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Should you Invest Rs 50,000 in NPS to Save Tax u/s 80CCD (1B)?

Invest in NPS to Save Tax

Budget 2015 had introduced a new section 80CCD (1B) which gives deduction up to Rs 50,000 for investment in NPS (National Pension Scheme) Tier 1 account This new deduction can help you save tax up to Rs 15,600 in case you are in the 30% tax slab.

The question is should you take advantage of this new tax deduction and invest in NPS?

NPS has not taken off as expected and finance minister by giving this additional tax saving option is trying to give it a push. We all know how many people invest blindly in poor schemes just to save tax. This post is to analyze if it makes sense for us to invest in NPS to save additional tax.

Assumptions:

For our calculation we assume that Amit is 30 year old and would retire at the age of 60. So he would make investment for 30 years.

NPS Investment Option: Most Aggressive i.e. 50% investment in equity and 50% investment in debt
Amount Invested Annually: Rs 50,000
Return on Equity: 12%
Return on Debt: 8%
Tax Bracket: 31.2% (surcharge revised in Budget 2018)
Also the tax bracket remains 31.2% at the time of withdrawal at the age of 60.

Alternatively, Amit can pay tax on this Rs 50,000 and invest the remaining amount (i.e. 50,000 * (1-31.2%) = Rs 34,400) in Equity Mutual fund which gives return of 12% annually.

Also Read: NPS Tax Benefit u/s 80CCD(1), 80CCD(2) and 80CCD(1B)

Updated Comparison: After introduction of Long Term Capital Gains Tax on Equity Mutual Funds in Budget 2018

Should you Invest in NPS to Save Tax u/s 80CCD (1B) – Revised Calculation after Budget 2018

As can be seen in the calculation above, the final amount generated by NPS is 90.47 Lakhs while in case of equity mutual fund its 92.98 Lakhs.

Additionally, in case of NPS you can withdraw maximum of 60% of the total maturity amount which is 54.28 Lakhs. 20% of NPS corpus would be further subjected to 31.2% tax, which means you would be left with net amount of Rs 48.64 lakhs after tax. Rest Rs 36.19 lakhs should be used to purchase annuity.

The proceeds received from this annuity is again considered income and taxed according to marginal tax rate. Also annuities in India have not evolved and the return from varies in the range of 6% – 7%. This makes it a sub optimal investment choice.

In case of investment in equity mutual fund, the long term capital gains in equity mutual fund is taxed at 10.4% (from FY 2018-19). At maturity you have Rs 93.39 Lakhs which after LTCG tax would be Rs 84.38 Lakhs.

If you see the taxation of both NPS and Mutual Funds have changed in last 2 years. So a long term decision (30 years in this case) cannot be made just based on present tax rules.

Download: Free ebook for Income Tax Planning for FY 2018-19

Significant points:

For people in lower tax brackets, investing in Equity Mutual Fund becomes much better option as compared to NPS. This is because the tax outgo is lesser and hence more money is invested in MF.
As the duration of investment goes up the mutual fund option becomes even better due to compounding at higher return rates.
You might be in lower tax brackets at the time of investment; but might fall in highest tax bracket while withdrawing NPS as it would be accumulated over a long period of 25 to 40 years.
With the new rules you can split your withdrawal till the age of 70 – lessening you tax outgo.
You need not purchase annuity if the NPS maturity corpus is less than Rs 2 Lakhs.

Should People nearing Retirement Invest in NPS?

I often get queries by people near retirement that if they can and should open NPS account to get tax benefit u/s 80CCD(1B). Below is my take and you can take your decision accordingly.

Anyone who is below 65 years of age can open NPS account – so technically you can open your NPS account.
Assuming you are 62 years or more and the tax exemption stays for next few years. You can invest 50,000 every year for 3 years. With 10% annual returns your NPS maturity amount would be less than Rs 2 lakhs.
As per rules, you need not purchase annuity if the maturity amount is less than Rs 2 lakhs. So after retirement you can withdraw the amount without much tax burden.
You can also time the withdrawal to a year (but before reaching 70 yeas of age) when the tax liability is lower or split the withdrawal in 10 installments.

