Creating a retirement corpus is essential if you want to live a financial stress free life after you retire and when your income stops. That is why it is advised that you should contribute towards a retirement corpus when you are working so that by the time you retire you have sufficient funds at your disposal to meet the financial requirements of your golden years. There are various instruments available in the financial market which helps individuals create a retirement corpus. The National Pension Scheme, also called NPS in short, is one such scheme which is designed to create a retirement corpus for investors. Let’s understand the scheme in details –
What is National Pension Scheme?
National Pension Scheme is an investment scheme which has been designed by the Government of India. Investments under the scheme can be made by individuals during their active working life. The investment would grow and accumulate into a corpus. Thereafter, when the investor retires, the accumulated corpus can be used for any financial need. At maturity of the scheme, the investor can withdraw a portion of the corpus in lump sum and then avail annuity pay-outs from the remaining part. Thus, NPS schemes create a regular income in the form of a pension for investors.
Who are eligible for investing in NPS?
Interested investors would have to fulfil the below-mentioned eligibility parameters if they want to invest in the National Pension Scheme –
- The investor should be an Indian citizen or NRI. In case of NRIs, though, if the citizenship of the investor changes after investment into the NPS scheme, the scheme would be closed.
- The age of the investor should be between 18 years and 60 years.
How can one invest in the National Pension Scheme?
For investing in the National Pension Scheme, investors would have to approach a Point of Presence (POP) which is a financial institution registered under the NPS scheme. Mostly all Indian banks and other non-banking financial institutions have registered themselves as POP and investment can be done through them. The POPs have authorized branches where investors can invest in the scheme. These authorized branches collect deposits from investors and are called Point of Presence Service Providers or POP-SPs.
The list of registered POPs can be found online on the official website of the Pension Fund Regulatory and Development Authority (PFRDA) which is https://www.npscra.nsdl.co.in/pop-sp.php. PFRDA is also the governing body overlooking the working of the National Pension Scheme.
Which documents are required to apply for the scheme?
To apply for the scheme, the investor would have to deposit the investment amount along with the following documents to the Point of Presence Service Providers –
- The filled Registration Form
- Proof of identity of the investor
- Proof of age
- Proof of address
How investments done in the National Pension Scheme work?
There are two types of investment accounts under the National Pension Scheme. When investing, the investor would be given a choice to invest in either one of the available two accounts or both the accounts. The accounts under NPS are as follows –
Types of NPS accounts
- Tier I Account
Tier I Account would be the compulsory account which investors would have to choose if they want to invest in the National Pension Scheme. When registering for the scheme, the minimum investment which should be made in Tier I Account is INR 500. Moreover, in one financial year, the minimum contribution to the scheme should be INR 1000.
Withdrawals, in general, are not allowed from this account till the investor attains 60 years. However, in the case of special instances, the account permits withdrawals subject to terms and conditions.
These instances when the account allows withdrawals include the following –
- Continuous unemployment for 60 days or above
- Paying the expenses of a marriage
- Paying for medical emergencies
- Buying a house, etc.
- Tier II Account
After the investor has invested in Tier I Account, he/she can choose to invest in Tier II Account too. Tier II Account is, therefore, voluntary in nature. It is a flexible account from where withdrawals can be made freely. Thus, the investor can choose to invest in Tier II account only if he/she has a Tier I Account and if the investor wants to make withdrawals from the scheme. The minimum investment required to open a Tier I Account is INR 250.
Having multiple NPS Accounts under a single name or identity is not allowed. If the investor opts for the National Pension Scheme, the minimum investments should be made in the accounts which have been opened. If the minimum yearly investments are not done, the NPS account would be frozen. For any future investment the investor would have to unfreeze the account by visiting any of the POP and paying a penalty of INR 100 along with the amount of investment.
Difference between Tier I and Tier II Accounts
Here are some basic differences between Tier I and Tier II Accounts which would give a clearer picture of the two accounts –
|Basis of difference||Tier I Account||Tier II Account|
|Investment into the account||Investment is compulsory||Investment is optional and depends on the investor|
|Withdrawal from the account||Withdrawals are restricted and are allowed for specific instances||Withdrawals are allowed freely without any restriction|
|Tax treatment||Investment into the account would be allowed as a deduction for up to INR 2 lakhs under Sections 80C and 80CCD combined||Investment up to INR 1.5 lakhs is allowed as tax-free investment only for Government employees|
|Minimum investment at a time||INR 500||INR 250|
|Minimum investment required in a year||INR 1000||No such requirement|
|Minimum investment required for opening the account||INR 500 would be required to be deposited when opening the account||INR 1000 would be required to be deposited to open the account|
How do NPS investments work?
