Is NPS a good tax saving instrument

With the budget proposal to give playing field to epf and NPS, the New Pension Scheme (nps) has come under renewed focus. so let us try to understand pros and cons of the pension scheme and its taxation.

When it comes to tax saving, any new announcement or any financial instrument offering a little more return is bound to attract attention. In the last annual Budget, when finance minister Arun Jaitley announced an additional tax deduction of Rs 50,000 for investment in the National Pension Scheme or NPS, it suddenly became the talk of the town. Many tax payers invested in droves just to avail the additional tax benefits on offer, without coming to terms with the objective behind the scheme and its nuances.

Here is a look at demystifying NPS as an investment avenue considering its tax savings potential and any practicalities that you may need to be aware of before taking a call on NPS investment.

Understanding NPS National Pension Scheme, or NPS, is a financial instrument developed primarily to promote pension planning for the common man. Under this scheme, you get a unique pension account which is fully portable across job changes.

You can open an NPS account with a minimum contribution of Rs 6,000 per year for Tier 1 accounts and Rs 1,000 for Tier 2 accounts. NPS is regulated by the Pension Funds Regulatory Development Authority (PFRDA) and the money accumulated is invested through various government appointed fund managers.

NPS offers two account types namely Tier I and Tier II. While Tier I account is compulsory, Tier II is an optional account and works as a pension savings account.

NPS and investment You can choose the various asset classes like equity, fixed income classes, where your NPS money will be invested. You can either exercise an active choice, where you choose to distribute money amongst the various asset classes or opt for an auto mode of investment where the distribution is done automatically based on your age.

You can choose to invest only up to a maximum of 50 per cent in equity asset class (Asset E), while the remaining funds should be invested in either government securities like bonds under Asset G or other fixed income securities under Asset C.

NPS and Taxation If you leave aside the extra Rs 50,000 tax deduction announced in the last year’s Budget, the maturity proceeds of your NPS taxation are taxable currently. With the recently announced Budget for the financial year 2016-17, withdrawal up to forty per cent of the corpus is proposed to be tax-free.

When you invest in NPS, you are eligible for a tax deduction of Rs 1,50,000 under section 80CCD. If your employer is also contributing towards your NPS account, then you can further avail 10 per cent of Basic Salary + Dearness Account (DA) under Section 80CCD(2). So if your basic salary is Rs 4 lakh per year, you can avail an additional tax deduction of Rs 40,000. Furthermore, you can avail an additional tax deduction of Rs 50,000 under Section 80CCD (1b) if you invest more than Rs 50,000 in NPS. The one thing most people overlook is that the deductions listed above are applicable only for tier-1 accounts and not for tier-2 accounts.

NPA Taxation on maturityand withdrawal NPS has been essentially based on the EET formula, also known as the Exempt- Exempt-Tax formula. Under this structure, NPS is tax-free while contributing towards it, tax free in the accumulation phase too, but taxable on maturity. So as an NPS subscriber, you will be taxed when you withdraw your mo-ney at maturity and taxed on the an-nuity you receive for the remaining sum. As m-entioned earlier, this has now been converted to a partially EET structure, where withdrawals are partially tax-free.

What happens when your NPS account matures NPS account will mature once you reach the age of 60 years. At the time of maturity, you can withdraw only 60 per cent of the money while at least 40 per cent of your NPS funds must be used to buy annuities.

Now, since the maturity corpus is fully taxable, you have to pay an income tax on the 60 per cent sum that you withdraw from your NPS account at maturity. With the recent taxation changes in the Union Budget, up to 40 per cent of this withdrawn amount is not liable to be taxed moving forward.

Although the Pension Fund Regulatory and Development Authority (PFRDA) has reportedly sought tax exemption for annuity income from the finance ministry, in order to make NPS more popular, it remains to be seen whether there would be any relaxations in place in this year's budget.

There is more to NPS than what appears as the initial Rs 50,000 investment tax sop that made NPS so popular. Before opting to invest in NPS, make sure you understand that certain deductions are only for tier-1 account holders alone and maturity proceeds up to 40 per cemt are not taxable.

Know your NPS National Pension Scheme, or NPS, is a financial instrument developed primarily to promote pension planning for the common man. This unique pension account is fully portable across job changes NPS is regulated by the Pension Funds Regulatory Development Authority (PFRDA) Money accumulated is invested through various government appointed fund managers NPS offers two account types namely Tier I and Tier II. Tier I account is compulsory, Tier II is an optional account Rs 6,000 per year: Money needed for Tier 1 accounts needed to open an NPS account Rs 1,000 for Tier 2 accounts

The writer is the CEO of BankBazaar.com

The writer is the CEO of BankBazaar.com