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NPS : National Pension Scheme

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National Pension Scheme is a voluntary and long-term investment plan for retirement under the purview of the Pension Fund Regulatory and Development Authority (PFRDA) and Central Government. In this article, we will cover the following aspects of NPS.
  1. What is National Pension Scheme?
  2. Who should invest in the NPS?
  3. What are the features & benefits of investing in NPS?
  4. How to open an NPS account?
  5. What are the types of NPS accounts?
  6. NPS  Vs other tax saving instruments
  7. NPS Vs tax saving mutual funds

1. National Pension Scheme or NPS

The National Pension Scheme is a pension program, a social security initiative by the Central Government. It is open to employees from public, private and unorganized sectors (except people from the armed forces). The scheme encourages people to invest regularly in a pension account during their employment period. After retirement, the subscribers can take out a certain percentage of the corpus. They can use the remaining amount as a regular pension. Earlier, the scheme covered only Central Government employees. However, the PFRDA has made it open to all Indian citizens on a voluntary basis. NPS has immense value for anyone who works in the private sector and may require a regular pension after retirement. Portable across jobs and locations, it also comes with tax benefits specified under Section 80C and Section 80CCD.

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2. Who should invest in the NPS?

The NPS makes a lot of sense for anyone who wants to plan for their retirement from an early age. A regular pension (income) in your golden years can be a godsend, especially for those retired from private sector jobs. The Government provides the pension for public sector employees – but people who have worked in the private sector or unorganized sector do not have that luxury. This is where a systematic investment like this can make a difference. Salaried people looking to take maximum advantage of 80C deductions can also consider this scheme.

3. Features & Benefits of NPS

Returns/Interest

A portion of the NPS is invested in equities which do not offer guaranteed returns. However, it can earn higher than traditional tax-saving investments like the PPF. This scheme has been in effect for over a decade, and so far it has delivered 8% to 10% annualized returns. The scheme allows you to change your fund manager if you find the fund performance below expectations.

Investor’s Contribution

Even though there is no upper limit, there is a minimum investment requirement. You must at least invest Rs. 500 monthly (Tier I account) or Rs. 250 monthly (Tier II account), or Rs.  1,000 annually (Tier I account). If you do not retain the minimum amount, they will freeze your account. You can unfreeze it by paying a penalty at the nearest Point of Presence (PoP) .

Risk Assessment

Currently, there is a 50% cap on equity exposure for the national pension scheme. This stabilizes the risk-return equation in the interest of investors. Hence, the corpus is somewhat protected against the equity market volatility. But it’s earning potential is higher as compared to other fixed income schemes. The PFRDA has proposed to increase the cap on equity exposure to 75%.

Tax-Efficiency

First of all, you can claim a tax deduction for NPS for up to Rs. 1.5 lakhs – for self-contribution and also for the employer contribution.

80CCD(1) covers the self-contribution, which is a part of section 80C. The maximum deduction one can claim under 80CCD(1) is 10% of salary, but no more than the said limit. For the self-employed taxpayer, this limit  is 20% of gross income. Any additional self contribution (up to Rs. 50,000) can be claimed under section 80CCD(1B). Therefore, the scheme allows a tax deduction of up to Rs. 2 lakh in total.

Post 60 Withdrawal Rules

Contrary to common belief, you cannot withdraw the entire corpus after retirement. You must compulsorily keep aside at least 40% of the corpus to receive a regular pension from a PFRDA-registered insurance firm.  Of the remaining 60%, 40% is tax free – the remaining 20% is taxed as per your tax slab.

Early Withdrawal/Exit rules

As a pension scheme, it is strongly recommended that you remain invested until the age of 60. However, if you have been investing for at least  3 years, you may withdraw up to 25% for definite purposes. These include children’s wedding or higher studies, building/buying a house and medical treatment of self/family among others. You can withdraw upto 3 times (with a gap of 5 years) in the entire tenure. These restrictions are only on tier I accounts and not on tier II accounts – scroll down for more details on them.

