The National Pension Scheme (NPS), a defined contribution pension, is a social security initiative by the Central government. It is one of the very few market-linked hybrid investments providing exposure to equity, corporate bonds and government securities together.

While it is compulsory for Central government employees, this pension scheme is open to employees from the public, private and even the unorganised sectors, except those from the armed forces. For those employed on a contractual basis, self-employed and small business-owners, NPS can be a solid retirement vehicle in the absence of employee provident fund.

And thanks to Budget 2024, NPS warrants our renewed attention now, with the taxman deciding to give more leeway to investments made in NPS.

Here we explain how NPS can be an effective tax-saving investment.

Tax saver

From the perspective of income tax, investments made via NPS qualify as an eligible deduction, thus reducing your tax outgo.

Taxpayers can claim their contribution to NPS (lower of actual and 10 or 20 per cent of their salary (Basic + DA) or gross income respectively, as the case may be), as a deduction up to ₹2 lakh, subject to other deductions claimed.

The salaried taxpayers, however, in addition to the deduction allowed on their contribution, also enjoy deduction on contribution made by the employer, up to 14 per cent of their salary, provided it forms part of the gross total income.

And these investments into NPS are locked-in till age 60, albeit premature withdrawals are allowed with some restrictions. At age 60, up to 60 per cent of your NPS corpus is eligible for lump-sum withdrawal, which will again be exempt from tax, while the remaining 40 per cent can be availed only through annuity and is taxable.

The tweak

Currently, for FY25, employees can claim employer’s contribution to NPS, up to 14 per cent of their salary, where the employer is the Central government or State government and up to 10 per cent, in case of other employers.

The Finance Bill, 2024, amended the above provision to allow up to 14 per cent deduction, irrespective of the employer. But this amendment is only applicable for taxpayers who have opted for the new tax regime, and is effective April 1, 2025.

And thus, this tweak will benefit only corporate-salaried taxpayers opting for the new tax regime.

Corporate NPS

As NPS is not mandatory (other than for Central government employees), an employer has to adopt NPS voluntarily. Entities such as companies, cooperative societies, public sector enterprises, registered partnership firms, amongst others, can adopt NPS.

An employer can adopt NPS along with other retirement benefit schemes and contributions towards NPS in corporate sector can either be from employer or employee only or from both employer and employee in varied proportions. In essence, there is no mandate for the employer to contribute to employees’ NPS account.

Salaried taxpayers who wish to benefit from this increase in exemption limit, have to ensure that their employer adopts NPS as a retirement benefit scheme for its employees. And if the employer has opted for NPS, ensure the investments are made from both the employee’s end and the employer’s end at the optimum level, as illustrated, to avail maximum tax savings.

The subscriber base and AUM of the NPS scheme has been growing steadily at a CAGR of 9.7 per cent and 34.4 per cent respectively between March 2014 and March 2024 (source: NPS Trust). And this tweak might just provide another push and further contribute to the rise of NPS as a leading retirement benefit scheme.

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