Here’s how investing in NPS can trim your tax bill under different sections of the Income Tax Act, whether you’re under the old or new tax regime.
New tax regime
People choosing the new tax system this year can lower their taxable income by investing in NPS under Section 80CCD (2) of the Income Tax Act, states an ET report. This deduction applies when employers contribute to their employees’ NPS accounts, reducing their take-home pay as these contributions are part of their overall compensation package.
An employee can claim a deduction on deposits made by the employer, up to 10% of their salary. Government employees, both at the central and state level, can claim up to 14% of their salary as a deduction for NPS contributions made by the government.
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Salary is calculated as the sum of basic salary and dearness allowance. Other components like house rent allowance or special allowance are not considered when determining the eligible deduction amount.
However, there’s a limit on the tax-exempt amount of employer contributions. If contributions to NPS, Employees Provident Fund, and other superannuation funds exceed Rs 7.5 lakh annually, the excess becomes taxable for employees. Additionally, any returns earned from this excess contribution are also taxable.
In the current financial year, the new tax system only permits deductions under Section 80CCD (2) and standard deductions from salary and pension income. Therefore, if you stick with the new tax regime, the maximum deduction you can claim through NPS is Rs 7.5 lakh, following the 10%/14% of salary rule mentioned earlier. The deduction amount under Section 80CCD (2) is indicated in the employee’s Form 16.
Starting from the current financial year, 2023-24, the government has aimed to enhance the appeal of the new tax system. Notable changes include revisions to income tax slabs, with the basic tax exemption limit raised by Rs 50,000 to Rs 3 lakh. Additionally, a standard deduction has been introduced for salaried individuals, pensioners, and family pensioners under the new tax regime. Furthermore, the tax rebate under Section 87A has been increased, resulting in zero tax payable for incomes up to Rs 7 lakh.
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It’s important to note that the new tax regime has now become the default option. This means that individuals who prefer the old tax system must actively choose it, unlike in previous years when it was automatically applied as the default regime.
NPS investment under old tax regime
The old tax regime offers individuals the right to claim deductions from their gross total income for investments made in NPS under three sections of the Income Tax Act. In addition to the deduction mentioned earlier under Section 80CCD (2), they can also avail deductions under Section 80CCD (1) and Section 80CCD(1B).
- Deduction under Section 80CCD (1): Deductions under Section 80CCD (1) fall within the broader scope of Section 80C. An individual can claim a deduction of up to Rs 1.5 lakh or 10% of their basic salary, whichever amount is lower, by contributing to their Tier-I NPS account. So, if 10% of an individual’s basic salary is less than Rs 1.5 lakh, they can only claim a deduction equal to 10% of their basic salary. To maximize the benefit of the maximum Rs 1.5 lakh deduction, individuals need to utilize other avenues specified under Section 80C.
- Deduction under Section 80CCD (1B): Section 80CCD(1B) deduction is an additional benefit beyond the deductions offered by Section 80C/80CCD (1). This deduction becomes available once an individual has used the limits of Section 80C/80CCD (1). The maximum deduction allowable under this section is Rs 50,000. By investing Rs 50,000 in their Tier-I NPS account, individuals can claim this deduction.
- Total deduction: Under the old tax regime, individuals can claim a maximum deduction of Rs 9.5 lakh under three sections of the Income Tax Act. This includes deductions of Rs 1.5 lakh under Section 80CCD (1), Rs 50,000 under Section 80CCD (1B), and Rs 7.5 lakh under Section 80CCD (2).