Following the Budget 2023, there has been some confusion regarding the tax benefits of the National Pension System (NPS) under both the new tax regime and the old tax regime. This is largely due to the government’s emphasis on promoting the new tax regime over the old one. To clear up this confusion, let’s take a closer look at the NPS tax benefits in both regimes.
Everyone knows that the Government introduced a new tax regime. Also, the Government has given the option to choose either the old tax regime or the new tax regime.
If a taxpayer chooses the new tax regime, they must forgo certain deductions and exemptions. The new tax regime aims to simplify the tax system, but it also requires taxpayers to give up some benefits they may have enjoyed under the old regime.
The following are the taxation issues related to NPS.
NPS Tax Benefits while investing
Yes, let’s first understand the tax benefits available at the time of investing in the National Pension System (NPS). Due to the changes introduced during the budget session, there are differences in the tax benefits for NPS investors who opt for the old tax regime and those who choose the new tax regime. So, let’s take a closer look at what each regime has to offer in terms of NPS tax benefits.
NPS Tax Benefits 2023 under the old tax regime – Tier 1
If you decide to stick with the old tax regime for your income tax return filing, the existing taxation rules with regard to the National Pension System (NPS) will remain unchanged. This means that you will continue to enjoy the tax benefits associated with the old tax regime for your NPS investments.
It’s important to note that tax benefits for Tier 1 and Tier 2 accounts under the NPS are not available for all investors. Only government employees are eligible for tax benefits for their Tier 2 NPS account.
a. NPS Tax Benefits under Sec.80CCD (1)
- The maximum tax benefit available for NPS investments is Rs. 1.5 lakh, including the limit under Section 80C of the Income Tax Act.
- The maximum amount of NPS contributions eligible for tax deductions is 20% of an individual’s annual income, or 10% of an employee’s (Basic + Dearness Allowance) contribution, whichever is lower.
b. NPS Tax Benefits under Sec.80CCD (2)
- There is a common misunderstanding that there is no upper limit for NPS contributions eligible for tax deductions. However, this is not correct. The actual limit is the least of the following three conditions:
- The amount contributed by the employer.
- 10% of the employee’s Basic + Dearness Allowance (For Central Government Employees, the limit is now 14% of Basic + Dearness Allowance, effective from April 1, 2019).
- The taxpayer’s gross total income.
- One must remember that self-employed individuals are not eligible for tax deductions under this section for their NPS contributions.
- If an employee’s employer contribution under Section 80CCD(2) of the Income Tax Act exceeds Rs. 7.5 lakh per year, along with contributions made to Employee Provident Fund (EPF) and Superannuation, then the excess amount will be considered taxable income for the employee.
- Not only the employer contribution to NPS that exceeds Rs. 7.5 lakh per year, along with contributions to Employee Provident Fund (EPF) and Superannuation, will be considered taxable income, but the returns generated from this excess amount will also be taxable each year.
c. NPS Tax Benefits under Sec.80CCD (1B)
- In the 2015 Budget, the government introduced a new tax benefit of up to INR 50,000 which can be claimed as a deduction from one’s income tax.
- In the 2015 Budget, the government added Section 80CCD (1B) which can be used to avail of a tax benefit of up to INR 50,000, starting from the financial year 2015-16.
- This income tax deduction under Section 80CCD (1B) is available to both self-employed individuals and employees.
NPS Tax Benefits 2023 under the old tax regime – Tier 2
Before the recent change in rules by the Government of India, there was no tax benefit available for investments made into a Tier 2 Account. However, this has changed and now, if a central government employee contributes to a Tier 2 Account, they can claim tax benefits under Section 80C with a combined maximum limit of INR 1.5 lakh. It’s essential to keep in mind that once such tax benefits are availed, the invested funds will be locked for 3 years, similar to investments in ELSS Mutual Funds.
NPS Tax Benefits 2023 under the new tax regime – Tier 1
If you choose to opt for the new tax regime, it’s important to note that, you will no longer be eligible for the tax benefits under Section 80C.
Therefore, if you have adopted the new tax regime, the tax benefits available under Section 80C, Section 80CCD (1), and Section 80CCD (1B) for NPS in 2023 will not be accessible to you. This is because Section 80CCD (1) and Section 80CCD (1B) are included under the limit of Section 80C.
