (1B). This deduction is an exclusive tax benefit for all NPS subscribers under Section 80CCD (1B) and it is over and above the Section 80C limit of Rs 1.5 lakh.
• If your employer also contributes to your NPS (in addition to your own contributions), then the employer’s contribution of up to 10% of Basic + DA is also eligible for deduction under Section 80CCD (2).
• There is no upper cap (in terms of amount) on this tax deduction but it is limited by the 10% rule on Basic + DA. And this deduction is in addition to the limits of Rs 1.5 lakh (Section 80C) and Rs 50,000 (Section 80CCD(1B)). For obvious reasons, self-employed NPS subscribers cannot avail this deduction.
• All these deductions are available on NPS Tier 1 account only.

So if you are investing in NPS, then a total of Rs 2 lakh can be claimed as a deduction for own contributions in NPS. If your employer also contributes, then the tax benefit on employer contribution is in addition to the Rs 2 lakh benefit on own NPS contributions.

And NRIs (or Non-Resident Indians) are also eligible for extra Rs 50,000 additional tax benefit on NPS.

As mentioned earlier, these tax benefits are available for contributions made to NPS Tier I account.

But what about Tax Benefits on NPS Tier-II accounts?

NPS Tier II tax benefits are now available only for the government employees. If the employee makes a contribution towards NPS Tier 2 Account and claims the tax benefits under Section 80C, then he will also have to have the invested money locked in for 3 years (like 3-year lock-in in ELSS Mutual Funds).

Let’s move on…

NPS Tax Benefits Under New Tax Regime (Latest 2023)

The new tax regime doesnt allow for any of the major deductions that you used to get under the old tax regime. But as detailed in the New Tax Regime deductions list, only your employer’s contribution under Sec.80CCD(2) under NPS is eligible for deduction under the new tax regime.

There are no tax deductions available for your contributions under Section 80C, 80CCD(1) and Sec.80CCD(1B) under the new tax regime.

NPS Maturity & Withdrawal Taxation (Updated 2023)

NPS Taxation At Exit (Retirement)

• As per the latest NPS Exit & Withdrawal Rules, at least 40% of the accumulated NPS corpus is to be utilized for the purchase of an annuity at retirement. And the remaining 60% can be withdrawn as a lump sum.
• The amount used to purchase an annuity (minimum 40% but more can be used) is fully exempt from taxes. However, the annuity income (or pension) coming from the annuity plan will be taxed as per tax slab in the year of receipt.
• The remaining 60% corpus (or less if more than 40% used for annuity purchase) is also exempt from any taxes.

So if you consider NPS as a retirement saving instrument, then like PPF and EPF, you don’t have to pay any taxes on exit from NPS at maturity (retirement). The amount (40% or more) you use to purchase annuity plan is exempt. The Lumpsum withdrawal (60% or less) is also exempt. So, your tax liability immediately from NPS on retirement is NIL. It is only that when you begin getting pension (annuity payments) that you will be taxed. Not bad if you can manage your taxes properly at retirement.

NPS Taxation At Premature Exit

• If someone wishes to exit NPS before 60 (retirement), then as per the latest NPS Premature Exit Rules, at least 80% of the accumulated NPS corpus is to be utilized to purchase an annuity. Only the remaining 20% can be withdrawn as a lump sum.
• The amount used to purchase the annuity, i.e. minimum of 80%, is exempt from taxes. However, the annuity income (or pension) received from the annuity plan will be taxed as per your tax slab in the year of receipt.
• The remaining 20% corpus (or less if more than 80% used for annuity purchase) is exempt from taxes.

NPS Taxation At Partial Withdrawal (Without NPS Exit)

• As per the latest NPS withdrawal rules, NPS permits limited partial withdrawals to be made under certain conditions. Withdrawals are allowed only to the extent of 25% of your own contribution (and not employers’) and that too only 3 times during entire NPS tenure.
• More importantly, these partial NPS withdrawals are exempt from income tax.

All said and done, these are the NPS tax benefits available when investing and NPS tax treatment at maturity or exit. And when investing in long term investment products like NPS or EPF or PPF, there is always one risk which people often forget about – The tax regime might change. You never know when a new politically-motivated government may change some policy decision and result in a change of taxation on NPS maturity amount. Or the tax rates might go up thereby heavily taxing your annuity pension income. We saw long term capital gains in equity became taxable again sometime back.

So even though the government is trying its best to make NPS popular by making it tax-free like PPF (Public Provident Fund and how to be a Crorepati), etc. things can change in future.

Before 2004, the government employees were eligible for pension under the Old Pension Scheme (OPS) system. Under this scheme, the pensioner used to get a starting pension of 50% of the last drawn salary. This was a defined benefit system, unlike NPS which is a defined contribution system. Do check the difference between NPS and OPS to know more.

Many of you mail me asking should I invest in NPS for extra Rs 50,000 tax benefit under Section 80CCD(1B)?

The answer is that you should never take investment decision just on the basis of tax considerations. It can backfire today or tomorrow. By then it would be late for you to make course corrections.

When it comes to retirement planning, you need to first find out what kind of retirement are you looking forward to? Is it regular retirement at 60 or early retirement?

Then you should do proper Retirement Planning Exercise to find out how much you need to invest for a chosen retirement lifestyle.

Its only then that you should ask yourself or take help from Fee-Only Financial Planner whether you need to invest in NPS or not. The government has done its bit to make NPS attractive by making it EEE (Exempt-Exempt-Exempt) now from the earlier EET (Exempt-Exempt-Taxed) status. But whether NPS fits in your retirement plan or not is another question.