Private Sector vs Government Employees: Taxation rules on National Pension System (NPS) explained

Sreekanth Nadella, MD and CEO, KFintech said “Any investment towards an NPS account accompanies tax benefits besides other perks, such as a large corpus for post-retirement. But it is different for every employee. If you are a government employee, you can definitely enjoy tax benefits under certain sections. However, the tax benefits and reliefs which a private employee gets are different.” 

NPS tax benefits for private and government employees

As per Sreekanth Nadella, below are the tax benefits available under NPS for private employees and government employees.

1. Tax Benefits for Central Government Employees

Central government employees’ tax exemption limit is ₹1.5 lakh. The lock-in period is around 3 years. There are three different tiers for government employees under the NPS. A central government employee can avail of up to 3 accounts under the NPS – (i) Tier I (mandatory), (ii) Tier II (optional) and (iii) Tier III (optional with a lock-in period and tax benefits under Section 80C).

2. Tax Benefits for State Government and Private Employees

Under Section 80C, the upper limit of tax deductions is ₹1.5 lakh every year. Fund contributions towards the NPS tier 1 account allow a subscriber to claim ₹50,000 as a tax deduction as well.

A private sector employee can also make fund contributions towards NPS tier-II account. They will not be eligible for tax deductions under Section 80C. However, they will continue to remain free from lock-in.

Key points to note under the present Indian tax regime

(i) Zero income tax is charged for income up to ₹2.5 lakh.

(ii) 5% income tax is charged for income in the range of ₹2.5 lakh to ₹5 lakh

(iii) 10% income tax is charged between earnings of ₹5 lakh to ₹7.5 lakh

(iv) 15% tax for income ₹7.5 lakh to ₹10 lakh bracket

(v) 20% for income range ₹10 lakh – ₹12.5 lakh

(vi) 25% for income range ₹12.5 lakh – ₹15 lakh

(vii) 30% for income range above ₹15 lakh.

3. Salary Benefits Available to Government Employees

There are certain exemptions available to government employees. They can claim tax benefits on their NPS contributions towards National Pension Scheme. State government employees can enjoy tax exemptions up to ₹1.5 lakh. The exemption for central government employees has already been made above.

4. Retirement Benefits Available to Government Employees

Under the new pension scheme, retirees can withdraw 60% of the lump sum corpus from their respective NPS accounts. The remaining 40% of the balance will be used to buy a life insurance annuity scheme. Retirees can select any insurance company.

Retiring government employees are eligible for death cum retirement gratuity. After being employed for a minimum of five years, the employee is eligible for this benefit. The gratuity amount is 25% of the basic employee salary plus dearness allowance. Maximum payable retirement gratuity is 16x of basic pay. The maximum limit is Rs. 10 lakhs.

5. Tax Relief Under NPS Tier 1: Both for Private and Govt Employees

Rs. 1.5 lakh deduction is allowed under Section 80CCD (1) Tier I account of the NPS. However, the total amount of deduction should not be beyond ₹1.5 lakh in a single financial year.

Taxpayers can also claim a further exclusive deduction of ₹50,000 through contribution towards NPS tier 1.

Under the new income tax regime, the exclusive deduction of ₹50,000 will not be permitted for employees under the old tax system. However, income tax deductions on employer contributions can be availed in any case.

6. NPS Tier II Account Tax Benefits: For Central Govt. Employees Only

The Tier I NPS account is mandatory for central government employees. The Tier II account is voluntary, and you can choose it of your own accord. You can withdraw your surplus funds anytime.

Under Section 80C (2) (XXV), Section 80C tax benefits can be availed by central government employees. That is if they have NPS Tier–II contributions. The subscribers should complete an NPS of a three-year lock-in period to be eligible for this.