National Pension Scheme

In this unit, we will discuss another type of investment that is helpful for retirement planning, i.e., the National Pension Scheme (NPS)

It is a pension scheme by the Government of India which aims to provide old age income, a reasonable market based return over long run and old age security to all its citizens. It is mandatory for government employees to invest in this scheme while private sector employees can choose between NPS and Employees' Provident Fund Organisation (EPFO). NPS is regulated and managed by the Pension Fund Regulatory and Development Authority (PFRDA). One can withdraw up to 25% of the contributions made after being in the scheme for 3 years. However, these withdrawals are for certain defined expenses like children's higher education or marriage or construction of the first house etc.

Types of NPS Accounts

NPS has two parts: Tier I and Tier II.

• Tier I: This is a mandatory no-withdrawal pension account and is eligible for tax benefits. The annual minimum amount to be deposited in this account is ₹1000. If one wishes to exit before the age of 60, 80% of the corpus should be used to buy an annuity and the rest, 20% can be withdrawn which is subject to taxation as per one’s income tax slab. For people retiring at the age of 60, 40% withdrawal from NPS is tax-free. Out of the rest 60%, 40% of the money needs to be used to buy an annuity and the rest can be withdrawn which is subject to taxation as per one’s income tax slab.
• Tier II: It’s a voluntary-withdrawal savings account, from which individuals can withdraw money anytime. It has no tax benefits. There is no annual minimum deposition limit.

How to Open a National Pension Scheme Account?

One needs to visit a Point-of-Presence (PoP) and fill out the prescribed form and submit the required documents for KYC compliance. Alternatively, one can open an account online at enps.nsdl.com and follow the steps mentioned therein.

Once registered, the Central Record Keeping Agency (CRA) will assign a Permanent Retirement Account Number (PRAN), which is unique to all subscribers.

Select the amount to invest and the investment option.

List of Pension Fund Managers (PFMs)

Following is the list of NPS managers: 

• HDFC Pension Management Company
• ICICI Prudential Life Insurance Company
• Kotak Mahindra Asset Management Company
• LIC Pension Fund
• Reliance Capital Asset Management Company
• SBI Pension Funds

Interest Rate Mechanism

For NPS Accounts, there is no guaranteed rate of interest. The rate of return would vary according to the returns given by different asset classes. NPS offers different funds with varying exposure to Equity, Corporate Debt and Government Securities. The following Investment options are available:

Active Choice Investment:  An investor can choose the exposure to different asset classes himself with maximum allocation towards equity being 50%.

Auto Choice Investment: Here investment allocation is done based on the investor’s age. In default version of this scheme, the equity portion is 50% till age 35, after which it reduces by 2% per year until it becomes 10% by age 55. The corporate debt portion is 30% till age 35, after which reduces by 1% per year until it becomes 10% by age 55. Other options within auto-choice are the aggressive and conservative life-cycle funds which begin with an equity allocation of 75% and 25% respectively. These are reduced as the NPS subscriber’s age advances.

Tax Implications

Under NPS, one can avail tax deduction on investments up to ₹ 1.5 lakh under Section 80CCD and ₹50,000 under Section 80CCD (1B) in a financial year. 40% of the amount received at the completion of the term is tax-free.

Risk associated with National Pension Scheme account

There is risk involved in this scheme as returns are linked to the market. If inflation turns out to be higher than the return rate of the scheme, there would be no real returns available. Since returns are market linked, the rate of return almost beats the inflation rate or stays at par with it.