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A comprehensive guide to NPS

Updated: Sep 20, 2023



A major role of financial planning is ensuring financial security post-retirement. It is advisable to start investing for your retired life as early as possible. But, choosing the suitable product for your individual requirements can be tricky. Here we are discussing one of the many products available in the market.


Table of Contents

1

​What is NPS?

2

Who can invest?

3

Types of NPS accounts

4

​Investment Options and Returns under NPS

5

​Guidelines for Partial Withdrawal and Exit from the Scheme

6

​Continuation of NPS account after the age of 60

7

​Deferment of Withdrawal of Corpus

8

​Tax treatment during Contribution, Withdrawal and Exit

9

​NPS Application Process

10

​Comparison between NPS, EPF and PPF

What is NPS?

National Pension System (earlier known as National Pension Scheme) is a retirement product sponsored by the Govt of India. Any employee in the public (except for armed forces), private, self-employed or unorganized sector can invest in this system. It gives individuals the dual benefit of (i) lumpsum withdrawal at the time of retirement and (ii) regular pension post-retirement.

NPS is a defined contribution plan wherein the employer, employee or both make regular contributions to the account. The returns of the investment is determined by the performance of the invested schemes. An employee can continue with the same account if he/she switches jobs or sectors (Public to Private and vice versa).


The Pension Fund Regulatory and Development Authority (PFRDA) under the Ministry of Finance is the regulatory body responsible for overseeing the scheme.


Who can invest?

Indian citizens (both residents and NRIs) in the age group of 18-70 years can open an NPS account. One cannot have multiple NPS accounts. Also, accounts cannot be operated jointly.


Types of NPS accounts

There are two types of accounts under the NPS - Tier 1 and Tier 2. Tier 1 account is mandatory for subscribers while a Tier 2 account can be opened as per individual choice. An individual can open a Tier 2 account at a later stage if he/she has an active Tier 1 account. Here are the features of both accounts.




Particulars

Tier 1

Tier 2

Minimum contribution while opening an account

₹ 500

₹ 1000

Minimum number of contributions per year

1


Not Applicable

Minimum amount per contribution

₹ 500

₹ 250

Minimum annual contribution

₹ 1000

​Not Applicable

​Withdrawals

​After meeting the exit conditions prescribed under NPS

​No restrictions

The subscribers can opt for a facility called ‘One Way Switch’ to transfer funds from Tier 2 to Tier 1 account. There is no cap for the amount of transaction and frequency.


Investment Options and Returns under NPS

The NPS investments of the subscribers are managed by Pension Fund Managers (PFMs), that are financial institutions appointed by the PFRDA. The PFMs invest the contributions (Tier 1&2) of individuals across 4 asset classes:


  • Asset class E - Equity and related instruments

  • Asset class C - Corporate debt and related instruments

  • Asset class G - Government Bonds and related instruments

  • Asset Class A - Alternative Investment Funds including instruments like CMBS, MBS, REITS, AIFs, Invites etc.

There are presently 10 PFMs managing NPS accounts and individuals can choose a PFM to manage his/her portfolio.


After choosing a PFM, the subscriber has to choose either of the 2 investment options - Active Choice or Auto Choice.


  1. Active Choice – Under this choice, the subscriber has the right to actively participate in the investment. He/she can choose the Pension Fund Manager (PFM) and decide the percentage allocation of investments across different assets. Once the allocation is decided, the subscriber can choose schemes offered by the chosen PFM across the asset classes.

The subscribers should note that, classes E and A carries higher risk. Hence, there is a maximum limit set for investments in them.


Upto 50 years of age, maximum investment in Class E is 75% and after this, every year, the maximum cap reduces by 2.5%. ie, for 51 years it is 72.5% and for 60 years & above it is 50%. Additionally, at any point of time, maximum allocation for Class A is 5%.


Under the Active Choice, the subscribers should have investment knowledge to make portfolio allocations, suitable schemes under PFMs and above all, should constantly monitor the portfolio performance.


The returns depend on the allocation of funds and performance of these asset classes.One can check the performance of various schemes under each asset class here.


  • Auto Choice – This option is a better choice for subscribers who do not want the hassles of getting actively involved in the investment process. Under this, the investments would be made in a life cycle fund. A life cycle fund is a fund which automatically adjusts the asset allocation by reducing the risk as a subscriber nears the retirement age. The investments are made only across Classes E,C and G. As you age, the contribution towards Class G becomes higher compared to Classes E &C.


Based on the risk tolerance of the subscriber, one can choose from either of the 3 options – Conservative, Moderate or Aggressive. Please find more details about these options here.


The subscribers have the facility to change the PFM once every financial year. Also, individuals can switch from Auto to Active choice a maximum of 4 times in a financial year.


Guidelines for Partial Withdrawal and Exit from the Scheme

While there is no withdrawal restrictions for Tier 2 account, certain conditions need to be met while making withdrawals from Tier 1 account.


Partial withdrawal: A subscriber can withdraw up to 25% of his/her contribution in Tier 1 after a lock in period of 3 years. Such withdrawals are allowed a maximum of 3 times during the entire tenure of subscription and only for the following reasons:


  • Higher education of children

  • Marriage of children

  • For the purchase/construction of residential house (in specified conditions)

  • For treatment of Critical illnesses

The closure of the NPS account of a subscriber is termed as exit.


