What’s NPS?

The NPS or National Pension System is a voluntary retirement scheme through which you can create a retirement corpus or your old-age pension. It’s managed by PFRDA (Pension Fund Regulatory and Development Authority) and available to all Indian citizens (resident or non-resident) between 18 and 65 years old. One can join the NPS as late as when they are 60 years old and continue to contribute until they are 70 years old. 

The NPS is useful for employees, employers, and also the self-employed. While employees and self-employed can subscribe to the NPS independently, employers have the choice to offer NPS or PF to their employees. Employers could also move existing PF benefits of employees to NPS if it’s mutually agreed upon.

Account types under NPS 

There are two different accounts to consider under the NPS– Tier I and Tier II. The Tier I account is the retirement account and comes with a host of tax benefits, but you cannot withdraw your contributions till you reach the age of 60. The Tier II account has no restrictions, and you can take out money anytime you want.

The Tier I account is mandatory, and when opening an NPS account, it is automatically functional. In contrast, Tier II can be opened only when one already has a Tier I account and can be opened with an additional application form.

Although Tier I has restrictions, there are conditions under which partial withdrawal is allowed earlier, such as cases when the subscriber has a critical illness or needs money for children’s education, wedding expenses, buying or constructing a house. The structure of the scheme has been created to ensure maximum lock-in so that the money gets used to fund retirement.

How your contributions get invested?

As an NPS subscriber, you are required to make an initial minimum contribution of Rs 500 under the Tier I account and Rs 1,000 for Tier II at the time of registration. Subsequent contributions, as well as frequency, could vary, but one needs to make an annual minimum Rs 1,000 contribution annually under Tier I and Rs 250 under Tier II.

Investments in NPS are market-linked, which deploy funds under three different funds that are governed by the asset classes in which your contributions can be invested. The broad asset classes are: Equity (E), Corporate Bond (C), Government Securities (G), and Alternative Investment Funds (A), which have further choices.

Within the available asset classes, NPS subscribers can opt for active or auto choice for asset allocation. In the active choice, the subscriber decides how much money gets invested in each asset class.

While in automatic choice, asset allocation gets determined based on the subscriber’s age. There are advantages under both options, and the choice should be based on how much you feel confident to manage the allocation on your own. Given the long-term nature of the NPS, there is the flexibility to move between the two variants. However, one needs to exercise choice in advance and only once in a financial year.

Tax benefits of NPS

The NPS has its share of income tax benefits both at the time of making contributions and at the time of withdrawal on maturity. Individual taxpayers can claim deduction on contributions under Tier I NPS up to Rs 1.5 Lakhs in a financial year under Section 80C. Further, NPS subscribers can claim an additional deduction for investment up to Rs 50,000 in Tier I account in a financial year under Section 80CCD (1B) over and above the Rs 1.5 Lakhs deduction under Section 80C. However, contributions to Tier II do not provide any tax benefits.

NPS withdrawal on maturity 

When you reach the maturity age, which is 60 years, you can withdraw the entire corpus from Tier I, of which only 60% is exempt from tax as with the remaining 40%, one has to purchase an annuity mandatorily.

An annuity is a fixed sum of money that you receive every year for your lifetime. An annuity is purchased by paying a lump sum to the seller, which is an insurance company. There are different types of annuities to suit the different needs of the annuitant. Remember, an annuity is treated as income and added to your other income sources and taxed as per the tax slab you fall in. Likewise, the entire corpus under Tier II is fully taxable as it is treated as income.

Bottom Line

Planning for retirement is a challenge, and it’s tricky to know exactly how much you will need to sail through your retirement years beforehand. There are several tools to estimate this corpus, which use either an income replacement or an expense replacement technique. Ideally, you assume the number of years you may live in retirement, and multiply that by the annual expenses or annual income that you have just before retirement.

However, things aren’t as simple because you also need to factor inflation, unexpected expenses arising out of emergencies, or a health ailment that costs more than the insurance you have. What you can do is to opt for NPS and make it your core retirement savings and supplement it with other available instruments to build a retirement corpus which complements your financial needs.