Benefits Of NPS You May Be Unaware Of

The National Pension System (NPS) has now been well-accepted by investors as a retirement saving instrument. However, there are certain aspects that are not commonly known, and which you can use to your benefit. These aspects are, tax efficiency, cost efficiency and utilising Tier II account as an investment vehicle.

Tax Efficiency

You can invest up to 10 per cent of your salary (basic + dearness allowance (DA) under section 80CCD(1) of the Income-tax Act, 1961, within the overall ceiling of Rs 1.5 lakh under Section 80CCE and a further Rs 50,000 in NPS tier I under Section 80 CCD(1B), thus taking your total investible amount to Rs 2 lakh. However, Section 80C is only available under the old tax regime (OTR). Now that we are steadily moving towards the new tax regime (NTR), NPS benefits should also be seen from that perspective.

Under NTR, according to the Finance Bill of 2024, employees can avail tax deductions under Section 80CCD(2), up to 14 per cent of the basic salary and DA. Technically, there is a ceiling of contribution of Rs 7.5 lakh per year, which includes employers’ contribution towards Provident Fund, superannuation and NPS for availing of tax benefits. However, employees in that category will be a handful, given the average salary of our working population. The contribution under Section 80CCD(2) is made by the employer, but the employee gets the tax benefit.

Let’s take the example of an employee who gets a basic salary of Rs 6.8 lakh per year. There are multiple other allowances and the total salary comes to Rs 17 lakh per year. After the standard deduction of Rs 75,000, the taxable salary becomes Rs 16.25 lakh. Since the employee has opted for NTR, the employer can contribute up to 14 per cent of basic salary­, or in this case, Rs 95,200 per year towards NPS. This amount is eligible for deduction under Section 80 CCD(2). Since the employee has opted for NTR, Rs 50,000 under Section 80 CCD(1B) is not applicable. Without NPS contribution, tax on salary of Rs 16.25 lakh, including education cess, is Rs 1.30 lakh. With NPS contribution, taxable salary becomes Rs 16.25 lakh minus Rs 95,200, or Rs 15.30 lakh. Tax on salary, including education cess, now becomes Rs 1.14 lakh. The differential in tax quantum between Rs 1.30 lakh and Rs 1.14 lakh, i.e. Rs 16,151 with NPS contribution, shows the tax efficiency under NTR.

Cost Efficiency

Any investment vehicle charges recurring expenses to cover its costs and margins. The returns you get from your investment net asset value (NAV) to redemption NAV, is net of the expenses charged. Your returns from any investment vehicle, such as mutual funds (MFs) or portfolio management services (PMS) or alternative investment funds (AIFs) is NAV to NAV, apart from any dividend/payout in between. Obviously, the higher the expenses, it takes away that much from the gross returns earned by the fund. Lower the expenses, the better.

NPS is the lowest-cost investment vehicle. Depending on the assets under management (AUM) of the fund manager, fees range from 0.03-0.09 per cent of the AUM. In MF, PMS or AIF, the expenses charged are much higher, and not comparable at all.

NPS Tier II

NPS Tier II is an underrated investment vehicle. It is meant to be an investment account. It is flexible in the sense that the liquidity restrictions of Tier I are not applicable to Tier II. You can withdraw your funds anytime. Note that it is compulsory to open a Tier-I account to be eligible to open a Tier-II account. You can open a Tier-II account, which is optional, along with Tier-I or anytime later. However, the tax benefits are applicable to Tier-I account only, since Tier II is supposed to be an investment vehicle. Employer contribution will also go only to the Tier-I account.

The taxation rules of NPS Tier-II are not clearly spelt out. There is one way to optimise the taxation in Tier-II investments: prior to withdrawal, say when you are approaching 60 years, transfer your funds from the Tier-II accounts to Tier-I. This transfer is treated as a contribution to Tier-I. Note that you can transfer funds from Tier-II account to Tier-I, but not the other way round.

The charges for Tier- I and Tier- II accounts are the same. From that perspective, it is better than MF, PMS or AIF.

Conclusion

From the taxation perspective, both under OTR and NTR, NPS falls under the exempt exempt exempt (EEE) category—exempt at the investment stage, exempt at the intermediate stage when you receive benefits and at the withdrawal stage as well. However, only 60 per cent of the corpus can be withdrawn as tax-free lump sum, and the rest 40 per cent has to be mandatorily used for buying annuity from an insurance company. Annuity income is taxable at the slab rate. But since retired people do not have active income, the marginal slab rate is on the lower side.

From the cost-efficiency perspective, there is a strong case for investment in NPS. There are multiple empannelled fund managers; you can take a look at their performance.

The only issue is liquidity in Tier-I, but that much you have to bear for the benefits you are deriving.

By Joydeep Sen, Corporate Trainer and Author