The Chapter VI-A of the Indian Income Tax Act provides various deductions for contribution towards Pension Plan. Specifically speaking, these deductions are offered under Section 80C, Section 80CCC and Section 80CCD which can be claimed when one files the income tax return.
Here, we focus on how you can Save Income Tax under Section 80CCD.
Deduction under Section 80CCD
The Section 80CCD of the Income Tax Act provides income tax deductions when an individual makes a contribution towards notified Pension Scheme declared by the Government of India which is known as the National Pension Scheme (NPS).
These deductions under Section 80CCD can be claimed only by the individuals and not by HUFs. The individual claiming deductions under Sec 80CCD may be Resident or Non-Resident.
There are two sub-sections or parts to Section 80CCD namely – section 80CCD (1) and section 80CCD (2).
Overview of National Pension Scheme (NPS)
NPS or National Pension Scheme is a pension scheme by the Government of India for Indian citizens who are in the age group of 18 to 65 years. NPS can be viewed as India’s answer to the US Retirement Scheme 401(K).
- NPS is compulsory for Central as well as State Government employees. However, it is optional for others.
- Initially, in 2004, NPS was introduced for the new government employees. However, from 2009, NPS was extended to all on a voluntary basis.
- NPS comes as a defined contribution plan in which an individual needs to contribute until the age of sixty years.
- The minimum annual contribution marked towards the pension account known as Tier I account is Rs.6000. However, the Tier II account under NPS functions similar to a savings account and offers liquidity.
- Investments under NPS are market linked. It offers three types of funds such as government securities fund and fixed-income instruments. However, individuals cannot invest more than 50% of their money in an equity fund.
- Currently, the fund management cost under NPS is fixed at 0.01%.
- When an individual attains the age of 60 years, he or she can withdraw up to 60% of the money under NPS in a lump sum. With the rest of the money, they can buy an annuity product. However, it should be noted that NPS is not a tax-saving scheme. It is, in fact, a tax deferral scheme wherein the accumulation is taxable at the time of withdrawal.
- Deferred exit options are provided to investors under NPS.
- Early exits are discouraged as it mandates that 80% of the accumulated corpus should be invested for buying an annuity. However, now partial withdrawals up to 25% are allowed of the contributions done under NPS for specific purposes.
Tax Benefits under NPS
Section 80CCD (1), 80CCD (2), and 80CCD (1B) are taken into consideration for calculating tax benefits on NPS.
However, it should be noted that the tax benefits together with annuity restrictions and exit or withdrawal rules apply to NPS Tier-1 account only.
The NPS Tier-II account is an open-ended fund and allows individuals to take out money at any time.
Section 80CCD (1)
Section 80CCD(1) allows deductions to both Salaried as well as Non-Salaried individuals who contribute to the NPS Scheme for availing tax deductions for the same.
The maximum amount that can be claimed for deduction under Section 80CCD (1) is:
In case of employees: 10% of the basic salary and dearness allowance (DA) up to Rs. 1.5 lakh (for the financial year) is considered for a tax deduction.
In case of non-employees: 10% of their total annual income up to a maximum of Rs. 1.5 lakh (This has been increased to 20% from Financial Year 2017).
Section 80CCD (2)
- Employer’s contribution up to 10 percent of basic salary and DA can be claimed for deduction under this section.
- This is also beneficial for the employer as they can show the contribution as a business expense and claim tax benefit.
- The employer’s contribution is not part of Rs.1.5 lakh allowed under Section 80C.
- This tax benefit is not applicable for self-employed people.
Section 80CCD (1B)
- It was introduced in Budget 2015 from FY 2015-16.
- Taxpayers who are in the 30% tax bracket get to save Rs.15000 by investing Rs.50000 in the NPS.
- Taxpayers in the 20% tax bracket can save Rs.10000 per year by investing in the NPS.
- Taxpayers in the 10% tax bracket can save Rs.5000 per year.
- It is not dependent on the type of employment. So, government employees, private sector employees, self-employed or even an ordinary citizen can claim the benefit of Rs.50000 under Sec 80CCD (1B).
So, the total tax benefits arising out of NPS under Sec 80CCD (1) and Section 80CCD (1B) is equal to 2 lakh for a given financial year.
Implications of Budget 2015 on Sec 80CCD
Before the year 2015, deductions that were allowed for making contributions to NPS was limited to Rs. 1 Lakh. However, the government decided to encourage people to make contributions towards NPS.
So, they increased the limit of investment in NPS from Rs. 1 Lakh to Rs. 1.5 Lakhs.
With Union Budget 2015, a new sub-section 1B was introduced to allow deduction with respect to the amount paid of up to Rs. 50000 towards contributions made by individual assesses under NPS Scheme.
This benefit of Rs.50000 comes as extra benefit for taxpayers which are over and above Rs. 1.5 Lakhs benefits allowed as a deduction under Sec 80C.
So, now the total deductions that can be claimed by taxpayers with respect to Sec 80C + Sec 80CCD = Rs. 2 Lakhs.
Contribution by the Employer towards NPS: Section 80CCD (2)
If an employer contributes towards NPS Scheme on behalf of the employee, then according to Section 80CCD (2) of Income Tax Act, the benefit can be claimed by the employee.
So, the employee can claim a deduction under Section 80CCD (2) if its employer makes a contribution to NPS.
The deduction allowed under Sec 80CCD (2) for employers contribution towards NPS is limited to 10 percent of the Salary of the Individual.
Thus, when an employee himself makes a contribution to NPS, it can be claimed as a deduction under Section 80CCD (1).
However, when the employer makes a contribution towards NPS, it can be claimed as a deduction under Sec 80CCD (2).
Tax applicable to the amount received back from the NPS
Contributions towards the NPS is received back by the individual after retirement (on attaining the age of 60 years) or on the surrender of the policy in the form of Pension.
As per the Budget 2016 Update, when the amount is withdrawn from NPS Account, 40 percent of the accumulated balance is exempted from tax. However, the remaining amount is taxable as per the Income Tax Slabs prevailing in the year of receipt.
Also, according to Budget 2017 Update, exemptions are allowed on partial withdrawals not exceeding 25% of the Contribution made by the employee.
This is in accordance with the terms and conditions stated under the Pension Fund Regulatory and Development Authority Act.
Further up, if the amount received under NPS is used for making a purchase of an annuity plan in the same year as the year of receipt, then no tax is levied on the same.
The taxpayer is deemed to have not received any amount from National Pension Scheme.
A Word of Caution
It should be remembered that NPS comes under the EET (exempt-exempt-tax) regime. So, NPS is a tax deferral scheme.
Under NPS, the individual does not pay tax on his income today but defers the tax payment when one turns 60 and withdraws the money.
Thus, one should not just base the decision of investing in NPS considering tax incentives on the current income. One should also take into consideration the taxation during withdrawal.
Lastly, we hope that you now know how to save tax under Section 80CCD. The article covers the basic information you need to know about saving tax under Sec 80CCD. We believe that the post proves useful to you.