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Thinking About Investing in the National Pension Scheme? Here's a Detailed Guide to NPS

The National Pension Scheme (NPS) is one of the best ways for salaried employees and self-employed professionals to build a retirement corpus. Check out this post to know what this scheme is, its features, benefits, and more.

Getting Started with National Pension Scheme (NPS)

Retirement planning is one of the most common goals in India. After working hard for several years, you'd want to live a comfortable and financially stable life after retirement. But this post-retirement dream is only possible if you start planning for it as early as possible.

For salaried employees and professionals, the government has introduced the National Pension Scheme (NPS) to help them start saving and investing towards their retirement. The reasonable annual returns, tax savings fund manager selection flexibility, and long-term growth prospect of NPS makes it an excellent choice for every salaried employee and professional serious about his/her retirement.

If retirement planning is on your mind, here is a detailed guide to help you understand what NPS is.

What is NPS?

The NPS scheme was introduced by the government, under PFRDA (Pension Fund Regulatory and Development Authority), in 2004 as a social security initiative for government employees. But in 2009, it was made open to all the citizens of the country aged between 18 and 60 years. It is a voluntary pension scheme available for employees from the private, public, and even unorganised sectors. Even employers are eligible to contribute to the NPS account of the employees. Also, while the scheme is targeted towards salaried employees, it is open for self-employed professionals too.

What is a Mutual Fund’s NAV?

Net Asset Value (NAV) is the price of the mutual fund which is essentially the combined market value of the securities, shares, and bonds held by a fund, after deducting all the expenses and charges. If you combine the market value of all the shares and securities in the fund and divide it by the total number of units from the fund, you'll arrive at the NAV per unit.

How an NPS Account Works

The basic functioning of NPS is as follows:

Employees or self-employed professionals open an NPS account and then start investing in the same at periodic intervals throughout their working years. After retirement, the account holder is allowed to withdraw a certain portion from their NPS account as a lump sum amount. The rest is compulsorily given as regular annuity (pension).

Types of NPS Accounts

There are two types of NPS accounts - Tier I (mandatory) and Tier II (voluntary). The most significant difference between the two is the withdrawal restriction. You are only allowed to withdraw the entire NPS corpus on retirement from Tier I account. But this withdrawal is only possible if you meet certain conditions.

But, you are free to withdraw the entire NPS corpus if you have a Tier II account. But note that the tax benefit under Section 80CCD (1B) is only available for the Tier I account.

Investment Choices Available for NPS Investors

As for the investment choices, one can select between Active Choice and Auto Choice. Within the Active Choice, the subscribers can build their portfolio among three asset classes:

  • Equity (E)-

    The Equity class can deliver the highest returns, but it also comes with the highest level of risk.

  • Corporate Bonds (C)-

    Investments are made in fixed income corporate bonds. Returns are lower than Equity, but the risk is low.

  • Government Securities (G)-

    Only invests in government-backed securities. Lower returns but minimum risk.

The Auto Choice is that of the Life Cycle Fund. If you don't select any of the asset classes from above, your account will be automatically treated as a Life Cycle Fund. Here, your investment will be divided into pre-fixed proportions based on your age.

For instance, the Equity (E) exposure will be high when you are young. The portfolio will be shifted towards safer Corporate Bonds (C) and Government Securities (G) as you age.

Tax-Savings with NPS

The contribution made by the employee, and the employer's contribution (if any) are eligible for a tax deduction upto Rs. 1.5 lakhs in a financial year.

  • Employee Contribution

    The contribution done by the employee is eligible for tax deduction under Section 80CCD(1). The maximum deduction under this section can be up to 10% of the annual salary of the employee. If you are a self-employed taxpayer, you can claim up to 20% of your gross income as a tax deduction by investing in NPS.

  • Employer Contribution

    The NPS contribution done by the employer is covered under Section 80CCD (2). Here, the maximum deduction can be the lowest of the employer NPS contribution, or the total gross income of the employee, or 10% of the basic salary + DA (Dearness Allowance) of the employee.

Moreover, there is also an additional deduction of up to fifty thousand Rupees under Section 80CCD (1B) available on self-contribution to Tier I account in a year. So, overall, you can claim a tax deduction of up to Rs. 2 lakhs in a year by investing in NPS.

Withdrawal After 60 Years

There is a widespread belief that subscribers are free to withdraw the entire NPS scheme contribution, along with the generated returns, once they retire. But this is not true. You can only withdraw up to 60% of the corpus. You will not have to pay any taxes on this 60%.

But the remaining 40% should be compulsorily used for purchasing an annuity (pension) plan from a life insurance company. You will get many different insurance plans to choose from. Also, in case of an emergency like medical treatment, child's education or marriage, house purchase, etc. you can withdraw up to 25% of the corpus after investing in NPS for at least three years.

A subscriber is allowed to make up to 3 withdrawals from the NPS account in 5 years. But note that these limitations are only applicable to the Tier I accounts. The Tier II account is free for withdrawal without any restrictions.

How to Open NPS Account?

You can open an NPS account, either online or offline. For online investment, visit the official NPS website (enps.nsdl.com) and click on the 'Apply Now' button. You must fill a registration form, which will be followed by e-KYC and providing additional details like PAN, bank account details, etc.

The initial contribution can also be made online. Subscriber will receive PRAN (Permanent Retirement Account Number) on successful online payment. If you want to open the account offline, you will have to visit the nearest NPS POP (Point of Presence). The majority of the banks are now NPS POPs. Visit the POP and ask for a registration form. Fill in the details and complete the KYC. Make the initial contribution through cheque or demand draft to receive the PRAN.

You will then receive an NPS kit by post. This kit will have the password, which you can use to login to your NPS account. But, note that there is a one-time fee of Rs. 125 for opening the account offline.

Who Should Open NPS Account?

Anyone and everyone can invest in the National Pension System. It is a flexible investment option that could help you build a considerable retirement corpus by encouraging you to invest throughout your working years.

It is highly tax-efficient, and you also get to choose and switch between investment funds as per your retirement goals. Not to forget that the equity component of NPS could help you generate returns higher than many other investment options in the longer run. Try to know more about the benefits of NPS and open an account as soon as possible to start working towards your dream retirement.