National Pension System: 7 strategic insights for tax-efficient retirement saving

The National Pension System (NPS) is a vital tool for salaried middle class people to save taxes and plan for retirement. Here are seven key insights of NPS that explain its importance and how it can be strategically used in saving taxes and preparing for retirement.

Primary reason to invest in NPS – tax saving: There is a lot of content out there on social media/ blogs/ YouTube about NPS. I have researched this topic in depth and understood that the key purpose behind investing in the NPS should only and only be tax saving. If you are investing for any other reason – be assured there are better vehicles available to invest.

No need for tier II account: The National Pension System offers two types of accounts: Tier I and Tier II.

Tier I account is where all the tax deductions are applicable. In Tier II accounts no tax deductions are applicable. You do not need an NPS tier II account. Also, the taxation in NPS Tier II Account is complex and there is a lot of ambiguity even between tax experts.

There was a time when credit card geeks exploited NPS tier II accounts to make big contributions and then withdrew them back to their bank (there is no lock-in in NPS Tier II). In this process, they earned rewards and miles. Now tier II contributions cannot be made through credit card. Please note, tier I contributions can still be made through credit card.

Available tax deductions: Reiterating, tax saving should be your primary reason for opening the NPS tier I account. Tax benefits under NPS are available across three sections:

a) 80CCD(1) – In this section one can invest up to ₹1.50 lakhs and claim deduction. But the problem is this deduction is within the overall ₹1.50 lakhs of 80C.

There are multiple avenues to claim 80C deduction – employees’ contribution to provident fund, Equity Linked Saving Scheme, Public Provident Fund, Principal portion of home loan repayment, tuition fees for kids, term insurance premium – so one should target this section through NPS.

b) 80CCD(1B) – In this section one can claim up to ₹50,000 of deduction – over and above the 1.50 lakh deduction available under section 80C. Important point to note here is that this deduction is available only in the old tax regime and not available in the new tax regime.

c) 80CCD(2) – This deduction is available for salaried employees whereby their employers have emplaned with NPS. The limit under this section is up to 10% of basic salary. This deduction is available under both the new and old tax regime.

If you are a salaried employee and fall under high tax brackets – you must explore this deduction and take its benefit.

In case your employer is not empanelled with NPS, you can request your employer. We have seen a lot of cases where an employer has empaneled with NPS once requested by a bunch of employees.

Asset allocation options: NPS provides investors with the liberty to choose between active choice and auto choice, enabling customization of asset allocation across equity, corporate bonds, government securities, and alternative investment funds.

• In auto choice, the asset allocation is pre-defined and one can choose as per the risk appetite.
• In the active choice one can customise the asset allocation with some restrictions – for example – you cannot opt for equity to be greater than 75%.
• In case you are opting for active choice – preferable you should keep alternative asset class at ZERO.

Tax exemption with caveats: While NPS enjoys EEE (Exempt-Exempt-Exempt) status, mandating tax exemption on invested amount, capital growth, and maturity proceeds – but at the time of withdrawal – 40% of the accumulated corpus needs to be invested in a pension-bearing annuity. The pension income will be taxable as per the slab rate.

Withdrawal flexibility (at the time of maturity): NPS offers withdrawal options at the age of 60 or upon superannuation – the good part is one can defer the withdrawal till 75 years of age. The slightly negative part is you cannot withdraw the money in between (except for some specific reasons).

The withdrawal will have two components:

• 60% (anytime, no questions asked)
• 40% (needs to be invested in a pension bearing annuity)

The annuity becomes the biggest roadblock in an investor's mind to start this wonderful journey of tax saving and wealth creation.

Readers who are in their 30s and 40s need to understand that their retirement is far away and by the time they retire, we expect that PFRDA will come up with new rules where systematic withdrawal of the 40% corpus will be possible without taking the annuity route.

Holistic retirement planning: Please understand – NPS can be one of the vehicles in planning for retirement. But if you have opened the NPS account for the reason of tax saving only – the accumulated corpus will not be enough. So a comprehensive holistic retirement plan will have multiple vehicles where NPS will be one of the vehicles.

Nishant Batra, Co-founder of Holistic Prime Wealth Private Limited