NPS, or the National Pension Scheme is an investment avenue designed specifically for retirement. Initially launched only for Government employees, the scheme was later made available for all Indian citizens, aged 18 to 60. In today’s knowledge nugget for our Financial Friday series, we go over the essentials of the National Pensions Scheme and what makes it the best investment avenue for retirement.
What is NPS?
For a long time, private sector employees did not have a good pension scheme to turn to. The National Pension Scheme, which was re-launched catering to this category of people, has undergone quite a few reviews and upgrades since 2009. In late 2018, the scheme was made almost entirely tax-free, putting it at par with the Public Provident Fund.
NPS is similar to the 401(k) plans of the United States. One can invest in this scheme at regular intervals throughout their working life. After retirement, a portion of this amount can be withdrawn as a lump sum and the balance will be received as pension salary on a monthly basis. There are a number of tax benefits for investing in NPS.
Some important terms to note:
- Retirement Age – For the purpose of this scheme, once you are 60 years old, you are considered to have retired.
- Annuity – A fixed sum of money you receive every month starting from age 60 for the rest of your life.
- Tier I – This is a basic pension account with limitations on withdrawal and a host of tax benefits. The minimum investment is ₹1,000 per year with an option to pay ₹500 per installment.
- Tier II – This is a voluntary savings account with no limit on withdrawals. The account can be opened only if you already have an active Tier I account. You may deposit a minimum contribution of ₹250 per month. Also, it is necessary to maintain a minimum of ₹2,000 at the end of the year. There are no tax benefits here.
- Note: We recommend Tier I for maximum benefit.
Key Features and Why We Recommend NPS
Where are NPS funds invested?
The NPS portfolio is a mix of a few instruments – Equity Mutual Funds, Bonds issued by various State Governments, PSUs and Private Firms and Bonds issued by the Central Government. The maximum exposure to equity is limited to 75%.
What are the returns on NPS?
The National Pension Scheme offers 8-10% returns per annum. The returns are linked to the equity market, so the risks as well as the rewards are higher. However, since NPS is designed for retirement, the duration for which your money lies invested is long. This long investment period results in high returns.
Withdrawal
After the age of retirement, you may withdraw up to 60% of the corpus in a lump sum and the balance of 40% will be converted to an annuity. Which means you will receive an amount every month in the form of pension.
What are the tax benefits?
Investment Portion – You get a deduction of up to ₹ 1,50,000 from your taxable income for the amount you invest in NPS. This is under Section 80C of the Income Tax Act. Further, Section 80CCD allows an additional deduction of ₹ 50,000. Therefore, the scheme allows a total deduction of up to ₹ 2,00,000.
Interest Portion – The interest you earn on NPS is tax-free.
Withdrawal Portion – The lump sum of 60% is tax-free. Only the 40% monthly pension is taxed as per your tax slab.
Who manages NPS?
NPS is managed by 7 fund managers appointed by the Pension Fund Regulatory and Development Authority (PFRDA).
- HDFC Pension Fund
- LIC Pension Fund
- ICICI Prudential Pension
- Birla Sun Life Pension
- Kotak Pension Fund
- SBI Pension Fund
- UTI Retirement Solutions.
You may opt for NPS from any of these seven pension fund houses.
How to invest in NPS?
Step 1: Pick one of the above seven fund managers.
Step 2: Choose your plan from one of the following two options.
- Auto Choice – Here, the proportion of funds invested across the three investment avenues – Equity and two types of Bonds, will be determined by a pre-defined portfolio which would change as per your age.
- Active Choice – Here you can actively choose the proportions in which you’d want your investment to be distributed among the three avenues.
- Note: We recommend the Auto Choice plan if you’re new to investing. The reason is simple – it’s much easier.
To sum up, the National Pension Scheme is a great way to save and invest for retirement. Returns and tax benefits aside, NPS brings in the much needed discipline that’s required to create a substantial retirement corpus.
