What is National Pension System : Benefits, Eligibility & How does NPS Works?

The Indian government sponsored the National Pension Scheme or NPS in January 2004 as a means to secure your financial future after retirement. However, it offers benefits beyond creating a regular income source post-retirement. Read on to find out.

What is National Pension Scheme (NPS)?

The National Pension Scheme (NPS) is a pension programme applicable to public, private and even unorganised sector employees, but not applicable to the armed forces. It was initially restricted to Central Government employees. A social security initiative by the Central Government, this scheme is meant to incentivise individuals to invest in a pension account from time to time while employed. 

Post-retirement, account holders can then withdraw a specific percentage from their corpus. The remaining amount will be disbursed as a monthly pension. Further, Central Government employees joining on or after 1 January 2024 will be mandatorily covered under NPS.

How Does NPS Work?

NPS is a pension scheme for self-employed individuals and employees of the private sector, the unorganised sector, and the public sector besides the Armed Forces. In this scheme, an investor (you) can make a yearly contribution starting at Rs. 1000, either in monthly instalments or as one lump sum payment. Your employer will also contribute an equal amount. The contribution you make will be invested in various funds such as index-based stocks, government bonds, or corporate bonds by your chosen fund manager. Depending on these investments’ performance, you can get long-term returns varying between 9% - 12%.

The contribution you make to the NPS account is locked until your retirement. However, you can make partial withdrawals of up to 25% of the contribution for specific reasons such as chronic illness, purchasing a house, or sponsoring a child’s education. These withdrawals are allowed after three years of opening the account.

The National Pension Scheme has broad eligibility. Any Indian citizen between the age of 18 and 60 can apply for the scheme. They need to be KYC compliant and not have a pre-existing NPS account. NRIs can also apply for NPS.

Objectives of National Pension Scheme

The National Pension Scheme has many vital functions. Its main objectives include the following: 

• The Government of India introduced the NPS to address the country's growing senior citizen population. 

• The NPS creates a corpus for an individual’s retirement. This is crucial for post-retirement financial planning and allows retired citizens to meet their expenses without facing monetary challenges.
• It also allowed citizens to save systematically during their employment years. This introduced financial discipline and allowed citizens to save for their future diligently. 

Features of the National Pension Scheme

It is essential to know the following features of the National Pension Scheme: 

1. Eligibility criteria 

• To apply for the NPS, applicants must be between the ages of 18-70. 
• Applicants must be Indian Citizens, NRIs, or OCIs to be eligible. 
• Applicants need to complete the KYC requirements on the subscription form. 

2. Flexibility 

• Subscribers to the NPS can select the auto-choice option, in which a fund manager handles investments based on an individual’s age. 
• Subscribers can also have an active choice in their investments, selecting the asset classes and percentage of funds to invest in. 

3. Liquidity and Flexibility 

• Tier I accounts are pension accounts. These do not have any restrictions on withdrawals, and can be opened with a minimum deposit of Rs 500. 
• Tier II accounts are investment accounts. They provide liquidity and allow subscribers to withdraw or invest funds without restrictions. These accounts require a minimum deposit of Rs 250, and can only be opened if the user already has a Tier I account. 
• Subscribers also receive unique IDs, known as Permanenet Retirement Account Numbers (PRANs). These are used for all contributions and management. 

Eligibility Criteria for National Pension Scheme

Here are the eligibility criteria for the NPS Scheme:

For Individuals:

• Both salaried and self-employed individuals are eligible
• The account holder must be between the ages of 18 and 70 years
• Accountholders can be a Non-Resident Indian (NRI), Hindu Undivided Family (HUF), and Overseas Citizen of India (OCI) but not a PIO cardholder

For Corporations:

• Corporations can benefit from the NPS to help promote their employees’ income security and retirement planning
• Corporations can offer NPS to their employees belonging to varying ages as long as they are between the ages of 18 and 70 years
• Corporations can choose the NPS model that meets their goals
• Corporations can set contribution parameters and choose from various Pension Fund Managers (PFMs), allowing employers and employees to contribute
• Corporations can also absorb specific charges on their employee’s behalf to make it more cost-effective and hassle-free

Benefits of NPS

Given below are the benefits of investing in the National Pension Scheme:

Tax exemption

Under Section 80C of the Income Tax Act, an NPS contribution of up to Rs. 1.5 lakhs is eligible for tax exemption. Moreover, you can claim additional tax benefit under section 80CCD, depending on whether you are a salaried employee or self-employed.

