What is the national pension system? Can I save tax if I invest in NPS?

Retirement: the twilight years of your life. Whether your retirement will be peaceful or not, depends on the bank balance you have managed to accumulate through your working life. Everyone does not have a comfortable nest. So. how does one ensure financial security post-retirement? Pension plans are one way to go.

What is the National Pension Scheme?

The National Pension System (NPS) is a financial tool provided by the Central Government. The scheme helps you plan a comfortable retirement by encouraging regular savings. Earlier, this scheme was exclusively available only to Central Government employees. It has now been extended to employees of the public, private and unorganized sectors. However, it excludes members of the armed forces.

Features of NPS

Some of the key points to bear in mind about NPS are as follows –

  • Overview

    An investor is required to regularly invest in an NPS plan till the age of 60. However, withdrawals up to 25% are permitted after the completion of three continuous years of investing for specified purposes. These include the purchase or construction of a house, medical treatment of self and dependents, etc. Such withdrawals may be made thrice in the entire tenure, with a gap of five years.

  • Returns

    On retirement, up to 60% of the corpus can be withdrawn. Such withdrawal is currently exempt from tax. The balance (40% or more) is to be mandatorily parked with a PFRDA registered insurance firm to generate regular pension income for the investor.

  • Annuity Pension

    The annuity pension earned after retirement from NPS is subject to tax in the year of receipt as per the investor’s income tax slab. In the event of the death of the investor, the accumulated amount would be paid to their legal heir. The same will be exempt from taxation. This scheme has been in effect for over a decade, and so far has delivered 8% to 10% annualized returns.

  • Minimum Investment Amount

    The minimum amount of investment in NPS depends on the scheme type, it ranges from Rs. 250 to Rs. 1,000. There is no limit on the maximum amount that can be invested.

  • Application Process

    The process can be undertaken either online or offline. The offline process requires a visit to a PoP (point of presence), typically a bank. You’re expected to fill out a subscriber form and submit your KYC documents along with an initial investment. Alternatively, an NPS account may be opened online via www.enps.nsdl.com by linking your account to your PAN, Aadhar, and contact details.

    Upon account activation, a PRAN (Permanent Retirement Account Number) is allocated to you which is then used for all future transactions.

  • Equity Allocation

    Contrary to traditional government securities, NPS has a certain fraction of equity exposure. Hence, it yields better returns as compared to PPF or an FD. Needless to say, the risk involved is also proportionately higher. However, the risk involved in NPS is comparatively lesser than investment in ELSS.

  • Lock-in Period

    The single point of contention while considering investing in NPS is the lock-in period. The amount of investment cannot be withdrawn till the age of retirement of the investor subject to certain exceptions. However, NPS offers a wide range of customizations to its investors. An investor may opt for a scheme, fund manager, or risk appetite preferable to him.

Does NPS Help You Save Tax?

NPS is a preferred investment avenue for many due to the tax benefit derived from the contributions which can be claimed as deductions under Chapter VIA. The deductions related to NPS are as follows –

  1. Self-Contribution

    Section 80CCD (1) covers self-contribution to the extent of 10% of salary or Rs. 1,50,000, whichever is lower. Applied to self-employed individuals, the deduction is capped at 20% of gross income.

  2. Employer’s Contribution

    Section 80CCD (2) corresponds to your employer's contribution to NPS, the amount of deduction will be the lowest of -

    • 10% of Basic + Dearness Allowance
    • Gross Total Income
    • Actual NPS Contribution by the employer.

    The section does not apply to self-employed individuals.

  3. Additional Provisions

    Section 80CCD (1B) includes self-contributions made to NPS by the taxpayer. The amount of deduction is subject to a maximum of Rs. 50,000. It is pertinent to note that the deduction under this section is in addition to the deduction under section 80C as discussed above in point 1. Hence, a taxpayer can claim a total deduction to the tune of Rs. 2,00,000.

NPS Categories

NPS Schemes can be bifurcated into various categories based on –

  1. Type of Contribution – Default & Voluntary

    In the case of contributions made by default, withdrawals are not permitted. However, the amount invested can be claimed as a deduction under section 80C and section 80 CCD (1B). The maximum amount of deduction is capped at Rs. 2,00,000.

    In the case of voluntary contributions, withdrawals are permitted. The amount invested can be claimed as a deduction under section 80C by government employees, other employees are not eligible to claim a deduction. The maximum amount of deduction is capped at Rs. 1,50,000.

  2. Equity Allocation

    An investment made in NPS is further invested in various schemes ranging from equity to money market instruments and fixed income securities. As an investor, you have the prerogative of choosing the asset class mix. Scheme E of the NPS deals is market-linked and associated with equity. The maximum investment in Scheme E is restricted to 50% of the total investment.

  3. Risk Profile

    Investment options available include auto or active choice. The auto option evaluates the risk appetite based on the age of the contributor and adjusts the asset class mix accordingly. For example, a contributor in the late 50s may be risk-averse and hence the equity investment will be limited. Whereas the active option enables the investor to decide the scheme and asset class mix irrespective of any other factors.

Who Should Invest in NPS?

Having laid out the various pros and cons of NPS, the choice of whether to invest or not depends on your risk appetite and investment goals. NPS provides a relatively safe, government-backed investment opportunity with a fixed lock-in period. One of the most attractive features of NPS is the tax benefits it offers and the flexibility in choosing the asset class mix. It’s especially beneficial for salaried employees and individuals inclined towards planning a fixed pension during retirement.

Final word

NPS is a secure yet popular retirement tool. If it makes sense within your financial goals and trajectory, what are you waiting for? Invest now!

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