National Pension Scheme (NPS) – An Indian Govt Approved Pension Scheme
Like any other western country, India also cares for its citizens and desires to support them during retirement. Thus, the Indian Government has crafted its pension scheme known as the National Pension Scheme (NPS). Being a government-sponsored pension scheme, NPS was launched in 2004 by the Pension Fund Regulatory and Development Authority of India (PFRDA). The scheme especially was invented to guard the financial future of the individuals after retirement. In the NPS scheme, subscribers are required to regularly make contributions towards their NPS account during their working life, and benefits of the regular annuity would be availed after they retire. Moreover, in case of any eventualities, subscribers can do a partial withdrawal from their NPS account.
Over the past few weeks and months, the National Pension System (NPS), a voluntary, long-term investment plan for retirement under the purview of the Pension Fund Regulatory and Development Authority (PFRDA) and Central Government, has endured a dramatic revamp. Although most of the reforms pertain to government employees, its key tax reform applies to everyone, including private-sector employees and the self-employed. This tax reform enables the NPS corpus to be tax-free on maturity, thereby making it one of the most attractive retirement option.
In this blog, Fintra will enlighten you on everything related to NPS by putting the limelight on the following topics:
- What is NPS (National Pension Scheme)?
- Who can invest in NPS?
- Features & Benefits of NPS
- National Pension Scheme Returns
- National Pension Scheme Tax Benefits
- What are Two Types of NPS Accounts?
- Comparing the NPS scheme with other Tax Saving Instruments
- How to Open an NPS Account?
What is NPS (National Pension Scheme)?
The National Pension System (NPS), earlier known as the New Pension Scheme, is a social security initiative by India’s Government. This pension program is for all employees belonging to the public and private sectors, excluding armed forces. It encourages individuals to invest in a pension account at regular intervals during their course of employment. After retirement, the applicants can withdraw a certain percentage of the corpus. As an NPS account holder, the remaining amount will be received as a monthly pension post your retirement. For example, it’s stated that after three years of opening the account under specific situations such as sponsoring a child’s education, purchasing a home, or treating any critical illnesses, the scheme will allow the subscribers to make partial withdrawal up to 25% of the contribution. Anyone who’s an Indian citizen aged between 18 years to 60 years can open the National Pension Scheme account. Regulated by PFRDA, NPS matures at the age of 60 years and can extend up to 70 years.
Earlier, this scheme was pertaining only to the Central Government employees. However, in recent years, the PFRDA has made it open to all Indian citizens on a voluntary basis. NPS scheme retains tremendous value for those who work in private sectors and requiring regular pension after retirement. The scheme is flexible and portable across locations and jobs, including possessing tax benefits under Section 80C and Section 80CCD. In the NPS scheme, in a financial year, the contributors may make a minimum contribution of Rs. 6,000, which can be paid as lump-sum or as monthly instalments of minimum Rs. 500. Moreover, the contribution made by the subscribers gets invested in market-linked instruments such as debt and equity. The returns depend on the investment’s performance. Based on the contribution made, the current interest rate of NPS is 8-10%.
Who can invest in NPS?
Whoever desires to prepare for their retirement early on and possess a low-risk appetite, the NPS scheme is definitely a good option to opt for. A regular pension or income during the retirement years will be a boon, especially for those retiring from private-sector jobs. A systematic investment such as this scheme will affect massively and bring a difference to the individual’s life post-retirement. In fact, the salaried people who desire to take advantage of the 80C deductions may also consider opting for this scheme. The eligibility criteria for opening an NPS Account and of the Scheme can be found here
Features & Benefits of NPS
Following are some of the benefits of the National Pension Scheme (NPS):
- Returns/Interest
A portion of the contribution made by the individual towards the NPS scheme gets invested in equities. Although NPS provide higher returns than other traditional tax-saving investment like PPF, at times, it may not provide guaranteed returns. With an interest rate ranging from 9%-12%, this plan is entirely suitable for those who desire to accumulate funds in the long-term and financially secure their life after retirement. Moreover, one advantage of NPS is the facility of changing the fund manager if you are not satisfied with the fund's performance.
