Many people invest in the National Pension System (NPS) to save for retirement. The additional advantage of NPS is that it offers tax benefits in the old as well as new tax regime. Under the old tax regime, NPS offers tax benefits under three sections of the Income Tax Act, 1961.
Here is a look at how investing in NPS can help you save tax in old and new tax regimes under various sections of the Income Tax Act.
Individuals opting for the new tax regime in the current financial year can get a deduction under Section 80CCD (2) of the Income Tax Act by investing in NPS. This deduction from gross total income can be claimed if the employer makes a contribution to NPS account on behalf of the employee. Here, the employer deposits money into the Tier-I NPS account of the employee. These NPS contributions are part of an employee’s cost to company (CTC) and so impact the take-home pay.
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Of such deposits (i.e. made by the employer) an employee can claim an amount up to 10% of their salary as the deduction. A government (central and state government) employee can claim up to 14% of his/her salary as deduction for the NPS contribution made by the government.
Salary is defined as basic salary plus dearness allowance. No other component (such as house rent allowance, special allowance, etc.) is taken into account as salary for calculating the eligible deduction amount.
There is another limit on how much of an employer’s contribution to NPS can be claimed as tax exempt. According to the law, if the employer’s contribution to NPS, Employees Provident Fund and any superannuation fund exceeds Rs 7.5 lakh in a financial year, the excess contribution will be taxable in the hands of the employee. Further, any interest, dividend or any returns earned from excess contribution will also be taxable in the hands of the employee.
In the current financial year, the new tax regime does not allow any other deduction or tax exemption except under Section 80CCD (2) and standard deduction from salary and pension income. Hence, if you continue with the new tax regime, you can claim a maximum deduction of Rs 7.5 lakh through NPS subject to the 10%/14% of salary rule mentioned above. The amount of deduction an individual is eligible for under Section 80CCD (2) is reflected in the Form 16 of the employee.
Remember that the government has tried to make the new tax regime more attractive from the current financial year, 2023-24. The income tax slabs have been revised under the new tax regime; basic tax exemption limit has been hiked by Rs 50,000 to Rs 3 lakh; standard deduction has been introduced in the new tax regime for salaried, pensioners and family pensioners; and tax rebate under Section 87A has been increased making zero tax payable for incomes up to Rs 7 lakh. Further, the new tax regime has become the default tax regime. Hence, individuals wanting to opt for the old tax regime will have to specifically choose it, unlike in the previous years when the old tax regime was the default tax regime.
NPS investment under old tax regime
The old tax regime allows an individual to claim deduction (from gross total income) on investment made in NPS under three sections of the Income Tax Act. Apart from deduction under Section 80CCD (2), as mentioned above, it also allows deduction under Section 80CCD (1) and Section 80CCD(1B).
Deduction under Section 80CCD (1): Section 80CCD (1) deduction comes under the overall umbrella of Section 80C. An individual can claim a deduction of Rs 1.5 lakh or 10% of basic salary, whichever is lower, by making a contribution to his/her Tier-I NPS account. Hence, if 10% of the basic salary of an individual is lower than Rs 1.5 lakh, the person can claim a deduction of only 10% of basic salary. To fully utilise the benefit of maximum deduction of Rs 1.5 lakh, an individual will have to use other avenues specified under Section 80C.
Deduction under Section 80CCD(1B): Section 80CCD(1B) deduction is available over and above Section 80C/80CCD (1) deduction. This deduction can be claimed once an individual exhausts Section 80C/80CCD (1) limit. The maximum deduction allowed under this section is Rs 50,000. Hence, by investing Rs 50,000 in NPS, an individual can claim a deduction under this section. The investment must be made in Tier-I NPS account.
Total deduction of max Rs 9.5 lakh under old regime: Thus, if an individual opts for the old tax regime, they can claim a total deduction of Rs 9.5 lakh under three sections of the Income Tax Act – under Section 80CCD (1) for Rs 1.5 lakh, Section 80CCD (1B) for Rs 50,000 and Section 80CCD (2) for Rs 7.5 lakh.
