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Everything to Know about the National Pension Scheme (NPS)

To address the challenge of lack of social security options, the Government introduced the National Pension Scheme (NPS). This article focuses on the National Pension Scheme (NPS): what it is, investment and maturity options, taxation, etc.
All about National Pension Scheme (NPS)

Lack of Social Security Options

Many people in India, whether a salaried, business person or self-employed, don't have either any form of social security or limited social security during their retirement years. The sources of limited social security include money received from Employee Provident Fund (EPF), gratuity, etc., on retirement. To address this challenge, the Government introduced the National Pension Scheme (NPS) in 2009. This article focuses on the National Pension Scheme (NPS): what it is, investment and maturity options, taxation, etc.

What is NPS and how does it work?

The National Pension Scheme (NPS) is a defined contribution pension scheme in which an individual can regularly contribute during their working years. The contribution amount is invested as per the investment fund selected by the individual. On retirement, the corpus can be used to purchase an annuity that provides regular income during the retirement years. The annuity amount will depend on the amount accumulated and the annuity scheme chosen.

The Government introduced the NPS in 2009 for Government employees. Later it extended the NPS to private-sector employees, business persons, and self-employed people. The Government gives tax benefits at the time of contribution and maturity to make the scheme attractive for investors. The NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA).

NPS features

The NPS is open to all individual citizens in the age bracket of 18 to 65 years. It is affordable to individuals across various income groups as the minimum annual investment requirement is just Rs. 1,000. The amount contributed is invested as per the selected funds. The individual has the flexibility to change the investment options. 

An individual can use the whole or partial amount to purchase an annuity on retirement. The individual can choose from the various annuity options available. During retirement years, an individual can enjoy a monthly income in the form of a pension.

Who should invest in NPS?

The NPS is open to salaried individuals, business persons, and self-employed people. Any individual who wants to build a retirement nest for themselves and enjoy a monthly pension during their retirement years should invest in NPS. The scheme is very flexible in terms of the amount you can contribute, the selection of investment funds, the choice of annuity schemes, etc. The tax deductions at the time of investments are added benefits for individuals investing in NPS.

Types of accounts

The NPS gives an individual two types of accounts: Tier I and Tier II.

  1. Tier I account
    • When individuals open an NPS account, they get the Tier I account by default and can use it for contributions. The amount deposited in the Tier I account cannot be withdrawn till retirement, except for specified conditions. You need to make an annual contribution of a minimum of Rs. 1,000 in the Tier I account. There is no limit on the maximum amount that can be invested in a financial year. However, there are limits on the tax deductions you can avail of.
  2. Tier II account
    • The Tier II account is optional. An individual can activate it and make contributions. You can make withdrawals from the Tier II account without any restrictions. There is no minimum annual investment requirement.

The role of Pension Fund Managers (PFMs)

The amount you contribute to the NPS is invested by professional Pension Fund Managers (PFMs) appointed by the PFRDA. The PFMs invest your money as per the investment funds selected by you. The PFMs manage money separately for the Government sector and others. The PFMs include:

PFMs for the Government sector

SBI Pension Funds Pvt. Ltd.

LIC Pension Fund Ltd.

UTI Retirement Solutions Ltd.

PFMs for other sectors

SBI Pension Funds Pvt. Ltd.

LIC Pension Fund Ltd.

UTI Retirement Solutions Ltd.

HDFC Pension Management Co. Ltd.

ICICI Prudential Pension Fund Management Co. Ltd.

Kotak Mahindra Pension Fund Ltd.

Aditya Birla Sunlife Pension Management Ltd

The other sector individuals (apart from the Government sector) can choose one of the above seven PFMs. They can change their PFM once in a financial year.

NPS investment options

An investor can choose the active or auto mode for investing their money.

