NPS – National Pension Scheme
What is NPS?
National Pension System(NPS) is a pension scheme offered by the Government of India. It is a voluntary contribution scheme that is market-linked and managed by professional fund managers. It was launched in January 2004 for government employees and later opened to all employees in 2009.
Pension Fund Regulatory & Development Authority(PFRDA) is entrusted as the regulator of NPS. It can be subscribed by employees of Govt. of India, State Governments, and by employees of private institutions/organizations & unorganized sectors.
Under NPS, subscribers regularly contribute to a pension account during their working life. On retirement, the scheme provides a part of the corpus in a lump sum to be withdrawn and the remaining corpus is used for buying an annuity to secure a regular income after retirement.
For government employees, contribution towards NPS Tier 1 is mandatory, but for all others opening an NPS account is purely voluntary. Like any other pension product, NPS has 2 distinct phases.
- Accumulation phase – when you make contributions to the account to build a retirement corpus.
- Distribution phase – when you withdraw a certain amount at regular intervals to fund your retirement expenses.
How to open an NPS account?
Any Indian citizen aged between 18 and 60 years can join this scheme after complying with KYC norms. An NRI can join NPS but the contributions made are subject to regulatory requirements as prescribed by RBI and FEMA from time to time.
However, OCI (Overseas Citizens of India) and HUFs are not eligible for the opening of the NPS account. Also if you change your citizenship, then you have to close the NPS.
NPS account can be opened with Points of Presence (POP), which also act as collection points. Many banks, both private and public sector ones are enrolled as POPs. Many financial institutions act as POPs.
You have to submit the registration form along with proof of identity, address, and date of birth at the POP to open an NPS account. You will be issued a card with a 12-digit unique number called Permanent Retirement Account Number or PRAN.
You can also open an NPS Account online. Click here to open online NPS account.
How NPS works?
NPS is a defined contribution pension system which means that you are going to decide on how much contribution you are going to make regularly for your pension. It does not guarantee any pre-fixed pension on retirement.
Your contributions are invested in a mix of assets as decided by you. Your retirement corpus and the resultant pension are dependent on the returns generated from those assets. The returns in NPS are market-linked i.e. the returns are neither fixed nor guaranteed. It solely depends upon how the markets have performed.
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How is NPS managed?
PFRDA has recognized eight pension fund managers namely SBI Pension Fund, UTI Retirement Solutions Pension Fund, HDFC Pension Management Company, and DSP Black Rock Pension Fund Managers, ICICI Prudential Pension Fund, LIC Pension Fund, and Kotak Mahindra Pension Fund for investing NPS subscriptions.
Dedicated pension fund managers are entrusted with the task of managing the investors’ money. You can choose to invest with any of the fund managers or you can split your investment between two fund managers.
The NPS provides two choices of asset classes for investment:
Active Choice – allows you to decide how your contribution should be invested in different assets. This choice offers three options:
- Asset Class E which invests up to 75% in stocks.
- Asset Class C which invests in fixed income instruments other than government securities.
- Asset Class G which invests only in government securities.
You can choose to invest in one of these funds or split your monthly investment between these three options. Once you cross the age of 50, the following equity allocation matrix will be followed.
Auto-choice or Lifecycle fund – This is the default option that invests your money automatically in line with your age as given in the below table.
Types of NPS Accounts
There are two types of NPS accounts – Tier 1 and Tier 2.
Tier 1 Account
A Tier 1 NPS account is a mandatory and basic retirement account. You can open it with a minimum investment of Rs.500 per month. After that, a minimum investment of Rs.1000 per year is mandatory.
When you are 60 years of age, 40% of the corpus is used to buy an annuity income from a PFRDA-listed insurance company. The other 60% of the corpus can be withdrawn tax-free. If you do not need the lump sum, you can postpone it until the age of 70 years old.
For contributions of up to Rs.2,00,000 per year in the Tier1 account, you are eligible for tax exemptions under section 80C of The Income Tax Act, 1961.
Tier 2 Account
Tier 2 NPS account is a voluntary account which can be opened if you have an existing Tier 1 account. This offers more flexibility in terms of deposits and withdrawals. A Tier 2 account can be opened with a minimum investment of Rs. 1,000. However, unlike a Tier 1 account, you are not obligated to invest once every year. You can withdraw from this account anytime according to your needs.
Also Read – What are ESOPs?
Advantages of NPS
Flexibility: You can choose the asset class type(Active or Auto choice) and the Pension Fund Managers (PFMs) or Pension Funds to manage the investments. You can also switch the Pension Fund once in a year and the investment option or asset class twice in a year.
Low cost: The overall costs in NPS are low. The amount saved on costs is invested and results in higher returns for you.
Safety: NPS is regulated and monitored by PFRDA which is a government body and hence, the safety of investment corpus is guaranteed.
Simple: NPS is easy to open and operate as most banks operate as PoPs.
Portability: NPS account (PRAN) is unique and the employee can transfer the pension account while changing the employer or while relocating.
Online Accessibility: One can access and operate the pension account online through a web-based interface or mobile application.
Disadvantages of NPS
Taxation of the corpus: The tax treatment of the corpus is one of the reasons why many investors do not subscribe to the NPS. Only 60% of the corpus is tax-free when compared to 100% in retirement products such as EPF and PPF. NPS rules require a 40% of the corpus to be put into an annuity, and the pension received from the annuity is again taxable.
Since pension from an annuity is a mix of the principal and the gain, you have to pay tax not only on the gains but also on the invested capital.
Compulsory annuity: You have to compulsorily put 40% of your corpus in an annuity which is low in yield and, also tax-inefficient.
No withdrawals allowed until 60: If you want to use your money to meet other financial goals and needs, it is not possible due to the rigid rules for withdrawals. Even though there is an option to exit before 60 years of age, 80% of the accumulated corpus will have to be put in an annuity and 20% will be available as a lump sum.
No assurance of returns: Though NPS is a safe investment, it does not offer a guarantee of returns.
Tax Benefits of NPS
- If you are an employee, then your contribution is eligible for a tax deduction of up to 10% of the salary (basic plus DA) under Section 80CCD(1) of the Income Tax Act within the overall ceiling of Rs.1,50,000 allowed under Section 80C and Section 80CCE. You can also claim an additional deduction of up to Rs.50,000 under Section 80CCD (1B).
- A self-employed person can contribute 10 percent of his gross income under Section 80CCD (1) towards NPS.