National Pension Scheme (NPS) is a retirement scheme regulated by the Pension Fund Regulatory and Development Authority (PFRDA). Set up in 2004, the scheme offers a mode of making systematic or regular investments by the public during their working years, to be available on retirement, thus acting as a saving plan. While it started out as being a mandatory scheme for government employees, voluntary contributions can now be made by private organizations or even separately by non-salaried individuals.
Types Of National Pension Scheme
There are two types of National Pension Scheme accounts: Tier I and Tier II.
Tier I NPS Account
This is the basic account which has restrictions around the withdrawal. The minimum contribution to this NPS account should be Rs 1000 a year.
Tier II NPS Account
Tier II account is a voluntary savings option which does not have any limits on withdrawals. This NPS account can be opened only if a person has a Tier I account.
Any individual Citizen of India can open a National Pension Scheme account, whether or not he is a resident of India. He/she must be between 18 – 65 years of age as on the date of submission of his / her National Pension Scheme application. However, OCI (Overseas Citizens of India) and PIO (Person of Indian Origin) card holders are not eligible for opening an NPS account.
On opening an NPS account, a 12-digit Permanent Retirement Account Number (PRAN) is allotted to the investor – it is a unique number that remains with the investor throughout his lifetime and serves as a reference point for all communication.
An individual can open only one NPS account of each type. The account is portable and can be used across different jobs in different locations.
How Does the National Pension Scheme Work?
It is managed by professional fund managers, registered with PFRDA. They make investments in either or a combination of four asset classes – equity, corporate debt, government securities, and Alternative Investment Funds. The returns from that place serve as the interest that accumulates on the contributions made to National Pension Scheme. A fund management fee is charged by the fund manager, albeit it is very minimal – 0.25% of the investment.
An investor can specify how would he like the mix of investment to be for his NPS account, though equity is not kept at more than 75% in any case. If preferences are not provided, investment mix for such NPS account is kept keeping in mind the age of the investor – the trend is that as age increases, the proportion of total investment in equity decreases (with an attempt to reduce volatility associated with equity for older aged investors). This is called Auto Choice or Lifecycle Fund, a default option if the investment choice is not made by the investor. Recently, more choices have been introduced to the Lifecycle Fund option based on maximum equity exposure that the investor would like to opt for up to the age of 35 years (Aggressive – 75%, Moderate – 50% and Conservative – 25%).
National Pension Scheme Fund Managers
- Birla Sun Life Pension Management Limited
- ICICI Prudential Pension Fund Management Company Limited
- LIC Pension Fund Limited
- Kotak Mahindra Pension Fund Limited
- Reliance Capital Pension Fund Limited
- SBI Pension Funds Private Limited
- UTI Retirement Solutions Limited
- HDFC Pension Management Company Limited
Apart from fund managers, there are others like Point of Presence Service Providers, Custodian, Trustee Bank, Central Recordkeeping agency, etc. who perform their respective roles in the National Pension Scheme framework. Since returns are market driven, they are not guaranteed/assured. They are based on fund performance, and are reinvested back into the funds (i.e., returns are not distributed as bonus or dividend).
National Pension Scheme Withdraw
Ideally, an exit from the National Pension Scheme should be made on superannuation, i.e., attaining 60 years of age. However, there are options for a premature exit as well, though such an exit can be made only after completion of 10 years. Of course, in case of death of the account holder, the entire accumulated corpus is paid to his / her nominee or legal heir.
As mentioned earlier, there are limits around withdrawal for a Tier I National Pension Scheme account. If withdrawals are to be made before retirement, i.e., the age of 60 years, only 20% of the corpus can be withdrawn (increased to 25% where specified conditions are met). Remaining 80% needs to be necessarily parked in the account using which the investor must buy an annuity, i.e., a regular payment (aka pension) to be made to him / her monthly. Post 60, 60% of the corpus may be withdrawn with the remaining 40% to be used to purchase an annuity.
A 100% withdrawal of the corpus can be made only if:
- In case of a premature exit, the total accumulated corpus is less than or equal to Rs 1 lakh.
- In the case of reaching 60 years of age, the total accumulated corpus is less than or equal to Rs 2 lakh.
As for the lump sum amount, it is available immediately on making that option. However, if retirement is reached, i.e., 60 years of age, withdrawal of lump sum can be deferred up to 70 years of age or opted for in the form of 10 annual installments till 70 years of age.
As for annuity, in case of premature withdrawal, it starts immediately after purchase. In case of reaching retirement age as well, it will start immediately on a purchase unless purchase itself is deferred (permissible up to 3 years after retirement age).
Annuity plans can be purchased from any of the PFRDA registered Life Insurance Companies. These are:
- Life Insurance Corporation of India
- HDFC Life Insurance Co. Ltd.
- ICICI Prudential Life Insurance Co. Ltd.
- SBI Life Insurance Co. Ltd.
- Star Union Dai-ichi Life Insurance Co. Ltd.
Annuity service providers offer different plans for an investor to choose from. Some of the common/general ones include:
- Annuity for life: Annuity payments cease on the death of the annuitant.
