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Employee, Employer, NPS Vatsalya and UPS Explained
The National Pension System (NPS) offers tax benefits at different stages of contribution, but not every NPS deduction works in the same manner. The tax treatment depends on who contributes to the pension account, whether the taxpayer is under the default tax regime, and whether the contribution relates to a regular NPS account, NPS Vatsalya or the Unified Pension Scheme (UPS).
From Tax Year 2026-27, the relevant framework is primarily contained in Section 124 of the Income-tax Act, 2025, together with paragraph 1(y) of Schedule XV.
One important distinction is that an individual's own NPS contribution is not dealt with entirely by Section 124. The regular contribution is first covered by Section 123 read with Schedule XV, while Section 124 provides the additional deduction, employer-contribution deduction and specific provisions relating to NPS Vatsalya and UPS.
Section 80CCD is now mapped to Section 124
Under the Income-tax Act, 1961, taxpayers generally recognised NPS deductions through Section 80CCD. Under the Income-tax Act, 2025, these provisions have been reorganised.
| Subject | Income-tax Act, 1961 | Income-tax Act, 2025 |
|---|---|---|
| Regular own NPS contribution | Section 80CCD(1) | Section 123 read with paragraph 1(y) of Schedule XV |
| Additional NPS deduction up to ₹50,000 | Section 80CCD(1B) | Section 124(3) |
| Employer's contribution | Section 80CCD(2) | Section 124(1) and 124(2) |
| NPS Vatsalya contribution | Section 80CCD(1B) | Section 124(4) |
1. Deduction for an individual's own NPS contribution
Where an individual contributes to his or her own eligible NPS account, the basic deduction is covered by Section 123 read with paragraph 1(y) of Schedule XV.
The eligible contribution is subject to the following limits:
- Employee: up to 10% of salary;
- Other individual, including a self-employed person: up to 20% of Gross Total Income.
The amount claimed under Section 123 also forms part of the overall ₹1,50,000 ceiling applicable to that section.
For this purpose, salary includes dearness allowance where the terms of employment provide for it, but excludes other allowances and perquisites.
2. Additional NPS deduction of up to ₹50,000 under Section 124(3)
Section 124(3) provides an additional deduction of up to ₹50,000 for an individual's contribution to an eligible pension scheme notified by the Central Government.
This deduction is separate from the ₹1,50,000 ceiling applicable under Section 123.
Suppose an eligible taxpayer contributes ₹2,00,000 to NPS and satisfies the applicable percentage-of-salary limit. Subject to all other conditions, ₹1,50,000 may be considered within the Section 123 ceiling and a further ₹50,000 may be claimed under Section 124(3).
However, the same contribution cannot be claimed twice. If an amount has already been claimed under Section 123, that exact amount cannot again be claimed under Section 124(3).
3. Employer contribution to NPS under Section 124(1)
Where an employer contributes to the NPS account of an employee, Section 124(1) allows the employee a deduction for the eligible employer contribution.
The maximum percentage depends on the employer and the applicable tax regime.
| Employer / tax position | Maximum deduction |
|---|---|
| Central Government or State Government employer | 14% of salary |
| Other employer where employee has opted out of the default regime | 10% of salary |
| Other employer where employee is taxable under the default regime under Section 202(1) | 14% of salary |
The eligible deduction under Section 124(1)/(2) is available even when the employee remains under the default tax regime. This makes employer NPS contribution different from most investment-linked Chapter VIII deductions.
Example: employer NPS contribution
Assume an employee of a private company has salary of ₹12,00,000 for the relevant Section 124 calculation and the employer contributes ₹1,56,000, or 13% of salary, to the employee's eligible NPS account.
If the employee is taxed under the default regime, the Section 124 ceiling for a private employer becomes 14% of salary.
Since the actual contribution of ₹1,56,000 is only 13% of salary, the entire ₹1,56,000 can qualify, subject to the remaining provisions of the Act.
If the employee had opted out of the default regime, the deduction for a private employer would ordinarily be restricted to 10% of salary, i.e. ₹1,20,000.