The investment in the National Pension Scheme is exposed to the market and earns market-linked returns. There are different types of investment options and the investor has to choose how he would like to invest. Two choices of investments are presented to the investor when he/she invests in the National Pension Scheme.
These choices and their respective investment strategies are as follows:
- Active choice:
Active choice of investment is when the investor chooses to manage his investments himself.
Three kinds of funds are available and the investor can choose to invest in one fund or in a combination of two or more funds.
The funds are:
- Asset Class E wherein 50% of the portfolio is invested in stocks
- Asset class C wherein the portfolio is invested in fixed interest instruments. However, the portfolio does not invest in Government securities
- Asset class G wherein the portfolio is invested only in Government securities.
- Asset Class A – wherein the portfolio is invested in alternative investment funds like REITS, MBS, AIFs, etc.
The investor cannot choose only Asset Class E for investing the entire amount. If Asset Class E is preferred, there would be a limit on the maximum amount of investment. A maximum of 75% can be invested in Asset Class E and the remaining investment can be split between Asset Classes C and G. Investment in Asset Class A is optional and if chosen the investment cannot be more than 5% of the total investment. Moreover, after the investor reaches 50 years of age, the equity exposure would reduce by 2.5% every year till it reaches 50% at the age of 60. Thereafter, from ages 61 and above, the equity exposure in Asset Class E would be restricted to 50%.
However, if the investor is looking for stable returns and does not want to invest in Asset Class E, the entire investment can be invested either in Asset Class C or Asset Class G without any limitations.
- Auto choice: Lifecycle Fund
If the investor is not sure of managing his investments himself, he can opt for Auto Choice investment strategy. Under this strategy, the investments are managed automatically in a predetermined manner as prescribed by the PFRDA. Investment is split into different asset classes depending on the age of the investor.
Thereafter, as the investor’s age increases, the equity exposure is reduced and the exposure in Asset Classes C and G is increased every year. The increase depends on the investor’s risk appetite. There are three risk profiles to choose from – Aggressive, Moderate and Conservative. The investment ratio in the three funds would then depend on the risk profile selected by the investor.
Let’s understand how –
- Aggressive Lifecycle Fund – Also called LC75, the equity exposure in this choice is the highest. Equity investment is capped at 75% and the remainder is divided into Asset Classes C and G in the ratio 10% and 15% respectively. This allocation is when the investor is aged up to 35 years. As the age increases, equity exposure in Asset Class E is decreased and investment in other two Asset Classes increase.
*Asset Class E is Equity, Asset Class C is Fixed Income, Asset Class G is Government Security
- Moderate Lifecycle Fund – this is called LC50 where equity exposure is capped at 50% till the investor is aged up to 35 years. The other two funds have an investment of 30% (Asset Class C) and 20% (Asset Class G).
*Asset Class E is Equity, Asset Class C is Fixed Income, Asset Class G is Government Security
- Conservative Lifecycle Fund – this fund is called LC25 and Asset Class E has an equity exposure of 25%. Asset Class C has an investment of 45% and G has an investment of 30%. As age increases, equity investment is further reduced increasing the allocation in Asset Class C and G.
*Asset Class E is Equity, Asset Class C is Fixed Income, Asset Class G is Government Security
The investor has the flexibility to change the investment strategy from Active Choice to Auto Choice and vice-versa. The choice of Asset Class can also be changed if the investor likes. Any change in the scheme is allowed once a year.
Who manages the investments of the National Pension Scheme?
The investment done in the National Pension Scheme is managed professional by fund managers registered with the PFRDA. At present, there are eight registered fund managers for managing NPS investments.
These are as follows –
- Reliance Capital Pension Fund
- LIC Pension Fund
- SBI Pension Fund
- ICICI Prudential Pension Fund
- DSP Blackrock Pension Fund Managers
- Kotak Mahindra Pension Fund
- UTI Retirement Solutions Pension Fund
- HDFC Pension Management Company
Investors can also choose the fund manager for managing their investments.
When do the investments mature?
Investments done in the National Pension scheme mature when the investor attains 60 years of age. On maturity of the scheme, the investor can choose to withdraw 60% of the accumulated corpus in lump sum. The remaining amount, i.e. 40% of the corpus, would then be paid in the form of annuity pay-outs.