Equity Allocation Rules

The NPS invests in different schemes and the Scheme E of the NPS invests in equity. You can allocate a maximum of 50% (proposed to be increased to 75%) of your investment in equities. There are two options to invest in – the auto choice or active choice options. The auto choice decides the risk profile of your investments as per your age. For instance, the older you are, the more stable and less risky investments will be chosen for you. The active choice allows you to decide the scheme and how to split your investments.

Option to change the Scheme or Fund Manager

You can change the pension scheme or the  fund manager if you are not happy with their performance. This option is available for both tier I and tier II accounts.

NPS

4. How to open an NPS account

The NPS is regulated by PFRDA and there are a couple of ways to open an account – offline and online.

Offline Process

To open an NPS account manually, find a PoP (Point of Presence) first, which could be an authorized bank. Collect a subscriber form from your nearest PoP and submit it duly filled along with the required KYC papers. Ignore if you are already KYC-compliant with the bank. Once you make the initial investment (not less than Rs. 500 or Rs. 250 monthly or Rs.   1,000 annually), the PoP will send you a PRAN – Permanent Retirement Account Number. This number and the password in your sealed welcome kit will help you operate your account. There is a one-time registration fee of Rs.125 for this process.

Online Process

Gone are the days when starting an NPS account was a tedious process. Thanks to the digital wave, it is now possible to do it in less than half an hour. Opening an account online (enps.nsdl.com) is easy if your account is linked to your PAN, Aadhaar and/or mobile number. Validate the registration using the OTP sent to your mobile. This will generate a PRAN (Permanent Retirement Account Number), which you can use to operate your account.

5. Types of NPS Account 

The two primary account types under NPS are tier I and tier II. The former is the default account while the latter is a voluntary addition. The table below explains the two account types in detail.
   Particulars NPS Tier-I Account NPS Tier-II Account
  Status Default Voluntary
  Withdrawals Not permitted Permitted
  Tax exemption Up to Rs 2 lakh p.a. None
  Minimum contribution Rs 500 or Rs 1,000 p.a. Rs 250  
  Maximum contribution No limit No limit
The Tier-I account is mandatory for everyone who opts for NPS. Central Government employees have to contribute 10% of their basic salary. For everyone else, the NPS is a voluntary investment option.

6. Comparing NPS with other Tax Saving Instruments 

Apart from the NPS, the other popular tax-saving investment options under Section 80C are Equity Linked Savings Scheme (ELSS), Public Provident Fund (PPF) and Tax-saving Fixed Deposits (FD). Here is how they are in comparison to the NPS:

Investment Interest Lock-in period Risk Profile
NPS 8% to 10% (expected) Till retirement Market-related risks
ELSS 12% to 15% (expected) 3 years Market-related risks
PPF 8.1% (guaranteed) 15 years Risk-free
FD 7% to 9% (guaranteed) 5 years Risk-free

The NPS can earn higher than the PPF or FDs, but it is not as tax-efficient upon maturity. For instance, you can withdraw up to 60% of your accumulated amount from your NPS account. Out of this, 20% is taxable. Taxability on NPS withdrawal is subject to change.

 

7. Comparing NPS with ELSS 

The good thing about the National Pension Scheme  is that it has equity allocation, but the equity allocation is still not as much as tax-saving mutual funds. Equity Linked Savings Schemes invest primarily in equities and  have the capacity to generate higher returns than the NPS.

The lock-in period of tax-saving mutual funds is also lesser than NPS – only 3 years as compared to the NPS where you have to stay invested till retirement. Also, if you are an aggressive risk-seeker, equity exposure by NPS won’t be sufficient in the long run. Since ELSS can meet that requirement, it serves investors with more risk-appetite better.

Hence, consider investing in NPS if the benefits elaborated above match your risk profile and investment goal. However, if you are open to more equity exposure, there are many mutual funds catering to investors from diverse backgrounds available. If you think researching, shortlisting and finalizing is too much work, ClearTax Invest has already taken care of it. We have handpicked the best-performing funds from the top fund house for you. It is never too late to invest.

 

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