  1. Active
    • When you choose the active mode, you can choose how much money you want to allocate to each asset class. The choice of asset classes include:
      • Equity (E): Investments are made in equity and equity-related instruments. It involves high risk and has the potential to give high returns.
      • Government Securities (G): Investments are made in various Government securities. It involves low risk and can give low to moderate returns
      • Corporate debt (C): Investments are made in various corporate debt securities. It involves moderate risk and has the potential to give moderate returns
      • Alternative investments (A): Investments are made in various mortgage-backed securities, real estate investment trusts (REITs), infrastructure investment trusts (InvITs), alternate investment funds (AIFs), etc. It involves moderate to high risk and has the potential to give moderate returns.
    • You can choose how much money to invest in each asset class. However, certain restrictions include a maximum allocation to equity based on age and maximum percentage allocation to AIF.
  2. Auto
    • If you don't want to choose how much money to allocate to which asset class, you can leave this task to a fund manager by choosing the auto option. Under the auto option, your money gets invested in various asset classes, in specified percentages. Based on your risk profile and age, you can choose one of the following funds under auto:
      1. Aggressive Life Cycle Fund (LC75): The maximum equity investment is 75% up to age 35 years.
      2. Moderate Life Cycle Fund (LC50): The maximum equity investment is 50% up to age 35 years.
      3. Conservative Life Cycle Fund (LC25): The maximum equity investment is 25% up to age 35 years.
    • As the age of the investor increases, the equity investment percentage goes down, and the Government securities investment percentage goes up.

Performance of NPS funds

Let us look at the returns given by the NPS Equity (E) Funds.

Scheme nameAUM (Rs. crores)1-year3-years5-years
SBI Pension Funds Pvt. Ltd.8,38218.00%13.74%12.92%
LIC Pension Fund Ltd.2,53920.40%14.51%12.54%
UTI Retirement Solutions Ltd.1,23918.24%13.84%13.12%
HDFC Pension Management Co. Ltd.12,42719.14%15.69%14.36%
ICICI Prudential Pension Fund Management Co. Ltd.4,60619.60%14.98%13.48%
Kotak Mahindra Pension Fund Ltd.87319.73%15.37%13.47%
Aditya Birla Sunlife Pension Management Ltd23417.65%14.85%NA%

(Source: https://www.npstrust.org.in/sites/default/files/Scheme%20E1.pdf)

Note: The returns are as of 31 March 2022. The one-year returns are absolute, and the three and five-year returns are CAGR. To know about the returns for other funds such as Government Securities (G), Corporate debt (C) and Alternative investments (A), refer to the following link: https://www.npstrust.org.in/return-of-nps-scheme.

NPS tax benefits at the time of investment

Under Section 80CCD of the Income Tax Act, an individual can avail deduction from taxable income for investment in NPS. You can avail the following deductions in a financial year:

SectionTax benefit
Section 80CCD(1)A salaried individual can avail of a deduction of up to 10% of their salary for contribution to NPS. Other individuals (a business person, a self-employed, etc.) can avail of a deduction of up to 20% of income for contribution to NPS. The maximum deduction allowed in a financial year is the amount contributed or Rs. 1,50,000, whichever is less.
Section 80CCD(1B)An individual can avail of a deduction of up to Rs. 50,000 in a financial year for contribution to NPS. The deduction is in addition to the deduction of up to Rs. 1,50,000 under Section 80CCD(1) discussed above.
Section 80CCD(2)An employee can avail of an additional deduction for the contribution made by the employer to the employee's NPS account. The maximum deduction allowed is 14% of the salary for a Central Government employee and 10% of the salary for other employees.

To summarise, an individual can avail of deduction on NPS contribution in the above three ways, making NPS one of most income tax favourable investment products.

Maturity Options

On retirement (age 60 years), an individual can use the NPS retirement corpus to purchase an annuity that will give monthly income. The individual can use the entire or partial corpus for purchasing an annuity. 

If needed, the individual can withdraw up to 60% of the accumulated corpus tax-free. It is known as commutation. The remaining 40% has to be used to purchase an annuity. An individual can purchase the annuity from various PFRDA empanelled Annuity Service Providers (ASP) and choose from various annuity schemes. The annuity amount is taxable as per the individual’s income tax slab.

Should you Invest in NPS?

The NPS is a good social security scheme for building your retirement nest. It is very flexible in terms of when and how much you want to contribute in a financial year. You can choose from the various pension fund managers and investment options. The NPS gives one of the best income tax benefits for contributions. On maturity, you can withdraw the commutation amount tax-free and use the remaining amount to purchase an annuity for regular income during your retirement years. Thus, the NPS is one of the best retirement planning tools and deserves to be a part of the investment portfolio.

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