National Pension Scheme (NPS) - All you need to know

Introduction

The National Pension Scheme (NPS) is primarily a pension product designed to promote retirement planning. As with all pension products, it requires regular and long-term investment during working years so that the investor gets a retirement corpus on which he/she can live off.

Started initially for government servants in 2004, it was extended in 2009 to all Indian citizens between the age of 18 and 65. As on March 31st 2020, NPS has over 1.3 crore subscribers and an AUM (Assets Under Management) of over Rs. 4 lakh crores. 

NPS offers comparatively higher returns, options for asset allocation, choice of fund manager, high tax benefits, and low fund management fees.

Why?

With increasing life expectancy, rising healthcare cost, changing family norms, and lack of social security, the need for retirement planning is increasingly important. This product is aimed at encouraging people to take care of their post-retired lives by investing in a pension product.

Advantages

Tax deductions: While there are many competitors for 80c deductions (mediclaim, life insurance, PPF, etc.), NPS offers an additional deduction of Rs. 50,000.

Secondly, for those who are earning a salary, the employer can contribute 10% of salary (Basic + Dearness Allowance) on behalf of the individual. This amount can also be claimed as tax deduction without any upper limit.

Thirdly, being an EEE (Exempt-Exempt-Exempt) product, the amount invested, accumulated interest, and amount withdrawn at the time of maturity are all tax-free. However, it must be noted that only 60% of the corpus withdrawn is tax-free while the remaining 40% has to be invested in an annuity. The income from the annuity will be charged as per the income tax slab.

Higher returns: As it allows the individual to invest in stock markets, the returns are generally higher than comparable products like PPF. 

Customisation: You can decide your asset allocation either through active choice or auto choice.

Low fees and choice of fund manager: Apart from a one-time cost of 0.25% for setting it up, NPS charges only 0.01% of the total amount invested. Secondly, you can choose from a list of fund managers from the public sector and private sector.

Drawbacks

Long lock-in period: Under normal circumstances, the individual can only withdraw the amount only at the time of retirement, i.e. 60 years. Under exceptional circumstances, he/she can withdraw a maximum of three times with the total amount not exceeding 25% of the contribution.

Compulsory annuity: - At least 40% of the maturity amount has to be invested back in an annuity product, to ensure that the individual gets a regular income. Therefore, the individual gets only 60% of the amount. Since most annuity products barely beat inflation, it is an ineffective investment. In case of premature withdrawals, the share of annuity can go as high as 80%. As mentioned earlier, this annuity income is not tax-free.

Limit to equity-debt allocation: Because it is a pension product, NPS has a conservative approach to investment. It doesn't allow more than 75% allocation to equity, and the share keeps getting smaller as the individual nears retirement age. Therefore, it will not provide the high returns seen in equity mutual funds.

Tier - 2 account

Although NPS is primarily a pension product, it can be used as an investment product with its Tier-2 account. The Tier-2 account doesn’t contain the lock-in period or compulsory investment in annuity. However, it provides the same returns and choice in asset allocation as well as the low cost of fund management.

To use the Tier-2 account, one needs to keep the Tier-1 active by investing a minimum of Rs. 6000 per annum. Secondly, there are no tax benefits for investments made via a Tier-2 account. 

So who should go for NPS?

1. Are you sure you won’t need the money till the age of 60?
2. Would you be happy with 40% of your corpus going into annuity?

If the answer to both questions is “yes”, then you should go for NPS. However, please bear in mind that NPS should only be one among many investment options in your portfolio.

How to get started?

You can create an account by visiting the nearest PoP (Point of Presence) or by creating it online through this link.

To know more about NPS, you can go through this set of FAQs.