Exit upon attaining the age of 60 years: After reaching superannuation (60 years), 60% of the accumulated corpus (value of investment) can be withdrawn as lumpsum. The remaining 40% has to be used to purchase an annuity. Annuity is a financial product that would provide a regular pension at specified intervals for a time period chosen by the subscriber. Pensioners can purchase an annuity from an Annuity Service Providers (that are Life Insurance Companies) under the NPS.


However, if the total corpus is less than or equal to 5 lakhs, then 100% of it can be withdrawn as lumpsum.


Premature exit: A subscriber can choose to exit the NPS before the age of 60 after 10 years. In this case, 80% of the total corpus need to be used for purchasing an annuity and the remaining 20% can be withdrawn as lumpsum. However, if the total corpus is less than or equal to 2.5 lakhs, then 100% of it can be withdrawn as lumpsum.


Due to death of the subscriber: In this case, the total corpus would be paid to the nominee/legal heir.


Continuation of NPS account after the age of 60

On reaching the age of 60 years, a subscriber can continue with his NPS account till the age of 75 years. During this period, all the features of a regular NPS account are available. Moreover, the tax benefits on contributions also can be availed. Individuals can exit from NPS at any point of time during the continuation period.


Deferment of Withdrawal of Corpus

A subscriber can defer the withdrawal of lumpsum, annuity or both. Lumpsum withdrawal can be deferred till 10 years and annuity till 3 years of superannuation.


Tax treatment during Contribution, Withdrawal and Exit


Upon contribution


Only the contributions made towards the Tier 1 account are subjected to tax deduction.



Particulars

Employees on Self contribution

Employees under Corporate Scheme

Self employed individuals

Deduction under 80 (CCE) with a cap of ₹1.5 lakhs

up to 10% of salary (Basic + DA) under section 80 CCD(1)

up to 10% of salary (Basic + DA) under section 80 CCD(1)

up to 20 % of gross income under section 80 CCD (1)

Deduction under section 80 CCD (1B) over and above 80(CCE)

Maximum of ₹50,000

Maximum of ₹50,000

Maximum of ₹50,000

Deduction under section 80 CCD (2) over and above 80(CCE)

up to 10% of salary (Basic + DA) (14% of such contribution is made by Central Government) contributed by employer


Upon withdrawal and exit


Partial withdrawal: The maximum withdrawal limit of 25% of the corpus is exempted as per conditions under PFRDA Section 10(12B).


Exit upon attaining 60 years of age: Lumpsum withdrawn is tax exempted as per section 10(12A). The remaining corpus used to purchase annuity is also exempted under section 80 CCD(5). However, the pension income received from the annuity is taxed under section 80 CCD(3).


Premature exit: In this case, the 20% lumpsum withdrawn is taxed at subscriber’s individual tax rate. The pension income from the annuity is also taxed as per individual tax slab.


NPS Application process

For opening an NPS account, both online and offline modes are available.


Offline: Individuals can join the NPS by visiting the eNPS website.


Online: Individuals can open NPS account with the Point of Presence (POP) entities registered under the PFRDA. Here is the list of POPs. https://npstrust.org.in/sites/default/files/inline-images/POP-as-on-11.04.23.pdf as on April 11, 2023.


Comparison between NPS, EPF and PPF

Particulars

NPS

EPF

PPF

Eligibility

All Indian citizens

All Indian employees

All India citizens except NRIs

Fund Manager

​Pension Fund Manager

​Employee Provident Fund Organisation (EPFO)

​Dept Economic Affairs under Ministry of Finance

Minimum and maximum contribution

For central govt employees, a minimum contribution of 10% of their salary (basic + DA).

For others, ₹1000.


​12% of (employee’s basic + DA) by employee and employer, each. Over and above this, employees can contribute to VPF.

​Minimum of ₹500 and up to ₹1.5 lakhs

Risk & Return

​Relatively risky. Returns depend on asset allocation and fund performance.

​Risk free. The returns are reviewed yearly. Latest return for FY22-23 was 8.15%.

​Risk free. The return is reviewed quarterly. Latest return for Q2FY2023-24 was 7.1%.

Tax on contribution

​Up to ₹ 2lakhs. For employees under the Corporate sector, Additional Tax Benefit on the employer's NPS contribution up to 10% of salary (Basic + DA), is deductible from taxable income, up-to 7.5 Lakh.

​Up to ₹1.5 lakhs

​Up to ₹1.5 lakhs

Tax on withdrawal

​Lumpsum withdrawal of 60% is tax exempt. Annuity income is taxable.

​Taxable if corpus os withdrawn before 5 years of continuous service.

​Tax free

Maturity

​Upon reaching 60 years

​Upon retirement

​15 years

Final thoughts

In the realm of retirement planning, NPS stands out as a viable choice for individuals. For those who have already incorporated a retirement product into their investment portfolio, leveraging the NPS gives additional tax benefits, while also guaranteeing supplementary post-retirement income streams.











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