Tax Benefit of NPS Investment

Tax and death are inevitable. Section 80C comes to the rescue of the majority. Section 80D provides further reprieve. Like the frog in the well, we are generally not aware of sections 80CCD(1B) and 80CCD(2). Let us dive deep into the tax benefit of NPS investment.

Updated for FY 2025-26. India now has two income-tax regimes, and the new regime is the default. Most deductions below — 80C, 80CCD(1) and the extra ₹50,000 under 80CCD(1B) — apply only if you choose the old regime. The one NPS tax break that still works in the new regime is the employer contribution under 80CCD(2).

Retirement is the least focussed financial goal for us. Even though products like NPS nudge us to initiate our journey towards a relaxed retirement, we have not made the effort to understand their impact on our pockets — in the present as well as in the future. (Not sure how much you'll need? Our retirement calculator gives you a number in a minute.)

Tax benefit in the accumulation phase

Section 80CCD(1) lets you invest ₹1.5 lakh in NPS as part of your ₹1.5 lakh section 80C limit — the very section that made us invest in ELSS mutual funds, life insurance, provident fund, 5-year fixed deposits, and so on. Like all of 80C, this applies under the old regime.

The magic happens when we come to know that we can further invest ₹50,000 in NPS (over and above the ₹1.5 lakh under section 80C) under section 80CCD(1B) — a deduction available only in the old regime. For someone in the 30% slab, that saves roughly ₹15,600 a year (30% plus 4% cess).

If you are a salaried employee, you can get your salary restructured so that your employer invests up to 14% of your salary (Basic + DA) in NPS under section 80CCD(2) — and this is the one NPS deduction that also works in the new regime (the limit is 14% in the new regime, 10% in the old). This amount is claimed as a deduction from taxable income. Note that employer contributions to EPF, NPS and superannuation above ₹7.5 lakh a year become taxable in your hands.

A self-employed individual can claim a deduction of up to 20% of gross annual income for the amount invested in NPS under sections 80CCD(1) and 80CCD(1B) — under the old regime.

This brings us to the close of tax benefits in NPS during the accumulation period. Let us now understand how it is useful during the withdrawal phase.

Tax benefit in the withdrawal phase

The following withdrawals are tax-free (regardless of regime):

• A premature withdrawal from the NPS corpus (up to the specified limit prescribed under NPS) before the maturity age of 60 years is reached.
• The withdrawal of up to 60% of the corpus on maturity after the age of 60 years.
• On the death of the investor, the full amount that is paid to the nominee.

The pension you receive on a regular basis from the annuity amount is added to your annual income and taxed as per your applicable slab. How much of it is tax-free depends on your regime: in the old regime, the first ₹2.5 lakh is exempt and a ₹50,000 standard deduction applies; in the new regime (FY 2025-26), the basic exemption is ₹4 lakh, the standard deduction is ₹75,000, and a rebate makes income up to ₹12 lakh effectively tax-free.

Exempt, Exempt, Exempt

To sum it up, NPS is a magnificent tool to prepare for retirement as well as to save on tax outgo. The tax benefit is threefold:

• Investing phase — tax-deductible (which deductions you can claim depends on your regime, as noted above).
• Fund growth phase — tax-free.
• Withdrawal phase — 60% lump sum tax-free.

This keeps NPS among the very few instruments in the EEE style — Exempt, Exempt, Exempt. The tax benefit of NPS investment is real, but choose it for the retirement goal first and the tax saving second.

Do not let go of a legitimate opportunity to rationalise your tax outgo. You have worked hard for every penny — and when legal methods are provided to us, not using them is like burning our own money.

For a plain-English deep dive into the NPS — including the deductions and how to choose your mix — grab the free NPS eBook.

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This article is general information, updated for FY 2025-26, and is not personal tax or investment advice. Tax rules change with each Budget and depend on the regime you choose — please confirm your own position with a qualified professional before acting.