- NPS Tax Benefit
Another NPS benefit given to individuals is the tax benefits. The contribution done towards the NPS scheme up to the maximum limit of Rs. 1.5 lakhs will be eligible for tax exemption under Section 80C of the Income Tax Act. Moreover, the contributions made by the employer and the employee are also applicable for the tax exemption.
- Premature Withdrawals and Exit Rules
Since this is a pension scheme, it is compulsory to invest in NPS until the age of 60. However, if you've been investing for three years from the date of opening the NPS account, you can do partial withdrawals of up to 25% of the total contribution made. However, this is only applicable under specific situations such as sponsoring a child’s marriage or education, purchasing/building a house, or in cases of a medical emergency. Subscribers are allowed to make a withdrawal up to three times with intervals of five years in the entire tenure. These rules are only imposed on Tier I accounts and not on Tier II accounts.
- Withdrawals Rules After 60 Years of Age
In this scheme, as a rule, it's stated the subscriber can't entirely withdraw the accumulated funds from the account after retirement. It is mandatory to set aside at least 40% of the acquired funds to receive a regular annuity from the PFRDA registered insurance firm. The remaining 60% of funds are tax-free.
- Equity Allocation Rules
In NPS, as per the equity allocation rule, the investors may allocate a maximum of 50% of the investment in equities. They have two options of investments to invest in, active choice and auto choice. In active choice, the investor can choose their fund and split the investment according to its risk appetite and suitability. On the other hand, in auto choice, the investment is done by analyzing the risk profile and the age of the investor.
- Risk Assessment
Currently, there's a cap between the range of 75% to 50% on equity exposure of the NPS scheme. This 50% cap is for government employees. In the prescribed range, the equity portion reduces by 2.5% every year commencing from the year when the investor turns 50 years old. Thus, this balances the risk-return equation for the investor, the invested funds remain safe from the volatility of the equity market. As compared to other fixed-income schemes, the NPS scheme gives higher earning potential.
- It is Voluntary
During a financial year, a subscriber can contribute anytime it wishes towards the scheme, and it can even change the amount it desires to invest every year.
- Offers Flexibility
The National Pension Scheme provides flexibility- The subscribers can pick their investment option, pension fund, and view their investment grow.
- It is Simple to Open NPS Account
To open the account, the subscribers can visit the eNPS website (https://enps.nsld.com/eNPS). They can also visit any one of the Point of Presence (POP).
- It is Regulated by PFRDA
Pension Fund Regulatory and Development Authority of India (PFRDA) regulates the NPS scheme by regularly monitoring, and with transparent investment norms, NPS provides transparency and reliability to its subscribers.
- Provides Option to Change the Fund Manager or the Scheme
One another benefit of NPS is the provision of allowing investors to change their fund manager or the pension scheme if satisfaction isn't achieved while observing the scheme's performance. This option is available for Tier I and Tier II accounts.
These are just a few advantages of NPS, but this scheme also has some disadvantages. Click here to know the disadvantages. On the whole, we can conclude the NPS scheme can be termed to be a more secured scheme than any other high return options, including mutual funds. Individuals who possess a low-risk appetite and desire higher returns on their investments, more than what PPF, EPF, and other similar schemes provide, can opt for the NPS scheme. They can invest more in Tier 2 account while maintaining their Tier 1 account.
National Pension Scheme Returns
NPS scheme's rate of interest isn’t fixed, but its returns are based on the market performance of the funds because they’re invested in market-linked securities. The subscriber's contributions made toward this scheme can be invested in four varied asset classes, equities, government bonds, corporate bonds, and alternative assets through different pension funds. The returns provided by these pension funds depend on the bonds and stocks market performance.
