The National Pension System (NPS) was established in 2004 by the Pension Fund Regulatory and Development Authority of India (PFRDA) and the Government of India. It is a retirement cum pension scheme that additionally allows tax savings up to Rs 1,50,000 a year. It is very inclusive because both government and private sector employees can invest in it. It is one of the oldest and successful social security initiatives by the State in India.
It allows people even from the unorganised sectors, only excluding members of the armed forces. The scheme started with the purpose of encouraging the normal working individual to keep putting aside money at regular intervals for future use. Earlier, he was allowed to withdraw only a portion of this amount at monthly intervals and the remaining was used to purchase annuities. But now, this has changed where he can withdraw it all as monthly pensions. Several other changes have occurred that will be discussed briefly later.
In the starting, it was not as pervasive as it is now. It only covered Central Government employees but now is open to all Indian citizens on a voluntary basis. The scheme is portable with change in jobs across different sectors. It allows tax savings under Section 80C and Section 80CCD.
Who should invest in the NPS?
Anyone who prefers low risks can invest in the NPS. It is a good tool for anyone looking to plan a financially hassle-free retirement life. With all its features, it is highly recommended for employees retiring in the private sector. In fact, salaried people who want to make the most of the 80C deductions can also consider this scheme.
Features and Benefits of the NPS
Interest/Returns: The NPS has proven to be more effective than traditional savings and investment instruments. It has given a return of 8-10% over the past decade. One major benefit is that the subscriber is permitted to change the fund manager if he/she isn’t satisfied with the output of the current fund.
Risks involved: There existed a limit in the range of 75% to 50% on equity exposure for the National Pension Scheme (NPS). For government employees, this is relaxed to 50%. In these given limits, the equity portion will reduce by 2.5% each year beginning from the year in which the investor turns 50 years of age.
However, for someone of the age 60 years and above, the limited is fixed at 50%. This stabilizes the risk-return equation in the best interest of the investors, which means the fund is somewhat safe from the equity market volatility. The earning potential of NPS is higher as compared to other fixed-income schemes.
Tax efficiency: As mentioned before, there is a deduction of up to Rs.1.5 lakh to be claimed for NPS – for the employee’s contribution as well as for the contribution of the employer. – 80CCD(1) covers the self-contribution, which is a part of Section 80C.
The maximum deduction one can claim under 80CCD(1) is 10% of the salary, but no more than the said limit. For the self-employed taxpayer, this limit is 20% of the gross income.
Section 80CCD(2) covers the employer’s NPS contribution, which will not form a part of Section 80C. This benefit is not available to self-employed taxpayers.
The maximum amount eligible for deduction will be the lowest of the below:
- Actual NPS contribution by employer
- 10% of Basic + DA
- Gross total income
You can claim any additional self-contribution (up to Rs 50,000) under section 80CCD(1B) as NPS tax benefit. The scheme, therefore, allows a tax deduction of up to Rs 2 lakh in total.
Early Withdrawal and Exit rules: As a pension scheme, it is important for one to continue investing until the age of 60. However, if one has been investing for at least three years, one may withdraw up to 25% for certain purposes.
These include children’s wedding or higher studies, building/buying a house or medical treatment of self/family, among others. Withdrawals can be made up to three times (with a gap of five years) in the entire tenure.
Equity Allocation Rules: The NPS invests in different schemes, and the Scheme E of the NPS invests in equity. One can allocate a maximum of 50% of your investment to equities. There are two options to invest in – auto choice or active choice.
The auto choice decides the risk profile of your investments as per your age. For instance, the older you are, the more stable and less risky your investments. The active choice allows you to decide the scheme and to split your investments.
To know more about how to open an NPS account, types of NPS accounts and the NPS calculator; follow Bajaj Finserv.