Union Budget: NPS taxation changed after Budget 2024; check old vs new tax regime rules for NPS

National Pension Scheme: The National Pension Scheme (NPS) became more attractive for individuals in Budget 2024 in July. The corporate scheme deduction was increased to a maximum of 14% of an employee's basic pay under the new exemptions regime. However, only salaried taxpayers benefited from this tax break.

In Budget 2024, the government made changes to the NPS rules for employees selecting the New Tax Regime. Employees opting for the New Tax Regime were eligible for an increased deduction of up to 14% of their basic salary for employer contributions to their NPS under Section 80CCD(2) of the Income Tax Act. This deduction applied to both public-sector companies and private-sector entities under the new tax regime.

NPS: Old tax vs new tax regime

Given the recent amendments to the National Pension System (NPS) provisions in the Budget 2024, the attractiveness of the Old Tax Regime versus the New Tax Regime might be evaluated as follows:

The Old Tax Regime permits a wide range of deductions and exemptions, including deductions for both employer and employee NPS contributions, as well as a variety of tax-saving instruments. On the other hand, the New Tax Regime offers lower tax rates but limits the deductions and exemptions that can be claimed.

It should be noted that under both regimes, taxpayers can claim a deduction for their employer's NPS contribution under section 80CCD(2). However, only those who opt for the New Tax Regime can avail of the higher deduction of 14% instead of the usual 10%.

The increased allowance of a 14% NPS deduction under the New Tax Regime has made it more attractive, particularly for those who prefer a simpler tax process with fewer deductions to claim. However, if a taxpayer has significant deductions and prefers to leverage them (including the full NPS deduction), the old tax regime might still be more attractive. 

Old Tax Regime for NPS 

Taxpayers who choose the Old Tax Regime can avail tax deductions for their National Pension System (NPS) contributions under three different sections of the Income-tax Act, 1961: Sections 80CCD (1), 80CCD (1B), and 80CCD (2).

In the Old Tax Regime, Section 80CCD (1) of the Income-tax Act, 1961 permits a deduction from the taxpayer's gross total income for NPS contributions. This deduction is available for both salaried and self-employed individuals. Under Section 80CCD(1), salaried employees can claim a maximum deduction of 10% of their salary (Basic + DA), while self-employed individuals can claim up to 20% of their gross total income, with a maximum limit of Rs 1.5 lakh in a financial year.

It is important to note that the total deductions under Section 80C, Section 80CCC, and Section 80CCD should not exceed Rs 1.5 lakh.

Moreover, Section 80CCD (1B) allows for an extra deduction of Rs 50,000 for NPS contributions, on top of the Rs 1.5 lakh limit under Section 80CCD (1). Section 80CCD (2) pertains to the employer's contributions to an employee's NPS account.

Expectations for Budget 2025

The upcoming Union Budget 2025 is viewed by experts and financial planners as a chance to tackle the issues with the NPS and enhance its appeal to a wider range of investors, including those who are self-employed.

“There is no tax benefit for the self-employed individuals in the new regime. So, we hope that the separate deduction limit of Rs 50,000 (section 80CCD(1B) available under the old tax regime will be incorporated in the new tax structure as well,” says Sumit Shukla, CEO, Axis Pension Fund.

Subscribers under the National Pension System (NPS) are eligible to withdraw 60 percent of their corpus without any tax implications once they reach the age of 60. The remaining 40 percent must be utilized to purchase annuities from specified life insurance companies, as per regulations. The extended lock-in period until age 60 poses a significant restriction on accessing funds. 

Limited liquidity is a notable disadvantage of the NPS, despite the option for partial withdrawals. There is a need for greater flexibility in withdrawal policies. 

Additionally, at least 40 percent of the accumulated funds must be converted into taxable annuities. It is recommended that the government consider exempting annuity income from taxes to promote higher investment participation in the NPS.