Own contribution vs employer contribution
| Contribution | Default regime | After opting out of default regime |
|---|---|---|
| Own contribution under Section 123 / Schedule XV | Not available | Available subject to limits |
| Additional ₹50,000 under Section 124(3) | Not available | Available subject to conditions |
| Employer contribution under Section 124(1)/(2) | Available | Available |
4. NPS Vatsalya deduction under Section 124(4)
NPS Vatsalya is designed for minor Indian citizens. The account is opened and operated by a parent or guardian on behalf of the minor.
Section 124(4) allows a parent or guardian to claim a deduction for eligible contributions made to the minor's pension account.
However, there is an important combined limit.
The aggregate deduction under Section 124(3) for the taxpayer's own pension contribution and Section 124(4) for NPS Vatsalya cannot exceed ₹50,000 in a tax year.
Example
Suppose a parent contributes:
- ₹35,000 to his own NPS account for additional deduction under Section 124(3); and
- ₹30,000 to his child's NPS Vatsalya account.
The combined contribution is ₹65,000, but the maximum aggregate deduction under Sections 124(3) and 124(4) would be ₹50,000.
The contribution-stage deduction for NPS Vatsalya is not available under the default tax regime. However, specified exemptions relating to qualifying withdrawals and exit can continue to apply irrespective of the regime, subject to the statutory conditions.
NPS Vatsalya withdrawal tax treatment
The Income-tax Act, 2025 also contains specific provisions for amounts received from NPS Vatsalya.
- Eligible partial withdrawals of up to 25% of the contribution made by the parent or guardian may be excluded from total income subject to Schedule III and applicable NPS conditions.
- On eligible closure or exit, lump-sum withdrawal up to 60% of the corpus is exempt subject to Schedule II.
- An amount used for purchasing an annuity in the same tax year is not treated as an amount received for the purpose of Section 124.
- If the minor dies and the account is closed, the amount received by the parent, guardian or nominee is not treated as that person's income under the specific Section 124 provision.
5. What is the Unified Pension Scheme (UPS)?
The Unified Pension Scheme (UPS) was introduced by the Central Government as an option under the National Pension System for eligible Central Government employees.
UPS became operational from 1 April 2025 and is structured around contributions to an individual corpus together with a separate pool corpus used for providing assured payouts, subject to the scheme conditions.
The Income-tax Act, 2025 specifically recognises UPS within Section 124 and the relevant schedules.
Tax treatment of employee and Government contributions under UPS
Under the UPS framework, the Central Government contributes 10% of monthly emoluments comprising Basic Pay and Dearness Allowance to the employee's individual corpus.
This contribution qualifies under Section 124(1), subject to the applicable tax provisions.
The employee's own eligible contribution to the individual corpus is treated under the corresponding NPS contribution provisions, including Schedule XV and Section 124 where applicable.
The Central Government also makes an additional contribution to the UPS pool corpus. PFRDA's current UPS guidance states that the 8.5% contribution made at an aggregate level directly to the pool corpus is not a contribution to the employee's individual corpus and is therefore not treated as salary or a taxable perquisite in the employee's hands.
Tax treatment when money moves from individual corpus to UPS pool corpus
Section 124(12) addresses an important part of the UPS structure.
Where the relevant amount is transferred from the subscriber's individual corpus to the pool corpus on superannuation, voluntary retirement or specified retirement under Fundamental Rule 56(j), the amount is deemed not to have been received by the subscriber for tax purposes at that stage.
A qualifying internal transfer from the UPS individual corpus to the pool corpus does not itself trigger taxation merely because the funds have moved between the two UPS components.
UPS withdrawal and payout taxation
The Income-tax Act, 2025 provides specific exemptions for eligible UPS receipts.
- An eligible withdrawal from the individual corpus at retirement can be exempt up to 60% of the total individual corpus, subject to Schedule II.
- The prescribed UPS lump-sum amount payable under the scheme is separately covered by an exemption under Schedule II, subject to the applicable conditions.
- Eligible partial withdrawal from the individual corpus is exempt up to the prescribed 25% of the subscriber's own contribution.
- Regular monthly UPS payouts received by the retired employee are taxable as pension income in accordance with the applicable provisions.
Tax treatment when an NPS account is closed or the subscriber opts out
Section 124 also deals with amounts received from an NPS account where a deduction was previously claimed.
