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NPS: A Tax Planning Or A Retirement Planning Tool?

The national pension system (NPS) is a long-term investment tool that comes with tax benefit

January 27, 2025
January 27, 2025

The National Pension System (NPS) is a social security scheme that is mandatory for central government employees and optional for state government employees in some states. However, it serves as a versatile financial planning tool for everyone, including those employed by organisations, self-employed individuals, residents, non-resident Indians, government employees, and private sector workers. It is a flexible scheme and continues to function seamlessly even during transitional phases when one is on a break or out of a job or in between. The account continues, but it is not closed.

However, tax planning is the key reason for the scheme’s penetration. While tax benefits are attractive, should it be the only reason to invest in NPS?

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NPS: A Tax Planning Tool

When people consider the NPS, they often find it attractive primarily for its tax benefits rather than for retirement planning.

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Old Tax Regime:

  • It is more appealing in the old tax regime due to Section 80CCD (1), which allows for tax savings on investments up to Rs 1.5 lakh investment.

  • Additionally, Section 80CCD (1B) provides an extra tax benefit on an additional investment of Rs 50,000.

  • For salaried individuals, there is another tax benefit under section Section 80CCD(2) on employer contribution (10 per cent of basic salary + dearness allowance) permitted.

New Tax Regime:

  • In the new tax regime, tax benefits are limited only to the employers’ contribution of up to 14 per cent under section 80CCD(2). Earlier, it was available only for government employees, but after the change was proposed in the Union Budget 2024, it became applicable to private sector employers as well, effective from April 1, 2024.

Kurian Jose, CEO, Tata Pension Management, emphasizes, “It's important to note that this enhanced deduction under Sec 80 CCD(2) is available only under the new tax regime. Under the old tax regime, the deduction for employer contributions remains capped at 10% of the salary for private sector employees”.

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NPS: A Retirement Planning Tool

The purpose of NPS is to provide social security to the subscribers in their old age, and that is why the scheme is open to all, unlike the Employees’ Provident Fund (EPF), which is only for the organised sector employees. Its most significant benefits include the non-measurable benefit of making people invest for the long term and be disciplined investors.

Jose further says that NPS offers a comprehensive solution to people, including flexibility, market-linked returns, and tax benefits. Also, there is no restriction on the deposit amount, and withdrawals are also flexible with lumpsum withdrawal or at monthly, quarterly, semi-annually, and annual intervals.

Why NPS?

For everyone, the reason to invest in NPS could be anything ranging from tax benefits, savings for the long-term, discipline in saving, gaining market-linked returns at low cost, or actually planning for retirement. People realise the need to save and plan for retirement when they approach their 40s or even later. However, the earlier one starts, the better it is.

When comparing the hard motivator behind investing in NPS, it comes out to be the immediate gratification in the form of tax benefits, and retirement planning takes a back seat because one cannot see the benefit in the immediate future.

According to Jose, “Tax benefits incentivise disciplined and consistent investment, a critical aspect of retirement planning. Enhanced tax benefits could act as a nudge, pushing young cohorts to start investing early and building a substantial corpus over time”.

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As the budget 2025 is also scheduled to be presented on February 1, 2025, Jose adds, “If the tax advantages are expanded (on NPS), investors might view NPS as a superior choice for building a retirement corpus compared to other options like Public Provident Fund (PPF), Equity Linked-Saving Scheme (ELSS), or traditional pension plans.

So, while tax benefits may offer an instant benefit, change in them every year, confusion between the old and new regime and their benefits, switching between them, and seeing various contenders for tax benefits under Section 80C, one should not consider only tax benefits for investing in NPS, but look at the bigger picture and take a long term view.

As Jose says, “By aligning financial goals with the flexibility and benefits offered by NPS, individuals can create a robust and portable retirement corpus, regardless of their career transitions”.

So, think about your motivation to invest and choose the option wisely.

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