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Restructure your salary this week, save additional tax with NPS

April & May is the time when your company allows you to restructure your CTC which helps you to optimize your taxes and accordingly declare your investments. Moreover, your company has rolled out the New Pension System (NPS), now employees can save additional tax of up to 1-3% of their basic salaries. If a company puts 10% of the basic salary of an employee in the NPS, that amount can be claimed as a deduction under Sec 80CCD(2). This tax deduction is over and above the `1.5 lakh under Section 80C and the new deduction of `50,000 introduced last year under Section 80CCD(1b). A person with a basic salary of `50,000 a month can reduce his annual tax outgo by up to `12,360 The NPS is in many ways like a seasonal fruit: it is cheap, best and has no side effects. It should be as big a hit as T20 because it gives 20 benefits for 20 years (or even more). Click here here to read about the 20 reasons to invest in the National Pension System. To conclude, this is the ONLY time to work upon for additional tax savings for FY 201718 by restructuring your CTC and planning your investments. 

The changes that have made the National Pension System more investor friendly:

There have been several change in the NPS rules which have made the scheme more attractive for investors. One of the biggest pain point in the NPS was that the corpus and pension received were fully taxable. This was rectified in the 2016 budget, which made 40% of the NPS corpus tax free for the investor, thus making the scheme more tax efficient.

The introduction of the additional deduction of Rs 50,000 under Sec 80 CCD(1b) in 2015 is another incentive for taxpayers to lower their tax. An investor in the highest 30% tax bracket can save up to Rs 15,450 in tax by investing under this section. This deduction is over and above the Rs 1.5 lakh under Sec 80C and is only available for investment in NPS.

Another problem was that NPS was not being pushed by distributors  and pension funds because of its ultra low commission and fund management charges. Though the fund management charges have been hiked, at 0.1% they remain the lowest for any financial product. An investor will pay Rs 100 a year for a corpus of Rs 1 lakh, compared to Rs 1,500-2,500 charged by mutual funds and Rs 2,500-3,500 charged by Ulips.

The low charges mean higher returns for investors. The post-tax return of the NPS has been roughly 12% in the past three years, compared to less than 9% for small savings options such as PPF, NSCs, Sukanya and bank deposits. Hybrid mutual funds with 50% in equities have yielded 12-14% but these don’t offer tax benefits on contributions.

The NPS help in saving additional tax?

An individual can save tax through NPS in three different ways. First, he can contribute to the NPS on his own or as mandatory contribution from his salary. This will come under the overall tax deduction limit under Section 80C.

Secondly, the taxpayer can contribute up to Rs 50,000 to the NPS and claim deduction under Sec 80CCD(1b). As mentioned earlier, this deduction is over and above the Rs 1.5 lakh under Sec 80C and is only available for investment in NPS.

Thirdly, an employer can contribute up to 10% of the basic salary of an employee in the NPS under Sec 80CCD(2d). So, if your basic salary is Rs 50,000 a month, your employer can reduce any other taxable portion of the income and contribute up to Rs 5,000 a month in NPS under Sec 80CCD(2d). This amount will not be taxable for the employee, so effectively you replace a taxable income with a tax free benefit in the pay package.

Higher tax savings on higher salary:
The tax savings in different slabs will differ because these are deductions. This also means that higher income earners will enjoy more tax savings than those in the lower income tax slabs. If you contribute Rs 50,000 under Sec 80C, Rs 50,000 under Sec 80CCD(1b) and Rs 50,000 under Sec 80CCD(2d), your total contribution will be Rs 1.5 lakh. If you are in the 10% bracket (taxable annual income of up to Rs 5 lakh a year), this will reduce your tax by Rs 15,450. If your annual income is between Rs 5 lakh and Rs 10 lakh, you are in the 20% bracket. This means your tax will be reduced by Rs 30,900. But in the highest 30% tax bracket (taxable income above Rs 10 lakh a year), the tax saved will be Rs 46,350.

