The unknown strategy to save taxes using NPS!

What is NPS?

The National Pension System (NPS) is a government scheme to help you save for retirement.

You invest regularly, and your money is put into a mix of shares, bonds, and government securities to grow over time.

At retirement, 60% of your savings (including profits) is tax-free, while the remaining 40% is invested in an annuity plan which is used to provide a monthly pension, taxed as per your income tax slab rate. It also offers significant tax relief but only for NPS Tier-I account holders.

Yes, there are two types of NPS accounts. But how does it differ? Let’s find out—

Difference between Tier-1 and Tier-2 Accounts

Here’s a big difference

No tax benefits of Tier-II Funds, but for Tier-I:

This means you can save up to ~₹65,000 or more from tax annually while securing your retirement, with an NPS Tier-I account, while there are no tax benefits for Tier-II accounts.

The Loophole!

Most people choose mutual funds for retirement, frustrated by Tier-I’s high lock-in period and no tax benefits of Tier-II. But what if we told you there’s a loophole?

You can invest in NPS Tier-II for mutual fund-like liquidity and switch to Tier-I at maturity to enjoy tax-saving benefits. Curious how it works?

You can move your Tier-II funds to Tier-I before turning 60 using a One Way Switch. This lets you withdraw 60% of the corpus tax-free, while the rest goes into annuities. And  you can still have easy access to your money, since Tier-II funds are liquid.

Lets understand with the help of an example

Two friends Ramesh and Suresh, aged 25 years, decided to invest ₹5000/ Month for retirement planning. Ramesh chose a mutual fund while Suresh chose the NPS loophole!

Let’s see how their investments turn out!

Step-by-Step Journey of Ramesh and Suresh

Tax Impact: Mutual Funds vs NPS Loophole

Suresh’s strategy not only saved on taxes but also ensured a steady pension income!

Note: This comparison was only with Equity Fund, if Ramesh would have opted for a Debt Fund, his tax liability would have been ₹97,42,903 [₹3,24,76,345  @ 30% (assumed tax rate)].

How to Switch Funds from Tier-II to Tier-I in NPS?

Step 1: Visit the CRA website and download the UOS-S form.

Step 2: Enter your PRAN, personal details, and the amount you want to transfer, along with other details.

Step 3: Take the completed form to your POP-SP (the bank or institution where you opened your NPS account)

Step 4: The POP-SP will verify your PRAN, check your account details, and confirm everything is in order.

Step 5: Once your request is accepted, you’ll get a 17-digit receipt number as confirmation.

Step 6: The POP-SP will handle the rest and process your request in the CRA system.

That’s it! No extra documents needed. Your funds will be moved to your Tier-I account smoothly.

Note: This is a one-way switch. You can move funds from Tier-II to Tier-I, but not the other way around!

Conclusion

For long-term retirement planning, NPS Tier-I is highly tax-efficient, offering deductions on contributions and tax-free withdrawals (60% of the corpus). However, 40% is locked for annuity income, which provides steady retirement payouts.

While mutual funds are liquid and offer diverse options, they attract higher taxes, especially on long-term gains.

For those seeking liquidity and tax benefits, NPS Tier-II offers mutual fund-like flexibility and the option to transfer funds to Tier-I for tax-free maturity. But the 40% lock-in limits access to larger funds for immediate goals.

So, carefully consider your goals, liquidity needs, and the pros and cons of NPS before using this strategy.