Additional Read: 5 Tips to grow your wealth while saving taxes

Flexibility in investments

NPS offers two options of investments: an active choice or an auto choice. In active choice, you can choose whether to invest in equity, debt or a combination of the two. In auto choice, an investment portfolio is created by assessing your age and risk profile. Initially, a higher equity cap is set, between 50% to 75%. After the age of 35, as your age increases, the auto choice feature will reduce the investment in equity portion by 2.5% per year to reduce the risk.

Also, the scheme offers various pension schemes and a portfolio of fund managers. You can choose and change either or both at any given point.

Tax Benefits on National Pension Scheme

Listed below are the different tax benefits for the National Pension Scheme. 

Some other tax benefits offered by the  NPS on Tier I investments include the following: 

• Up to 25% of any withdrawals made by subscribers will be exempt from taxation. 

• Any annuity purchases made from the NPS’s corpus are exempt from taxation. However, income generated from these purchases is liable to taxation.  
• Any lump-sum withdrawals (of up to 40% of their NPS corpus) made by a subscriber after they turn 60 years of age is exempt from taxation. 

Who Should Invest in NPS?

The National Pension Scheme is an excellent way to secure your future and ensure an assured income source in your retirement days. It is flexible, provides high returns, and offers tax benefits to investors.

It is an excellent scheme for anyone with a low risk appetite looking to plan for their retirement. 

Especially if you have a private sector job, you will benefit from a regular income post retirement. The earlier you start planning, the better it is. What’s more, salaried individuals who want to benefit from 80C deductions can also start saving under this scheme.

Additional Read: Secure your Retirement with Wealth Management Planning

FAQs

What is a Pension Fund Manager?

Pension Fund Managers of PFMs are individuals who are responsible for supervising the financial management of pension funds. PFMs invest pension funds to grow assets for the future.

What is a Permanent Retirement Account Number (PRAN)?

A Permanent Retirement Account Number (PRAN) is a 12-digit numerical code that is issued to every individual enrolled in the NPS. Each NPS account holder will have their own unique PRAN. 

What is Auto Choice in the National Pension System (NPS)?

This facility is designed for investors who want a hands-off approach to asset allocation. Auto choice in NPS allows investments to be automatically distributed across asset classes depending on the individual’s age. 

How does Auto Choice work in NPS?

Auto Choice in NPS allows an individual’s investments to be managed automatically depending on the age and the life cycle of the investment. It begins with a high exposure to equity in the case of young individuals and steadily moves towards a more conservative allocation of assets as the individual comes closer to retirement.

How does NPS annuity income get taxed?

The National Pension Scheme is an Exempt-Exempt-Exempt product (or EEE). This means all investments are completely tax-free at any stages.  Subscribers receive returns from their investments at maturity tax-free. 

Will the Government put money into my NPS account?

While the National Pension Scheme is an initiative by the Government of India, the government does not contribute to a citizen’s NPS account. 

Is there NPS for private sector employees?

Yes, private sector employees can contribute to a Tier II NPS account. However, they are not eligible for tax exemptions under Section 80C. 

How much monthly pension will I get from NPS?

Your monthly pension from the NPS will depend on many factors. These include the duration of your investment, contribution amounts, and the assets classes invested in. 

What is NPS interest rate?

The interest rate of NPS typical varies from 9% to 12%. This is dependent on the performance of different assets. 

Can I withdraw money from NPS?

Yes, subscribers can withdraw money from the NPS depending on the duration of their investment. For example, users can withdraw 25% of the corpus after 3 years.