Also Read: NPS – Maturity, Partial Withdrawal & Early Exit Rules

Even for lower age people you can start investing Rs 50K for tax saving until its provided for and keep account active by contributing minimum of Rs 1,000 per year.

Conclusion:

Budget 2016 had brought down the tax liability on NPS maturity to acceptable level while Budget 2018 introduced Long term capital gains on equity mutual funds. You get instant tax saving if you choose NPS. You may look to invest in NPS but keep the following in mind:

The NPS tax benefit may be done away in future but you are ready to continue the same with minimum annual investment
Tax on investments keep on changing and tax on both mutual funds & NPS can change in future
Equity Mutual Funds would outperform NPS in most cases
NPS would outperform if compared to fixed deposits (in most scenarios)

Amit

Hi Readers! I am Amit, the mind behind Apnaplan.com I am MBA from NITIE, Mumbai and BIT from Delhi University. This blog is my online diary where I write about my tryst with my investment decisions. In the 400+ posts on this blog you will find articles on Personal Financial Planning, Investments, Retirement Planning, Insurance, Loans, Fixed Deposits, Provident Funds, Stock Markets, Gold, Silver, Real Estate Investment, Credit Cards, Credit Score, Taxation, Inheritance Planning and Reviews on various Financial Products.

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View Comments

Khalandar says:

January 25, 2016 at 2:19 pm

Should I have to show the sorces througwhich I cleared the home loan e. If yes then only agreement of leased document wil be sufficient. And can I deduct hra from the time of closing the home loan
- Amit says:
  
  January 26, 2016 at 1:46 pm
  
  I am sorry could you please rephrase your question - I could not understand.
Warrior says:

January 25, 2016 at 8:20 am

For NPS the investment definition is:
Employee’s own contribution to NPS upto 10% of fixed salary (Basic+DA)is eligible for deduction within overall limit of 1,50,000 of 80C. Employee can also claim additional Rs 50000 in 80CCD1 in addition to above 80C limit of Rs 1,50,000.

I have already exhausted my 80 C limit of 1.5L. I have not yet invested in NPS. If i invest only Rs. 50K and nothing before that in NPS, can i straightaway clim it under 80CCD1 ?
- Amit says:
  
  January 25, 2016 at 10:06 am
  
  Yes you can invest 50K in NPS and claim tax exemption u/s 80CCD(1B)
khalandar azad says:

January 24, 2016 at 8:12 pm

hi amit,
for this FY my gross salary is 675400,
i closed a home loan of 12 lacs by leasing my new constructed house for 9 lacs in nov 2015 and presently staying in a rented house . my nps contribution is 61158.
since the ppl amount of home loan comes in sec 80 c , can i use my nps contribution of 50000 in 80 ccd (1B) and 11158 in 80c
- Amit says:
  
  January 24, 2016 at 8:46 pm
  
  Yes you can take tax advantage of investment in NPS (Tier 1) account in whatever section you want. So yes you can take tax benefit of Rs 50K u/s 80CCD(1B) and rest under sec 80C.
  - khalandar azad says:
    
    January 24, 2016 at 10:46 pm
    
    under section 80c 1)LIC =5430 2)KGID 30000 3)GIS 2160 4)PLI 5)principal of home loan 1200000 6) NPS 61158 put togeter amounts to be nearing 1300000 (thirteen Lacs) in this exemption of 1.5 lacs can be availed .
    under this .section
    my question is,,can i place 50000 of NPS under 80CCD(1b) and only 11158 in 80c..pls clarify
    - Amit says:
      
      January 24, 2016 at 11:21 pm
      
      Yes you can place 50000 of NPS under 80CCD(1b) and only 11158 in 80c
rakhee says:

January 23, 2016 at 5:28 pm

I HAVE OPENED AN NPS ACCOUNT ON MY OWN AND INVESTED RS. 150000/- UNDER NPS TIER-II. CAN I CLAIM DEDUCTION UNDER SEC. 80C?
- Amit says:
  