In general, the National Pension System (NPS) consists of four asset classes. The Asset Class E invests in stocks or equities, the Asset Class C invests funds in Corporate Bonds, in the Asset Class G funds are invested in Central and State Government Bonds, and in Asset Class A the investments are made in alternative assets like Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InVITs).
National Pension Scheme Tax Benefits
Under Section 80C of the Income Tax Act, the NPS scheme allows tax exemption on contributions made toward it up to the maximum limit of Rs. 1.5 lakh. Moreover, the employer and the employee contributions are both applicable for tax exemption.
- 80CCD(1) - Under this section, the maximum deduction of up to 10% of the salary will be claimed for tax exemption. For self-employed taxpayers, this limit is 20% of the gross income.
- 80CCD(2) - This section covers contributions done by the employers towards the scheme. Do bear in mind that this benefit doesn't apply to self-employed taxpayers. The maximum amount entitled to tax exemption is the lowest of the Actual NPS contribution by employer, 10% of Basic + Dearness Allowance, and Gross total income.
Individuals can claim an additional self contribution of up to Rs. 50,000 under section 80CCD(1B) as NPS tax benefit. Speaking about tax benefits on NPS returns, they are market-linked, thus, they depend on the performance on the broader market performance. However, the returns earned on investments are entirely tax-exempt. With regards to the tax benefits on maturity, since the NPS account matures at 60 years of age, only 60% of the accumulated corpus is allowed to be withdrawn at the time of maturity, and as a mandatory rule, it's a must to invest rest 40% of the corpus in an annuity. Therefore, this enables NPS to a completely tax-free investment product.
What are Two Types of NPS Accounts?
NPS offers two types of accounts:
- This account provides a tax deduction under Section 80C up to Rs. 1.5 lakh per annum along with an additional amount of up to Rs. 50,000 per annum under Section 80CCD (1B).
- This is a non-withdrawable permanent retirement account. Upon maturity, when the subscriber has reached the age of 60, it can withdraw 60% of the corpus that is tax-free, and another 40% is mandatorily used to purchase an annuity. The balance 20% can be used to purchase an annuity or be withdrawn after paying tax. However, as per the declaration made in the Union Budget 2019, the NPS corpus which can be withdrawn at the time of retirement, 60% of the total accumulated corpus will be tax exempt from FY 2020-21. This makes NPS be on par with other saving schemes like PPF and EPF in terms of tax treatment.
- Tier II Account is the voluntary retirement-cum-savings account that can only be opened if you have the Tier I account. Subscribers can freely invest or withdraw their funds anytime as per their convenience. The account possesses no tax deductions for private-sector employees or self-employed.
- During the Union Budget 2019, the finance minister Nirmala Sitharaman proclaimed that from FY 2020-21, the tax benefits can be claimed on Tier II accounts contributions but it'll have a lock-in period. Thus, this makes NPS at par with Equity Linked Saving Schemes (ELSS).
Comparing the NPS scheme with other Tax Saving Instruments
Along with NPS, there are other popular tax saving investment instruments available, too. They are the Public Provident Fund (PPF), Equity Linked Savings Scheme (ELSS), and tax-saving fixed deposits (FDs). The following table displays the comparison between NPS and other tax-saving instruments:
|
Investment |
Interest |
Lock-in period |
Risk Profile |
|
NPS |
9% to 12% |
Till retirement |
Market-related risks |
|
ELSS |
12% to 15% |
3 years |
Market-related risks |
|
PPF |
8.1% (guaranteed) |
15 years |
Risk-free |
|
FD |
7% to 9% (guaranteed) |
5 years |
Risk-free |
From the above table, we can note NPS can earn higher returns than FDs or PPF, however, upon reaching maturity, it’s not as tax-efficient as the other investment options. For instance, one can only withdraw up to 60% of the accumulated amount from the NPS account, and out of this, 20% is taxable. Please note: Taxability on NPS withdrawal is subject to change.
