The Tax Implications of NPS Withdrawal for Young Professionals

The Tax Implications of NPS Withdrawal for Young Professionals

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The government launched the National Pension Scheme (NPS) as a retirement savings scheme to build a solid financial base for one's post-retirement phase. The Pension Fund Regulatory and Development Authority (PFRDA) manages it and makes it available to the public and private employees, as well as those employed in the unorganized sector. For young professionals starting in the industries they choose, the National Pension Scheme is a wise consideration when they think about the long-term benefits: how it provides a structured contribution, and also the tax advantages associated with it.

NPS Types of Account

Before anything else can be discussed regarding withdrawal-related taxation, it is important to understand that NPS has two kinds of accounts:

Tier I: This is the primary account designated for saving for retirement. The major account carries tax benefits and restrictions on withdrawal.

Tier II: This is a voluntary account for savings, which is much more flexible but does not possess tax benefits under Section 80CCD.

Withdrawal from NPS Tier I Account upon Retirement

According to current rules, when a subscriber attains the age of 60 or retires before retirement, they can withdraw a maximum of 60% of the total corpus accumulated up to that point in a lump sum. The remaining corpus of 40% must purchase an annuity from an insurance company to generate regular income after retirement.

Tax Implications: The 60% lump sum withdrawal is exempt from income tax. This provision aims to align the scheme better with the post-retirement objectives while improving post-retirement liquidity.

Withdrawal before the date of retirement

If a subscriber decides to discontinue the National Pension Scheme before attaining the age of 60 years, the general rules permit him to withdraw only 20% of the total accumulated corpus as a lump sum amount, and the remaining 80% should purchase an annuity.

Tax Implications: The 20% lump sum amount is free of taxes. The annuity purchased by the remaining 80% will be taxed as income in the year it is received.

This taxation is supposed to nudge the subscribers towards long-term investments in the scheme, thereby minimizing early withdrawals, which are likely to affect savings toward retirement.

Partially Withdraw from NPS Tier I Account

As per the guidelines of the PFRDA, a subscriber can take partial withdrawals from the Tier I account in case of certain situations such as medical emergencies, higher education, marriage, purchase or construction of a residential house, or starting a new business; a subscriber can make up to Three Partial Withdrawals through his/her lifetime.

Tax Implications: Partial withdrawals of up to 25% of the subscriber's contributions are exempt from income tax. It is important to note that this withdrawal is not based on the total corpus but only on the subscriber's contribution portion.

For example, if the young professional contributed ₹500,000 to NPS and his employer contributed another ₹300,000, then he may make a tax-free withdrawal of up to ₹125,000 (25% of ₹500,000) under the prescribed conditions.

Withdrawal from Tier II Accounts

Subscribers can withdraw any amount from the Tier II account at any time without restrictions.

Tax Implications: The Tier II account does not provide tax exemption for contributions, nor are the returns or withdrawals exempt from this taxation. The earnings from investments made in Tier II are treated as capital gains and taxed based on the asset class chosen (Equity or Debt) and the acceptance period.

Tax Deduction on Contributions

It becomes beneficial to understand the tax benefit at the time of contribution, which is also essential in NPS withdrawals. Under Section 80CCD(1), deductions of up to ₹1.5 lakh would be allowed, which lie within the overall limit of Section 80C. An additional deduction of up to ₹50,000 may be granted under Section 80CCD(1B) over and above the 80C limit.

Employers can also claim deductions for their contributions to NPS under Section 80CCD(2) up to 10% of the employee's salary (Basic + DA) without any upper monetary limit. These deductions can reduce the current tax liability and improve the net return from the investment in the long run.

Conclusion

The important thing about the above that every young professional has to learn if he or she is planning to have the NPS in the portfolio of finances is to understand the consequences of the tax withdrawal from there.