However, if the total value of the investment is below INR 2 lakhs, annuity pay-outs would not accrue. In such cases, the investor can take the entire amount in one lump sum.
Moreover, in case the investor dies before the maturity of the scheme, i.e. before reaching 60 years of age, the entire invested corpus can be taken in lump sum by the nominee.
Partial withdrawals from the National Pension Scheme
Though the scheme matures after the investor reaches 60 years of age, the investor can withdraw from the scheme fully or partially.
Let’s understand how these withdrawals work:
- Full withdrawal from the scheme before maturityIf the investor wants, he can exit from the scheme before attaining 60 years of age. In such cases, 20% of the corpus is allowed to be withdrawn in a lump sum. From the remaining 80%, the investor would have to receive annuity pay-outs.
- Partial withdrawalsThe scheme allows partial withdrawals before maturity. These withdrawals have the following terms and conditions –
- Up to 25% of the corpus can be withdrawn through partial withdrawals
- Partial withdrawals are allowed from the third year of opening the NPS account
- The withdrawal should be done only for meeting specific financial needs. These specific needs include paying for wedding related expenses, meeting a medical emergency, paying for children’s education, buying a home, etc.
- Withdrawals can be made for up to three times during the investment period
- Each subsequent withdrawal should have a gap of 5 years or more.
How to withdraw from the scheme?
Withdrawals can be done through the following steps –
- The withdrawal form should be filled in and submitted to the POP with the relevant documents.
- The POP would verify the documents and forward the withdrawal request to the Central Recordkeeping Agency (CRA) and NSDL.
- The CRA would register the withdrawal request and issue an application form which should be filled for withdrawal.
- Once the formalities are completed, the CRA processes the withdrawal application and the amount is paid.
Extending the investment period
The National Pension Scheme also allows investors to extend the maturity date. This is called deferment and this deferment is allowed for up to 10 years. This means that the investor can choose to extend the maturity age from 60 years to 70 years.
Tax implications of the National Pension Scheme
Investments done in the National Pension Scheme, the amount received on maturity or death and the partial withdrawals done from the scheme all have a specific tax treatment which investors should know before they choose to invest in the scheme.
Here are the different tax implications of the different benefits received under the NPS scheme:
- Investment into the scheme:
Contributions done towards Tier I Account qualify for tax deductions in the hands of the investor. However, Tier II account contributions do not enjoy tax benefits. Such contributions are done from the taxable income of the investor.
Here are the different sections and their rules for claiming deduction on the contribution done to Tier I Account:
|Eligible investors||Quantum of contribution||Maximum tax-free limit||Applicable Income Tax Section|
|Salaried and self-employed individuals||Salaried – up to 10% of basic salary including Dearness Allowance|
Self-employed – Up to 10% of annual income
|INR 1.5 lakhs including eligible deductions under Section 80C||80 CCD (1)|
|Salaried employees (contribution done by employers)||Up to 10% of basic salary including Dearness Allowance||Up to 10% of basic salary including Dearness Allowance||80 CCD (2)|
|Salaried employees, self-employed individual, other individuals with an income||Up to INR 50,000||Up to INR 50,000 excluding eligible deductions under Section 80C||80 CCD (1B)|
- Maturity of the scheme
When the scheme matures, the following tax implications would apply:
|60% of the corpus withdrawn in lump sum||40% of the corpus paid in annuity|
|No tax would be charged||Tax would be applicable. Annuity would be categorised as income and added to the investor’s taxable income. Thereafter, it would be taxed at his slab rate|
- Death of the investor
If the investor dies before maturity, the entire lump sum corpus which is withdrawn would be tax-free in the hands of the beneficiary.
- Exit from the schemeIn case the investor exits from the scheme before attaining 60 years of age, the taxability of the benefits would be as follows –
- 20% of the corpus received in lump sum would be tax-free in the hands of the investor
- 80% of the corpus received in annuity would be taxable. Annuity pay-outs would be considered an income and added to the investor’s taxable income. It would then be taxed at the investor’s income tax slab rate.
- Partial withdrawals from the scheme
In case of partial withdrawals, 25% of the corpus withdrawn in lump sum for specific expenses would be tax-free in the hands of the investor.
Annuity payments under the National Pension Scheme
Since NPS is a retirement oriented investment avenues, it pays annuities when the scheme matures or when the investor opts for an early exit from the scheme. Annuity pay-outs create a regular income and the investor can choose from an array of annuity options.