Broadly, where the accumulated amount and earnings are received because the account is closed or the subscriber opts out, the amount may be treated as income in the year of receipt, subject to the specific exemptions available under the schedules.
For a regular NPS account, Schedule II provides an exemption for up to 60% of the total amount payable on eligible closure or opting out.
Further, where an eligible amount is used to purchase an annuity plan in the same tax year, Section 124 provides that the taxpayer is not regarded as having received that amount at that stage.
Partial withdrawal from NPS
Schedule III provides an exemption for qualifying partial withdrawals from NPS, subject to the conditions prescribed under the pension law.
The exempt amount is restricted to 25% of the contribution made by the subscriber. The percentage is applied to the subscriber's own contributions rather than the entire accumulated value of the NPS account.
What happens on the death of the subscriber?
Section 124 provides relief where the accumulated amount becomes payable to a nominee because of the subscriber's death.
An amount received by the nominee on closure of the NPS account due to the subscriber's death, in the circumstances covered by Section 124, is not deemed to be the nominee's income merely under the withdrawal-tax provision.
A similar specific protection applies where an NPS Vatsalya account is closed because of the death of the minor subscriber and the amount is received by the parent, guardian or nominee.
Complete NPS deduction example
Assume Rohan works for a private company and has relevant salary of ₹15,00,000 for Tax Year 2026-27. He has validly opted out of the default tax regime.
During the year:
- Rohan contributes ₹2,00,000 to his NPS account;
- his employer contributes ₹1,80,000 to his NPS account; and
- he contributes ₹20,000 to his child's NPS Vatsalya account.
Rohan's own contribution
10% of salary is ₹1,50,000. Accordingly, assuming all other conditions are satisfied, up to ₹1,50,000 of his own contribution may fall within the Section 123 framework.
The remaining ₹50,000 may potentially qualify under Section 124(3).
NPS Vatsalya
Rohan has already used the entire ₹50,000 additional deduction limit under Section 124(3).
Since Sections 124(3) and 124(4) share an aggregate limit of ₹50,000, he cannot claim another ₹20,000 deduction for the NPS Vatsalya contribution.
Employer contribution
As Rohan has opted out of the default regime and works for a private employer, the employer-contribution deduction is restricted to 10% of salary.
Therefore:
10% of ₹15,00,000 = ₹1,50,000
Although the employer contributed ₹1,80,000, the deduction under Section 124(1) would be restricted to ₹1,50,000 on these facts.
The ₹1,50,000 Section 123 ceiling, the additional ₹50,000 Section 124 deduction and the eligible employer contribution are separate components. However, every component has its own conditions and the same contribution cannot be claimed twice.
Common mistakes while claiming NPS deductions
- Assuming every NPS contribution is deductible under Section 124: The basic own contribution is primarily covered by Section 123 read with Schedule XV, while Section 124(3) provides the additional deduction.
- Claiming the additional ₹50,000 under the default regime: Section 124(3) is generally not available while computing income under the default regime.
- Ignoring the combined NPS Vatsalya limit: Sections 124(3) and 124(4) together cannot provide more than ₹50,000.
- Applying the same employer limit in every case: Government employers, private employers and taxpayers under the default regime can have different percentage limits.
- Calculating the employer deduction on gross salary: For Section 124, salary has a specific meaning. It includes qualifying dearness allowance but excludes other allowances and perquisites.
- Claiming the same contribution twice: An amount allowed under Section 123 cannot again be claimed under Section 124(3) or 124(4).
- Assuming the entire NPS corpus is tax-free on exit: Tax treatment depends on the type of withdrawal and the specific exemptions provided under the Act.
Key takeaway
NPS continues to have an important place in the deduction framework of the Income-tax Act, 2025, but taxpayers should separate the different components before making a claim.
An individual's regular NPS contribution is covered through Section 123 and Schedule XV, while an additional deduction of up to ₹50,000 is provided by Section 124(3). Employer contributions are separately deductible under Section 124(1)/(2), including under the default tax regime subject to the applicable percentage limit.
Section 124 also extends the additional-deduction framework to NPS Vatsalya and contains specific provisions for the Unified Pension Scheme.
Before claiming the benefit, taxpayers should therefore check who made the contribution, the tax regime applicable, the percentage or monetary ceiling, and whether the same contribution has already been claimed elsewhere.
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