The National Pension Scheme is a government-backed savings scheme open to all, but compulsory for government employees. It was launched in 2004, solely for government employees to replace the old pension scheme, but was opened to all sections in 2009. The scheme’s primary aim is to promote retirement planning. NPS is a market-linked scheme, which functions as a mix of a pension and investment plan. Subscribers are allowed to withdraw 60 percent of the corpus after retirement, but the balance amount has to be mandatorily invested in an annuity plan. Investors are free to choose the mix of equity and debt exposure according to their risk profile and return expectations. Being a market-linked scheme, NPS is likely to generate better returns than other savings schemes.
To understand the benefits of NPS, one should have a clear idea of the structure of the scheme. There are two types of accounts under NPS—Tier 1 and Tier 2.
The Tier 1 accounts are further divided into NPS (Central Govt), NPS (State Govt), NPS (Corporate) and NPS (All Citizens Models). There is a difference in rules governing Tier 1 and Tier 2 accounts, but the broad contours are similar. As the NPS has replaced the Old Pension Scheme, the government contributes an amount equal to 14 percent of the basic salary in NPS accounts of its employees.
The basic difference between Tier 1 and Tier 2 accounts is that the former is primarily a retirement account and doesn’t promote withdrawal before retirement. The Tier 2 account can only be opened after opening a Tier 1 NPS account. Private sector employees and self-employed people can invest in a Tier 2 account and withdraw anytime with complete freedom without any lock-in period or penalties.
On the other hand, there are restrictions on withdrawals from a Tier 1 account. Any kind of withdrawal from a Tier 1 account is allowed only after a minimum investment tenure of three years. Only three partial withdrawals are allowed during the entire tenure of the NPS account, that too for specific reasons like medical emergency or marriage. If you want to exit prematurely, you can only withdraw 20 percent of the corpus, while the balance 80 percent has to be invested into an annuity. A Tier 1 NPS account matures at the age of 60 and 60 percent of the accumulated corpus can be withdrawn, while the balance has to be used for an annuity.
NPS has largely been accepted as the default retirement savings scheme in India. Most of the benefits associated with NPS are for investments in Tier 1 accounts. Contributions to an NPS account provides several advantages such as flexibility, tax benefits and returns.
If you do not want to be actively involved in asset allocation, you can choose the auto option. The auto choice options change the allocation mix according to the age of the investor. It starts with a higher allocation to equity when you are young and gradually moves to relatively safer investment assets.
NPS effectively has an Exempt-Exempt-Exempt or EEE status, which means investment, accumulation and withdrawal has been made tax-free in NPS. Investors are allowed to withdraw 60 percent of the corpus after maturity and 40 percent has to be invested to buy an annuity plan. Earlier, only 40 percent of the withdrawal was tax-free, but recently the government made the entire amount tax-free. The 40 percent that has to be invested for an annuity is already tax-free. However, the income from the annuity plan will be taxed as per the income slab.