However, under the new tax regime, the employer contribution under Section 80CCD (2) remains eligible for tax deductions.
NPS Tax Benefits 2023 under the new tax regime – Tier 2
Before the recent change in rules by the Government of India, there was no tax advantage for investments made into a Tier 2 Account. However, now if a central government employee contributes to a Tier 2 Account, they can claim tax benefits under Section 80C, with a combined maximum limit of INR 1.5 lakh. It’s important to keep in mind that if such tax benefits are claimed, the invested funds will be locked for a period of 3 years, similar to investments in ELSS Mutual Funds.
However, if you have chosen the new tax regime, you are not eligible for tax deductions under Section 80C, which means that investing in a Tier 2 Account under NPS will not offer any tax benefits.
NPS Tax Benefits while withdrawing
Upon reaching the age of 60 or upon retirement, as per Section 80CCD (5), up to 60% of the accumulated pension wealth can be withdrawn as a lump sum, tax-free. The remaining 40% must be used to purchase an annuity from a life insurance company. This annuity income will be taxed as per your applicable tax slab.
For example, if you have accumulated pension wealth of Rs. 1000, you must purchase an annuity of Rs. 400 from a life insurance company. The pension received from the annuity will be taxed based on your income tax slab. Meanwhile, the remaining Rs. 600 can be withdrawn tax-free.
Note: According to the Budget 2017, a subscriber with an NPS account that is at least 10 years old is eligible to withdraw 25% of their contributions (excluding accrued income) as part of the total 60% tax-free withdrawal.
NPS Tax Benefits on Pre-mature withdrawal
The annuity income purchased from 80% of the accumulated corpus in case of premature withdrawal from the NPS will be taxed as yearly income.
There is currently ambiguity surrounding the tax treatment of the 20% lump sum withdrawal from NPS in case of premature withdrawal. The existing rules state that 40% of lump sum withdrawal from NPS is tax-free, but there is no clear guidance on how this applies to the 20% lump sum withdrawal in this specific case. The IT department needs to clarify this aspect.
Thus, there is still no clarity on whether the entire 20% is exempt from taxation (since it falls below the 40% tax-free threshold) or if only 40% of the 20% is tax-free (equivalent to 8% of the 20%).
NPS Tax Benefits on Pre-Mature Partial Withdrawal
Although it is permitted to make partial withdrawals from the National Pension System (NPS) under specific conditions, there is still no clear information regarding the tax implications of these withdrawals. It is speculated that partial withdrawals may be taxed according to the subscriber’s income tax bracket in the year of the withdrawal.
NPS Tax Benefits on Pre-Mature Withdrawal For Govt. Employees And Non-Govt. Individuals
For government employees, a nominee is only permitted to withdraw 20% of the lump sum amount. The remaining 80% must be used to purchase an annuity. However, if the accumulated corpus is less than or equal to INR 2,00,000, then the spouse (or nominee) is allowed to withdraw the entire amount without any obligation to purchase an annuity.
For individuals who are not government employees, the nominee is allowed to withdraw the entire accumulated corpus. However, the nominee also has the option of purchasing an annuity.
The lump-sum withdrawal made by the nominee will be exempt from income tax. If the nominee chooses to purchase an annuity, then the income received from the annuity will be taxed according to the nominee’s income tax bracket in the year in which it is received.
NPS Tax Benefits from Tier 2 Accounts withdrawal
Unfortunately, there is still no clarity on this matter. Some people argue that since the structure of Tier 2 of the NPS is similar to mutual funds, taxes can be paid like mutual funds (depending on whether the holdings are in debt or equity) based on the proportion of debt or equity holdings.
However, others argue that since no Security Transaction Tax (STT) is paid in the case of a Tier 2 NPS account, it should not be taxed similarly to mutual funds. Instead, it should be taxed under the category of “Income from Other Sources.” Currently, the Tier 2 NPS account is not classified as a Capital Asset under Section 2.
While treating the NPS Tier 2 account as income from other sources seems like a reasonable viewpoint. However, this should not be considered as a fixed rule. It’s important to keep in mind that without clear guidance from the Income Tax Department, it is difficult to make a definite determination.
Disclaimer: The views expressed in the blog are purely based on our research and personal opinion. Although we do not condone misinformation, we do not intend to be regarded as a source of advice or guarantee. Kindly consult an expert before making any decision based on the insights we have provided.
