Have you used up tax-saving deductions like sections 80C, 80D and 80TTA of the Income-tax Act, 1961? Are you looking for more options to bring down your tax liability further? If you answered yes to both these questions, then investing in the National Pension System (NPS) can help you save tax (subject to certain conditions).
The NPS allows you to invest more than Rs 2 lakh in a financial year which can help you bring down your tax liability.
Here’s a look at how you can invest more than Rs 2 lakh in NPS to save tax.
De ductions available for investments made in NPS
There are three sections under the Income-tax Act that allows individuals to claim deductions for the money invested in NPS:
(i) Section 80CCD (1): This deduction comes under the overall umbrella of section 80C with a maximum investment limit of Rs 1.5 lakh in a financial year. Maximum investment allowed is either 10% of basic salary or Rs 1.5 lakh, whichever is lower. This deduction is available under the old tax regime.
(ii) 80CCD (1b): This is an additional deduction for a maximum of Rs 50,000 which is over and above section 80C. This deduction is available under the old tax regime.
(iii) 80CCD (2): Employer’s contribution to an employee’s Tier-I NPS account, where maximum contribution up to 10% of employee’s salary (14% in case of central government employee) is allowed in a financial year. This deduction is allowed under the old as well as new tax regime.
From FY 2020-21 onwards, an individual has the option to continue with the old tax regime and avail the common deductions and tax exemptions. He/she also has the option to opt for the new, concessional tax regime by foregoing the 70 deductions and tax exemptions. However, deduction under Section 80CCD (2) is available under new tax regime as well as old tax regime.
How section 80CCD (2) helps you save tax
Section 80CCD(2) can help you save more tax even after the maximum tax breaks under section 80CCD (1) and section 80CCD(1b) have been availed.
As per current income tax laws, an individual is eligible for deduction on the employer’s contribution to the employee’s NPS account. The maximum deduction of 10% of salary can be claimed by an individual. In case of central government employees, a maximum deduction of 14% is allowed. As proposed in Budget 2022, even state government employees will be applicable for higher tax exemption on NPS contribution. This amendment will be retrospectively from FY 2019-20.
Here is an example to know how much deduction can be claimed by an individual working in the private sector. Suppose your annual basic salary is Rs 8 lakh and your employer contributes Rs 80,000 to your Tier-I NPS account. Then you can claim a deduction of 10% of your basic salary, i.e., Rs 80,000 (10% of Rs 8 lakh)
What if your employer contributes, say Rs 90,000 into your NPS account? Dr Suresh Surana, founder, RSM India says, “Employer’s contribution to employee’s NPS account exceeding 14% of salary in case where contribution is made by central government, (10% of salary in case of other employers) will be taxable in the hands of an employee. Any excess contributions will be taxable as perquisite under the head salary.”
For this purpose, “salary” includes basic and dearness allowance, if the terms of employment so provide, but excludes all other allowances and perquisites.
Further, effective from FY 2020-21, employer’s contribution to NPS, Provident Fund (PF) and superannuation funds on an aggregate basis exceeding Rs 7.5 lakh in a financial year will be taxable in the hands of an employee. Also, interest, dividend etc. earned on the excess contribution will be taxable in the hands of an employee.
What it means that if the employer is contributing 10% towards NPS, then a total deduction of up to Rs 9.5 lakh under section 80CCD(1), 80CCD(1b) and 80CCD(2) can be utilised by an employee depending upon the basic monthly salary. While a person with basic monthly salary of Rs 50,000 can get a total deduction of Rs 2.6 lakh (Rs 60,000 under section 80CCD(2) ) and if the basic monthly salary is Rs 6.25 lakh or above the maximum possible deduction of Rs 9.5 lakh (Rs 7.5 lakh u/s 80CC(2)) can be availed only from NPS.
An individual having basic annual salary of Rs 12 lakh
|Deduction under section||Maximum amount available|
|Section 80 CCD (1)||Rs 1.5 lakh or 10% of basic salary whichever is lower|
|Section 80CCD (1b)||Rs 50,000|
|Section 80CCD (2)||10% of basic salary Rs 12 lakh: Rs 1.2 lakh|
|Total maximum amount available||Rs 3.20 lakh|
The Central Board of Direct Taxes (CBDT) has notified rules related to the methodolgy of calculating and reporting excess contributions in March 2021.
Do keep in mind that the amount of tax saved on the employer’s contribution by you depends on the income tax rate applicable on your income.
Tax saved on employer’s contribution of Rs 1 lakh
|Tax amount saved in old tax regime||Tax rate||Tax amount saved in new tax regime|
|Rs 5,200||5%||Rs 5,200|
|Not applicable||10%||Rs 10,400|
|Not applicable||15%||Rs 15,600|
|Rs 20,800||20%||Rs 20,800|
|Not applicable||25%||Rs 26,000|
|Rs 31, 200||30%||Rs 31, 200|
How tax benefit under section 80CCD (2) can be claimed
The tax benefit under section 80CCD (2) of the Income-tax Act can be availed only if the employer is willing to contribute to the NPS account of an employee.
If the employer is willing, then using this route, investment in NPS account will exceed Rs 2 lakh in financial year.
Rs 1.5 lakh under section 80CCD (1) (Under the umbrella of section 80C) + Rs 50,000 under section 80 CCD (1b) + 10% of employee’s basic salary plus DA contributed by an employer to employee’s NPS account = Investment in NPS exceeding Rs 2 lakh in a financial year.
Remember, if an employer contributes any sum to your NPS account, the same is likely to be a part of your CTC or cost to company and may lead to reduction in some other component.
Surana says, “Employer contribution to NPS will be part of gross salary and employee is eligible to claim deduction under section 80CCD (2). The Form-16 given by the employer will contain all the details of the gross salary paid to any employee and amount of deduction he/she is eligible to claim under section 80CCD (2) and excess contribution which will be taxable in the hands of an employee, if any.”