  January 24, 2016 at 8:04 pm
  
  No the tax exemption is only available for investment in NPS Tier - 1 account. Recommend you to shift your investment from NPS Tier - 2 to Tier 1 to get tax benefit.
Kashmiri Lal Saini says:

January 23, 2016 at 11:19 am

Good morning
In total I have saved Rs 245498-00
Including Rs 44646-00 in NPS
Can I take benefit of tax deduction on this amount under section 80CCD(1B) on this amount of NPS
- Amit says:
  
  January 24, 2016 at 8:11 pm
  
  Yes you can consider your investment of Rs 44K in NPS - Tier 1 account for tax benefit u/s 80CCD(1B)
Sanjay says:

January 22, 2016 at 12:38 pm

Is money deducted from salary every month and govt.contribution in same amount in NPS will be taxable on retirement.
- Amit says:
  
  January 22, 2016 at 1:22 pm
  
  Yes the lumpsum withdrawal part out of total maturity NPS (Tier 1) amount would be added to the income for the year and taxed at marginal tax slab.
Yogesh Dave says:

January 20, 2016 at 10:41 pm

One query. Can a person, who will complete 60 years of age before 31/03/2016 open a Tier I NPS account this year & avail additional tax benefit ?
If yes, how will this investment be returned to investor after completion of 60 years ?
- Amit says:
  
  January 21, 2016 at 11:10 am
  
  Yes any person before completing age 60 can open NPS account and get additional tax benefit. You can read NPS withdrawal rules details here. As the total maturity amount would be less than Rs 2 Lakh you will get lumpsum as maturity amount.
Rad says:

January 19, 2016 at 10:46 am

Hi,

I can see that the 15k which is saved by a person in 30% bracket due to the investment in NPS is not factored in the calculation. If the amount of tax saved due to investment is invested into some equity plan, wont the benefit be greater than what you get by investing the after tax amount in MF?
- Amit says:
  
  January 19, 2016 at 10:58 am
  
  Amount invested in NPS is Rs 50K while in Mutual Fund is Rs 35K (i.e after deduction of 15K tax).
  - Rad says:
    
    January 20, 2016 at 2:18 pm
    
    Hi Amit,
    
    Query is how the calculation will be impacted if the 15k saved on tax is also invested. So, 50k is invested in NPS which helps a person to save 15k tax and he decides to invest that 15k into a equity plan as you suggest. I believe that will be a double benefit and so should be factored in the calculation.
    - Rad says:
      
      January 21, 2016 at 2:15 pm
      
      Hi Amit,
      
      Reason for adding 15k is coz of tax savings due to contribution to NPS. When tax is already paid now in the second case, I will not have the surplus 15k to invest in MF. So 15k can only be added to the NPS side of calculation and not to the other.
      
      Thank you.
      
      Regards,
      Radhesh
      - Amit says:
        
        January 21, 2016 at 2:56 pm
        
        Sorry I disagree :)
    - Amit says:
      
      January 20, 2016 at 2:29 pm
      
      :) So you essentially mean invest Rs 50K in NPS and Rs 15K in equity Mutual Fund. You can do calculation this way but in that case while comparing with Equity mutual fund the investment has to go up from Rs 35,000 to Rs 50,000! Essentially you would be adding Rs 15K on both side of the calculation and end up with same results!
Prahlad says:

January 18, 2016 at 3:08 pm

great explanation with example. Many thanks
Prateek says:

January 18, 2016 at 10:20 am

hi.. I m a govt. employee .. i m currently making annual contribution of 108000 in nps as mandatory contribution @10% from my pay and i am also paying 75000 annually to LIC .. My question is can I break this amount of 108000 into 75000 under 80ccd and 38000 under ccd(1B) to avail the additional tax benefit ??
- Amit says:
  
  January 18, 2016 at 10:36 am
  
  I suggest you to break your NPS investment as Rs 50,000 for CCD(1B) and rest Rs 58,000 for 80CCD. Then you can invest remaining Rs 17,000 in tax saving instrument u/s 80C.