The maximum deduction that an individual can claim by investing in the NPS:
Though there is a cap of Rs 1.5 lakh under Sec 80C and Rs 50,000 under Sec 80CCD(1b), the tax deduction under Sec 80CCD(2d) is linked to the income of the individual. It is 10% of the basic salary of the taxpayer. If the basic income is high, so is the deduction. For example, if the basic salary is Rs 25,000 a month, then the total deduction under the section can be only Rs 30,000 in a year (Rs 2,500 a month). But for a senior person with basic salary of Rs 1-2 lakh a month, the deduction can be as high as Rs 1.2-2.4 lakh a year. But to claim such a deduction, the employer must change its salary structure and include NPS benefit in the cost to company.

Apart from tax savings, there are 20 other benefits of investing in NPS:

SK: The NPS is in many ways like a seasonal fruit: it is cheap, best and has no side effects. It should be as big a hit as T20 because it gives 20 benefits for 20 years (or even more). Here are some of the benefits:

  1. NPS is the cheapest investment product in the country. It charges only 0.1% as fund management charge in a year, which is a fraction of what mutual funds and Ulips charge.
  2. It is tightly regulated by a government body and managed by the top pension fund managers.
  3. NPS returns have been quite attractive in the long term. NPS investors have earned 3-4% higher returns than what EPF investors earned.
  4. The long-term lock-in of the NPS enforces investment discipline in the investor. He is not allowed to take out the money before 60.
  5. This lock in till 60 years is relevant because changing scenario (changing social values, nuclear families, increasing average age, high medical and living cost).
  6. But NPS is also very flexible in case of emergencies. Investors are allowed to withdraw up to 25% of the corpus in case of emergencies.
  7. NPS offers equity exposure which is must for beating the inflation. Inflation is a silent killer of the value of money, just like blood pressure damages body parts silently.
  8. Investors in India do not treat equity as regular and long term investment but use it for gambling in the short term. NPS forces this discipline automatically.
  9. NPS is also very flexible. Investors can shift corpus among 7 top most fund managers without any tax and transfer charges, based on performance. No other investment has this free freedom for your movement.
  10. NPS offers 20% deduction of total income for self employed which is over and above 80C limit of Rs 1.50 lakh. Self employed people do need regular investment and tax saving.
  11. NPS gives the option to invest in different asset classes simultaneously i.e. debt, equity and govt securities. Investors can shift between these funds without tax implications.
  12. NPS offers flexibility in investment i.e. monthly, yearly , minimum and maximum year over year as per availability of funds and tax saving needs.
  13. NPS investment is transparent and related to market. NAV is declared on daily basis and moves as per the overall growth of financial assets. You never loose opportunity to participate in higher growth simultaneously secures from additional risk by limiting 50% exposure in equity.
  14. NPS investment can be done and managed online as well as offline. Hence, offers the convenience as per taxpayer profile.
  15. NPS has the strength to bring the fixed return rates down after winning trust of taxpayers for few years. Which would make the cost of product and services lower and competitive in the world market.
  16. NPS auto choice has very intelligent and simple distinction based on age with respect to who and how much money in fixed income and equity should be invested
  17. Portable- NPS provides seamless portability across jobs and across locations,
  18. No additional cost for employer: Corporate can join NPS free of cost, so there is no cost of setup or maintenance of Self Administered Pension Funds. There is also no need to form a Trust. Simple procedure to add or remove employees at any point of time, corporate acts merely as facilitator, the Account maintenance responsibility / obligation remains with the employees only
  19. Flexibilities to corporate: NPS can be roll out for all on voluntary basis / for select group of employees. Corporate can select a Pension Fund Manager, Asset Allocation and Investment option on behalf of employees, Corporate can fix the percentage / frequency of contribution.
  20. A safe retirement fund: Introduced by the Government of India and regulated by the Pension Fund Regulatory & Development Authority (PFRDA).