Most Indians haven’t thought about their retirement yet. Because retirement seems so far off in our 20s and 30s that it hardly feels real. In fact, it’s one of the most common excuses people make to justify not saving for retirement.
But it’s easier to save and invest when we’re young and have fewer responsibilities. And NPS is one way to do it. So, let’s understand NPS in detail.
Estimated read time: 4 minutes and 34 seconds
Buckle up, here we go!
What is the National Pension Scheme (NPS)?
The NPS is a voluntary defined contribution pension system in India launched in January 2004. The scheme is open to all citizens of India between the age of 18 and 60. It is intended to provide individuals with a retirement savings option.
Under the NPS, you can make regular contributions to your pension account. Your investment is invested in various assets, such as government bonds, corporate bonds, alternative investments, and equities.
The returns on these investments will be used to provide pension income to you after retirement. The Pension Fund Regulatory and Development Authority (PFRDA) manages the NPS.
Under the NPS account, there are two types of accounts – Tier 1 & 2.
What are Tier 1 & Tier 2 accounts in NPS?
Tier 1 account is mandatory for investing in NPS, and all the tax-saving benefits apply to this account type. However, it is a restricted and conditional withdrawable retirement account which can be withdrawn only upon meeting the exit conditions prescribed under NPS.
A tier 2 account is optional in nature. It is available as an add-on to any Tier 1 account holder. Subscribers are free to withdraw their savings from this account whenever they wish. However, there are no tax benefits to investing in a Tier 2 account.
Since most of us are only interested in NPS for tax purposes, let’s focus only on Tier 1 accounts. Before discussing the tax benefits and withdrawal conditions, let’s understand how investment in NPS works.
How does the investment process of NPS works?
To start with NPS, you need to open your Tier 1 account. And like how we have multiple ELSS funds from different mutual fund houses, we have 7 pension funds, like ICICI PF, HDFC PF, etc.
These pension funds perform investment management functions following the guidelines issued by the PFRDA. Check more here.
After opening the account, you can start investing a minimum of ₹6k yearly or ₹500 monthly. There is no upper limit for your investments.
Now the best part of NPS is it allows you to decide where your money can be invested. You can invest in 4 asset classes through your NPS account.
- Government bond
- Corporate bond
- Alternative investment fund
As you know, each asset class has distinct risks and returns. And most people don’t have enough knowledge to make these choices. So, under NPS, you can select between two investment strategies – Active Choice and Auto Choice.
As the name suggests, your investment asset mix will be system driven in auto investment choice. You can select between three modes – LC 75, LC 50 and LC 25. These are also known as Aggressive Auto Choice, Moderate Auto Choice and Conservative Auto Choice, respectively. Check the asset mix here.
And in active investment choice, you get the freedom to decide your own asset mix, restricting the exposure to Equity to 75% of the contribution amount till the age of 50. Check the asset mix here.
Also, NPS offers you flexibility in terms of changing the asset mix and investment choice twice in a financial year. You can change the pension fund manager once in a financial year.
Remember, your returns will depend on the strategy and asset mix you select. You can look at the past performance of NPS fund managers here.
Also, the fund management fee or other charges under NPS are very low. For example, the fund manager fee ranges from 0.03% to 0.09%. To know more details on these charges, read here.
When can you withdraw from NPS?
There is a lot of confusion about withdrawal from an NPS account. To understand it more clearly, let’s divide the withdrawal option based on maturity withdrawal and pre-mature withdrawal.
On maturity (age 60), you can’t withdraw the complete accumulated corpus. NPS has a condition that you should invest a minimum of 40% of the corpus in annuity plans. These annuity plans will offer you monthly or yearly payout as a pension until death.
After investing a minimum of 40% in annuity plans, you can withdraw the balance in a lump sum. This amount will be tax-free only if you invest in an annuity. Or else it will be taxed.
Also, you can be invested in NPS until the age of 75.
For pre-mature withdrawal, you can only withdraw up to 25% of the contribution deposited. Under NPS, we can make only 3 withdrawals. We can exercise the first withdrawal after 3 years of account opening. We can exercise 2nd and 3rd withdrawal any time after the previous one.
Partial withdrawal is allowed only in certain exceptional cases, like for children’s education, marriage expenses, house construction or medical emergencies. However, this withdrawal comes with certain conditions. Read more here.
What are the tax benefits under NPS?
The National Pension Scheme provides several tax benefits. These benefits are intended to encourage us to save more for our retirement and to make the NPS an attractive investment option. Following are the tax benefits under the NPS include:
- Tax Deduction: Contributions made to the NPS are eligible for tax deductions under Section 80C of the Income Tax Act, up to a maximum of ₹1.5 lakhs per financial year.
- Additional Tax Deduction: An additional tax deduction of up to ₹50k is available under Section 80CCD (1B) for contributions made to the NPS.
- Corporate Contribution: If your employer agrees to contribute towards NPS, under Section 80CCD (2), you can claim a tax deduction of up to 10% of your salary (Basic + DA). The upper limit of this tax benefit is ₹7.5 lakhs.
- Exemption on Maturity: Up to 60% of the corpus withdrawn in a lump sum at the time of retirement is exempt from tax if a minimum of 40% of the corpus is invested in annuity plans.
Now, we have covered all most everything about NPS. But one thing remains unclear. Should you invest in NPS or not? Does investing in NPS build a better retirement corpus for you or not? We have covered that here.
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