What is NPS?

The National Pension Scheme is a government-backed savings scheme open to every citizen of India, but compulsory for government employees, except people in the armed forces. It was launched in 2004 to replace the Old Pension Scheme for government employees but was opened to all sections of the society in 2009. It is a market-linked scheme, which is a major departure from the earlier defined benefit system. Individuals have to invest in NPS regularly during their working life. After retirement, 60 percent of the accumulated corpus can be withdrawn, while the balance 40 percent has to be compulsorily used to buy an annuity. NPS is regulated and managed by the Pension Fund Regulatory and Development Authority (PFRDA).

Structure of NPS

There are two types of accounts under NPS—tier 1 and tier 2.

  • Tier 1 account: It is the basic pension account with limitations on withdrawals. Tier 1 accounts are further divided into NPS (Central Govt), NPS (State Govt), NPS (Corporate) and NPS (All Citizens Models). Before retirement, only 20 percent of the accumulated corpus can be withdrawn, while the remaining amount has to be used to buy an annuity. The withdrawal is permitted only after a period of three years from opening the account. After the age of 60, individuals are allowed to withdraw 60 percent of the corpus, but the balance has to be used to buy an annuity. An annuity plan ensures regular payments after retirement. In the case of government fund, 10 percent of the employees’ basic salary is deposited by the employer and 14 percent is contributed by the government. Other individuals have to deposit a minimum of Rs 6000 every year.
  • Tier 2 account: It is a voluntary contributions account, from which an individual can withdraw freely without any lock-in period or penalties. Only people who have a tier 1 account are allowed to open a tier 2 account. A minimum contribution of Rs 1000 has to be done at the time of account opening or a minimum contribution of Rs 250 per month can also be chosen. It is compulsory to maintain a minimum balance of Rs 2000 at the end of the financial year.

Features of NPS

The defining feature of NPS is the flexibility it provides with the investment asset and fund managers. The accumulated fund is not invested in a single asset like other savings scheme, rather investors are given a choice to decide the proportion of investment in the four assets offered under the scheme. Subscribers to the scheme are offered two options—active choice and auto choice. Four investment schemes are offered under the active choice. Investment in fixed income instruments is known as Scheme C and in government bonds is known as Scheme G. Investments in equities and alternative investment funds are called Scheme E and Scheme A, respectively.

An investor can put in his/her money in any of the schemes, but investment in the equity scheme is capped at 75 percent. NPS allows you to choose from eight fund managers to manage your investments. If you are not satisfied with the performance, you can change the fund manager once and the allocation mix twice in a year. Anyone between the ages of 16 and 65 can open an NPS account. NPS investments mature at retirement but can be extended for an additional 10 years. Even Non-Resident Indians are allowed to open NPS accounts.

How to open an NPS account?

An individual can invest in NPS easily through Finserv MARKETS in four simple steps.

  • Provide the amount to be invested
  • Complete the payment
  • Complete the Know Your Customer process with required documents
  • Upon a successful transaction, you will get your unique Permanent Retirement Account Number or PRAN.

Benefits of NPS

  • Flexibility: Under the active choice, NPS offers a host of investment options to subscribers. Account holders can choose from four asset classes and decide the asset mix. For people who want to be passive investors, NPS has auto choice. The portfolio under the auto choice is adjusted by the fund managers according to the age of the investor. At a young age, the equity proportion is high, which is gradually decreased as retirement nears. With Finserv MARKETS, the subscriber can switch between fund managers and investment plans.
  • Tax Benefits: The government has announced a slew of tax benefits for NPS investors. A contribution of up to Rs 1.5 lakh in NPS is eligible for tax deduction under Section 80C of the Income Tax Act, 1961. The tax deduction is limited to 20 percent of an employee’s salary and 20 percent of the gross income in the case of self-employed individuals. An additional tax deduction of Rs 50,000 is allowed under Section 80CCD (1B) for contribution to NPS.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. The entire withdrawal amount has been exempted from income tax, while the amount to be invested in an annuity is also tax-free. However, the income from the annuity plan will be taxed as per the income slab.
  • Annuity plan: Even though partial withdrawal may be deal-breaker for people who want to save for specific purposes like child’s marriage or education, it provides a financial buffer for retirement. Account holders have to compulsorily invest 40 percent of the accumulated corpus to buy an annuity plan, which will eventually help to ensure a regular income after retirement.
  • Low-Cost Investment: NPS functions like a mutual fund to an extent. Contributors have an option to invest in equity markets, besides bonds and fixed-income securities. Investors have the freedom to change fund managers and asset mix. All these facilities come at a nominal cost because the scheme is backed by the government. The accumulated corpus is managed by professional fund managers who charge just 0.01 percent to manage the pool of money. In addition to a low management cost, NPS has delivered annualised returns of 8-10 percent over the decade. 

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