One positive aspect of the National Pension Scheme (NPS) is that it has equity allocation. However, the equity allocation isn't as much as tax-saving mutual funds. Moreover, Equity-Linked Savings Schemes, which invest primarily in equities, can generate higher returns than NPS. Even the lock-in period of tax-saving mutual funds is lesser than NPS, only three years compared to the NPS. In the long run, for those who are aggressive risk-seekers, equity exposure by NPS will not be sufficient. For this reason, ELSS meets that requirement along with serving investors with a better and more risk-appetite.
How to Open an NPS Account?
The Pension Fund Regulatory and Development Authority of India regulates the National Pension Scheme, and it offers an online and offline process of opening an NPS account. Let’s glance at how to open an NPS account both ways:
Online Process
To open an NPS account online, it is vital to link the account to your PAN, Aadhaar, and mobile number. For opening an NPS account online follow the below steps:
- Visit the website of enps.nsdl.com
- Pick the type of subscribers from the available options such as ‘corporate subscriber’ and ‘individual subscriber’
- Select the appropriate residential status- Option includes “India Citizens” and “NRI”
- Choose either Tier I account type or both the accounts as it is mandatory for long-term savings
- Enter PAN details and pick a suitable POP or bank
- Click on the registration tab and opt for the option of registering with Aadhaar
- Feed-in the Aadhaar number and click on the option of generating OTP
- OTP will be received on the registered mobile number
- Enter the OTP along with your personal information, bank details, and nomination details
- When the application form has successfully been submitted, the Permanent Retirement Allotment Number (PRAN) will be allotted to you
- Once you submit the e-signature along with a photograph, OTP will be sent to the registered mobile number
- Once again enter the OTP to verify the signature and proceed to make payment via net banking.
- Once the payment is successfully completed, the permanent retirement account number will get generated
Offline Process
For opening an NPS account offline, you will have to find PoP. Once you've submitted the required documents along with the application form and made the initial investment, the point of presence will send you a Permanent Retirement Account Number (PRAN). The PRAN number and password will arrive in a sealed welcome kit, this will enable you to operate your account. The offline process of opening the NPS account will require you to make one-time registration fees of around Rs.125. Follow the steps below to open an account offline:
- Pick the status of the bank account, for example, repatriable or non-repatriable
- Provide the NRE or NRO bank account details along with a scanned copy of your passport
- Select the appropriate communication address- either overseas address or permanent address
- Later on, when the permanent retirement account number (PRAN) has been allotted, you will have to proceed further for the authentication
- If you desire to opt for the e-sign option, you'll need to pick the option of e-sign from the E-sign/ print & courier page
- An OTP will be sent on the registered mobile number for authentication. Please Note: The mobile number must be linked with your Aadhaar Card
- After the Aadhaar authentication, the registration form will successfully be signed
- Do bear in mind, a service charge will be applicable for NRIs for E-signing the registration form
Conclusion
In a nutshell, the National Pension Scheme (NPS) due to its advantages it has become one of the most popular annuity products in India. As the above information reveals, investing in the NPS scheme provides an advantage over other fixed-income schemes for its investors along with offering the perk of tax exemption Under Section 80C and 80CCD of the Income Tax Act. Although this scheme has a lock-in period till retirement, it allows premature withdrawals under specific circumstances. NPS scheme also provides its investors with the authority to allocate their investment. They can pick the option of investing in funds either manually or automatically.
If you're considering investing in the NPS scheme, do glance at the benefits elaborated above and check whether it matches your risk profile and investment goals. However, Fintra does caution you that if you desire to have more equity exposure, then there are various mutual funds in the market that cater to investors from diverse backgrounds. It can be very taxing for researching, shortlisting, and finalizing on a scheme, but not to worry, Fintra is here to be your guide! Contact us or browse through the various information we've crafted about the best-performing funds from the top fund houses and schemes on our website.
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