The annuity pay-out options available under the NPS are as follows:
|Annuity paid at a uniform rate throughout the investor’s life|
|Guaranteed annuity payable for 5,10 or 20 years and thereafter for the investor’s lifetime|
|Uniform annuity paid throughout the investor’s life and return of purchase price on death|
|Increasing annuity payable throughout the investor’s life increasing at a simple rate of 3%|
|Uniform annuity paid throughout the investor’s life. On his death, 50% annuity payments throughout the spouse’s life|
|Uniform annuity paid throughout the investor’s life. On his death, 100% annuity payments throughout the spouse’s life|
|Uniform annuity paid throughout the investor’s life. On his death, 100% annuity payments throughout the spouse’s life. In case of spouse’s death, purchase price is returned|
The annuity pay-outs are paid by insurance companies which are empanelled with the PFRDA for paying annuities under the National Pension Scheme. The investor can choose any empanelled insurer for receiving annuities.
Currently, the following insurance companies are authorised to pay annuities under the scheme:
- Reliance Life Insurance Company Limited
- Bajaj Allianz Life Insurance Company Limited
- Life Insurance Corporation of India
- ICICI Prudential Life Insurance Company Limited
- HDFC Standard Life Insurance Company Limited
- Star Union Dai-ichi Life Insurance Company Limited
- SBI Life Insurance Company Limited
Interest earned from NPS investments
Since NPS investments are market-linked, the returns are not guaranteed. Returns depend on the performance of the funds in which the money is invested.
Benefits of National Pension Scheme
The National Pension Scheme provides a range of benefits to investors which include the following –
- Investors can save additional tax by investing up to INR 50,000 in NPS schemes
- The scheme also allows partial withdrawals which help in meeting the financial needs of individuals
- The investments are invested in the market which allow the investor to earn market linked returns
- Annuity payments are paid under the scheme when it matures. These payments ensure a regular source of income for the investor.
Permanent Retirement Account Number (PRAN)
Just as a PAN number is allotted for income verification purposes, a PRAN number is allotted to investors of NPS scheme to identify them. The number is contained in a PRAN card which is issued to investors of the scheme. The card contains the investor’s name, father’s name, signature or thumb impression and the investor’s photograph.
PRAN card can be availed online or offline through the following steps –
- Online application – The investor would have to visit NSDL’s website, download the PRAN application form, fill and submit it online. The PRAN number would be generated on successful submission of the form
- Offline application – for offline method the investor would have to visit NSDL’s website and download the PRAN application form. The form should then be filled manually and should be mailed to NSDL’s office along with the relevant documents of the investor. On successful verification of the form, the PRAN number would be generated by the NSDL
Investors should, therefore, understand all the aspects of the National Pension Scheme before they choose to invest in it.
How NPS fares over Mutual funds and fixed deposits?
NPS is often compared to other popular investment avenues like mutual funds and fixed deposits. So, here is a comparative analysis of NPS, mutual funds and fixed deposits on different parameters –
|Basis of comparison||NPS||Mutual funds||Fixed deposits|
|Underlying risk of investment||Moderate to high risk as the fund invests in the market||Moderate to high risks due to market related investments||No investment risk. Returns are guaranteed|
|Liquidity||Tier I account has limited liquidity while Tier II account is quite liquid||Except ELSS funds which have a lock-in period of 3 years, other mutual fund schemes are highly liquid||Liquidity is an issue since the deposit is locked in for the chosen term. If withdrawn prematurely, high penalties are levied|
|Returns||Inflation adjusted returns depending on market performance||Inflation adjusted returns depending on market performance||Returns range from 3% to up to 8% and are not inflation adjusted|
|Tax benefits on investments||Deduction of up to INR 1.5 lakhs under Section 80C and an additional INR 50,000 under Section 80CCD on the invested amount||Investments into ELSS schemes earn a deduction under Section 80C up to INR 1.5 lakhs. In case of other schemes, there is no tax benefit||Investments in 5-year deposit schemes earn a deduction under Section 80C up to INR 1.5 lakhs. For any other deposit scheme, no tax benefit is available|
|Tax benefit on returns||60% of the withdrawn corpus would be tax-free.||The returns would attract long term or short term capital gains||Interest earned is taxable. Senior citizens can, however, get exemption on interest earned under Section 80TTB up to INR 50,000|