NPS Tax Dilemma: Here's How Much Can You Really Invest

When it comes to planning for retirement in India, navigating the National Pension System can feel like trying to solve a Rubik's cube—confusing, and sometimes frustrating. As more Indians jump on the NPS bandwagon, questions about how much to invest and the associated tax benefits arise. Spoiler alert: it's not just about putting in a few bucks and hoping for the best.

Launched in 2004 and revamped for the general public in 2009, the NPS is a government-backed retirement savings scheme that allows individuals to invest in a mix of equity, corporate bonds, and government securities. One of its main attractions is the tax benefits it offers.

Under Section 80C of the Income Tax Act, an individual can claim deductions of up to Rs 1.5 lakh on NPS contributions. Moreover, an additional deduction of Rs 50,000 is available under Section 80CCD(1B), bringing the total potential tax deduction up to Rs 2 lakh. According to the Income Tax Department, this means one can save a maximum of Rs 60,000 in taxes (assuming the highest tax bracket of 30%).

“These tax benefits make NPS an attractive option for investors looking to save on taxes while securing their retirement," said Gajendra Kothari, managing director and chief executive officer of Etica Wealth Management.

But the question remains—how much can one actually invest and still optimise these benefits?

While the official contribution limit for tax deductions may be capped at Rs 2 lakh, the reality is that the NPS allows one to invest much more. The minimum contribution to the NPS is Rs 500 per month (or Rs 6,000 annually), while the maximum is Rs 2 lakh for individual taxpayers and an unlimited amount for corporate entities.

“Investors should not treat the Rs 2 lakh limit as a cap on how much they can invest. The more you invest, the better your retirement corpus will be. But yes, tax benefits are capped," Kothari emphasised.

For many taxpayers, the additional Rs 50,000 deduction under Section 80CCD(1B) can be a game-changer. This provision is particularly useful for those looking to maximise their tax-saving potential.

A study by the Financial Planning Standards Board found that nearly 40% of Indian taxpayers were unaware of this additional deduction, which could lead to substantial savings. If one is looking to reduce taxable income further, they can take full advantage of this benefit.

If one is employed, there is good news: an employer can also contribute up to 10% of an employee's (basic + dearness allowance) to the NPS account. Employer contributions are also be eligible for tax deductions under Section 80CCD(2).

“This is a golden opportunity for employees to boost their retirement savings while enjoying tax benefits,” Kothari explained.

If an employer is contributing, one can factor this into overall retirement planning.

As with any investment, it's essential to consider how much is “too much.” The NPS has a lock-in period until retirement, which means that funds contributed will not be easily accessible. While this encourages disciplined saving, it is vital to balance NPS investments with other financial needs.

“The primary goal should be to build a solid retirement corpus, not just to maximise tax deductions,” Kothari said. It’s crucial to ensure that NPS contributions don’t hinder one's ability to meet short-term financial goals.

Some may wonder if investing more than Rs 2 lakh in NPS is worth it. The NPS not only provides a structured retirement plan, but also a range of investment options tailored to different risk profiles.

Further, the returns on NPS investments can be attractive. According to the Pension Fund Regulatory and Development Authority, the NPS has delivered annualised returns of around 9% over the last decade.

“NPS is not just about tax benefits, it's about creating a reliable source of income post-retirement. The sooner you start, the better,” said Kothari.