- 50% or 100% annuity payable to a spouse for his / her lifetime on death of the annuitant: If the death of spouse happens before the annuitant, annuity payments cease after the death of the annuitant
- Annuity for life with return of purchase price to the nominee on death of the annuitant
NPS calculator uses basic data fed in by the investor to calculate interest earned on contributions, total corpus accumulated and annuity/pension receivable on retirement. Such data to be provided is:
- For computing total accumulated a corpus
- Current age
- Retirement age (up to 60 years)
- Amount of contributions made every month in the NPS account
- The expected return on investment (this will depend upon the investment choice made)
NPS calculator would then compute the total investment made and interest earned on such investment (this is compounded interest, as whatever interest is earned, it is reinvested back into the corpus), thereby providing total corpus available with the investor on retirement. Advance Pension Calculator may also work out tax savings based on the amounts invested.
- For computing annuities receivable
- Proportion (in percentage terms) of the corpus to which annuities are to be purchased (should be 40% or more)
- Expected returns from the annuity (usually does not exceed 10% in most calculators)
NPS calculator would then generate the lump sum amount withdrawn and pension receivable every month on retirement. There are various NPS calculators available on the internet, a quick search will give you multiple results. Some website links to such NPS calculators are:
National Pension Scheme Benefits
Usually, there are three broad types of investment schemes, when seen from an income tax point of view:
- EEE: Exempt, Exempt, exempting
Such schemes, the investment made is allowed as a deduction, returns thereon are exempt, and so are withdrawals from the accumulated corpus. Thus, the scheme is completely tax-free.
- ETE: Exempt, Taxable, Exempt
Contributions made to such schemes are exempt, however, tax needs to be paid on returns made thereon. Withdrawal of contribution and return is exempt from tax in National Pension Scheme (especially since returns have been taxed already).
- EET: Exempt, Exempt, Taxable
While making contributions to such schemes is deductible and returns are not taxable, the withdrawals from such schemes are subject to tax.
NPS is of EET category, that is, contributions are exempt, earnings are exempt, however, withdrawals are taxable (albeit partially).
National Pension Scheme Tax Benefits
Under the income tax rules, certain deductions are allowed from total taxable income in order to encourage such payments. These are commonly known as Chapter VI-A deductions or deductions under sections 80C to 80U of the Act. These include contributions to EPF, housing loan repayment, investments in infrastructure bonds, etc. Contribution to the National Pension Scheme also falls under this category, and the rules are prescribed under section 80CCD as under:
Employee’s contribution to NPS Account
Contribution deposited by the employee, up to 10% of salary, is allowed as a deduction. However, the same is subject to the limit of Rs. 1.5 lakhs prescribed in section 80CCE as the overall limit for all deductions. The salary for this purpose means a basic salary plus dearness allowance.
This is referred to as section 80CCD(1) deduction.
In addition to this, another Rs. 50,000 can be reduced from total income under section 80CCD(1B).
Employer’s contribution to NPS Account
Where the contribution is routed through the employer as a deduction from salary, investment up to 10% of salary is allowed as a deduction. The salary for this purpose means a basic salary plus dearness allowance.
NPS Tax Benefit on Returns
Interest accumulated and reinvested into the corpus is not taxable in the hands of the investor. Lump sum amounts allowed to be withdrawn (40% after retirement or 20%/25% in case of premature withdrawals) are not subject to tax. No tax needs to be paid on balance either when they are being used to purchase an annuity. However, annuities received by the investor post retirement are added to his / her total income and taxed at the income tax slab rates applicable to such investor.
The above tax benefits are from an investor’s point of view. For corporate employers, contribution towards National Pension Scheme up to 10% of salary (basic salary plus dearness allowance) is allowed to be deducted as a ‘Business Expense’ while computing their income under the income head Profits / Gains from Business / Profession.
NPS Account for Non-Salaried individual
The tax treatment specified above for salaried individuals. In case of a self-employed person, he/she can contribute 10 percent of his/her gross income under Section 80CCD (1) in the National Pension Scheme. This is also subject to the overall limit of Rs. 1.5 lakhs as per section 80CCE.
To summarize, maximum investments allowed as a deduction would be as under:
- If salaried, and investment made through the employer:
10% of the salary (basic plus dearness allowance) plus Rs. 50,000
- If salaried, and investment made by self:
Rs. 1.5 lakhs plus Rs. 50,000 = Rs. 2 lakhs
- If non-salaried taxpayer:
Same as in case (2), i.e. Rs. 1.5 lakhs plus Rs. 50,000 = Rs. 2 lakhs
The tax benefits are available for a Tier I NPS account only.
Investment In NPS Account – Option Worth Considering
Of course, investing in the scheme has income tax benefits listed above. Apart from that, one of the most important features available is an investment in equity by the funds, as well as the option available to make the investment choice in terms of equity and debt mix, unlike EPF and others. In fact, the option is also available to make changes to your investment choice once in a financial year. Other features like seamless portability when shifting jobs, online registration and tracking, low cost (fund manager fee), various annuity plan options, applying for withdrawal online, etc. also make it a good investment option worth considering for your old age.