While most of us may have heard of the National Pension System (NPS), navigating the nuances of its various account types, contributions, tax benefits, and withdrawal rules can still be challenging.
During a recent ‘Parichay‒Ask the Expert’ session with greytHR, Amaranath Ambati, Co-founder of Arush India, shared his insights and simplified the complexities of NPS.
In this blog post, we'll cover a few key questions he addressed during this interactive session.
Popularly known as the National Pension Scheme, the National Pension System is a voluntary contribution-based retirement savings scheme designed to help subscribers make systematic savings during their working life.
NPS is regulated by a government agency called Pension Fund Regulatory and Development Authority (PFRDA). Introduced in 2003, NPS was provided only to government employees. In 2009, private sector employees and all Indian citizens became eligible for it. Any Indian citizen aged between 18 and 65 years is eligible to join the scheme.
NPS is a low-cost investment compared to other investments like mutual funds, debt funds or equity funds. It offers tax breaks for individuals. Since it is a market-linked scheme, the returns will be high if the market performs. Even in terms of contributions, NPS also offers more flexibility compared to other products.
There are two types of accounts: Tier 1 accounts and Tier 1 accounts. One must open a Tier 1 account before opening a Tier 2 account; which means a Tier 1 account is mandatory to open an NPS account.
A Tier 1 account has some withdrawal restrictions since there are significant tax benefits. The Tier 2 account is like a voluntary savings scheme where the members can withdraw the amount anytime without any restrictions. But there are no tax benefits. A Tier 2 account is similar to a bank account. However, it earns returns based on fund performance since it is completely linked to the market.
It is similar to opening a bank account. By submitting a form and the KYC documents, an NPS account can be opened within a few hours (if done right). If the Aadhaar is available, the individual can link the KYC to the Aadhaar and open the online NPS account (on the NSDL portal) within minutes, and get a permanent retirement account number (PRA). Contributions and withdrawals can be made online.
Tax benefits under NPS apply only to Tier 1 accounts. Any NPS subscriber can claim a tax benefit of up to INR 1.5 lakhs under Sec 80CCD (1), and an additional deduction of up to INR 50,000 is available under 80CCD (1B). The employer’s contribution of up to 10% of salary (Basic + DA) will also be deducted.
In the Tier 2 account, only the contributions made by government employees qualify for a deduction under Section 80C. The limit is INR 1.5 lakhs, and the lock-in period is three years. However, the Tier 2 account doesn't offer additional tax benefits beyond those available under regular income tax laws.
Tier 1 account: The minimum amount per contribution is INR 500, and the minimum contribution per year is INR 1000. There is no limit to the number of contributions that can be made in a year, but at least two contributions (in a financial year) are mandatory.
Tier 2 account: The minimum amount per contribution is INR 250. However, a minimum contribution of INR 1000 is required for account activation. Unlike the Tier 1 account, there are no mandatory contribution requirements for the Tier 2 account, and the subscribers can choose to contribute as per their financial goals.
Unlike PF, where equal contributions are required, NPS contributions are flexible. The same can differ from employer to employer and also between employee and employer. The contributions can also be unequal between the employer and employee.
In the case of NPS, the government does not guarantee any return on the investment, since it is completely market-linked and based on the fund performance. Past trends show an average yield of 9% to 12%.
If you log in to your account, at the end of the year, you can see the percentage of return from the fund to date.
Subscribers can choose to make a withdrawal anytime between 60 years and 75 years of age. Although the person can continue the fund till the age of 75 years, the contribution has to stop at the age of 65.
A maximum of 60% and a minimum of 40% can be withdrawn as a lump sum. If 60% is withdrawn, it is entirely tax-free. If 40% is withdrawn, it has to be invested in an annuity that generates a tax-free monthly pension.
As per a recent amendment, if the total corpus is less than five lakhs, 100% withdrawal can be made.
Partial withdrawal is allowed for higher education/marriage of children, purchase or construction of a house, treatment of specified diseases and self-employment/set of a startup. But the subscriber should have also completed at least three years in the NPS scheme. There is also a limit of three withdrawals before 60 years. Withdrawal (only 25%) before three years is permitted only for expenses related to skill development, reskilling or self-development activities. Such a withdrawal is completely tax-free.
If there is an individual NPS account, the subscriber can merge the same with the new company’s corporate account. All future contributions will be made to the same account. If there is an existing corporate account, the person can request inter-sector shifting with the aid of an ISS form.
NPS charges are considered minimal when compared to other investment schemes. To open an NPS account, an initial registration charge of INR 200 is levied; this can go up to INR 400 depending on the service provider and the amount of contribution. For subsequent contributions, a service charge of 0.5% is charged; this is reduced to 0.2% for online transactions.
A maintenance charge of INR 100 per annum is recovered quarterly, and a fee of INR 32 is charged for non-financial transactions such as a change of address. If the minimum contribution is not made in a financial year, there is no penalty, but the account will be frozen, and no transactions can be made until reactivation.
Now that you understand NPS better, you may be eager to learn more. If so, we invite you to listen to the webinar recording, where the expert answered more questions.
Please note: As the government may make amendments to the laws, it is important to refer to official websites and documents for the latest information.
Listen to the recording of the entire webinar