National Pension System Features, Benefits, Tax Deduction and Withdrawal Rules
What is National Pension Scheme?
National Pension System or New Pension Scheme (NPS) is a predefined contributory pension system which was introduced by the government of India in January 2004. This NPS scheme was primarily meant for the Govt. employees only.
Before 2004, NPS used to be a defined benefit plan, wherein the benefits available to the pensioners post-retirement were pre-defined. But to reduce its pension liability the Central Govt. resorted to a contributory pension plan in the name of National Pension System.
From a Govt. sponsored contributory pension plan, National Pension System emerged as a pension plan for all since 2009 irrespective of his employment category.
The way the interest rates on FDs, RDs, PPF, VPF, NSC, Senior Citizen Savings Scheme, Pradhan Mantri Pension Yojana are being reduced gradually in our country, it is indeed becoming difficult for the senior sections of the society to make a sustainable living.
Features of NPS /National Pension System
It is said that NPS has been designed in line with the world’s best pension fund standards. In India, the National Pension System is being regulated and maintained by the Pension Fund Regulatory Authority of India(PFRDA).
Features of NPS are as follows:
- Regulation: NPS is governed and administered by the PFRDA with transparency and stringent rules;
- Defined Contribution: NPS is a defined contribution based pension scheme;
- Voluntary: This is a voluntary savings scheme accessible to all citizens of India irrespective of his professional status;
- Flexibility: This scheme is most popular due to its immense flexibility such as the option to choose investment pattern;
- Low investment: The minimum investment in NPS has been kept as low as Rs.1,000/- per year;
- Portability: It is said that at present in India there is no other retirement product as portable as NPS. The change in a job does not indulge any fund transfer, as this is a unique plan based on Permanent Retirement Account Number or PRAN;
- Low maintenance cost: One of the most important features of this NPS scheme is that it is world’s one of the low-cost product. The fund managing cost is as low as 0.001%.
Benefits of NPS Account/ National Pension System
Before the emergence of NPS, in India, there was no other pension scheme sponsored by the Govt. of India that invests its retirement pool in equities. Because equity is the only asset class that may fetch manifold return on its investments if it is held for a longer tenure.
NPS enjoys the status of “E E E T” i.e. Exempt(Investment), Exempt(Returns) and Exempt(60% withdrawal) and Taxable. This means the investment, returns, withdrawal at maturity are exempt from tax and the monthly pension from the compulsory 40% annuity is taxable only.
National Pension System offers flexibility in investment options:
NPS is a low-cost retirement product at the same time it provides flexibility in terms of investment pattern. I mean the monthly savings pool is not invested in a static pattern. It offers various investment choices.
NPS has got some major benefits as well.Tax Benefit up to ₹1.5 Lakh U/S 80C and ₹50,000 under section 80CCD(1B).The returns earned from this scheme is better than various other tax saving products in case of Auto Choice.
In the case of Active Choice, the composition of the portfolio matters. Besides these 2 factors, it ensures regular saving for retirement for a longer time horizon and helps in creating a substantial corpus at retirement.
A subscriber of NPS has the flexibility in choosing his investment pattern. NPS offers two unique investment choices such as Auto Choice and Active Choice.
You may read the following:
Auto Choice Investment Option(E.C.G):
Under this investment option, the subscriber has the freedom to choose various asset classes available where his monthly contribution would be invested.
They are primarily called Life Cycle (LC) fund because of its investment principle with the age of the subscribers.
LC75 – Aggressive Life Cycle Fund: In this Fund, the investment exposure in Equity(E) starts with 75% till age 35 and gradually decreases as per the increasing age of the subscriber. The balance gets invested in Corporate Bonds(C) and Government Securities(G).
LC50 – Moderate Life Cycle Fund: Here the exposure in Equity(E) investments starts with 50% till age 35 and gradually decreases as per the increasing age of the subscriber. The balance gets invested in Corporate Bonds(C) and Government Securities(G).
LC 25 – Conservative life cycle fund: In this Life Cycle Fund, the exposure in Equity(E) investments starts with 25% till age 35 and gradually decreases as per the increasing age of the subscriber. The balance gets invested in Corporate Bonds(C) and Government Securities(G).
Active Choice Investment Option:
Under this option, the investor has the freedom to decide the asset allocation on his own. Yes, PFRDA provides you with so much flexibility in deciding how you want to invest your own money in a regulated manner.
In this Active choice NPS account, the maximum permissible investment limit to Equity(E) is 75% up to the age of 50 years. Thereafter it reduces by 2.5% each year and it will be 50% when you retire at 60 Years.
Earlier the maximum investment limit to equity class was only 50%. But recently this has been enhanced to 75%. This enhancement will help the young employees to accumulate a substantial retirement corpus over the periods of time when they turn 60.
Apart from offering a range of investment options to employees, this scheme allows individuals to make decisions about where their pension fund is invested, permits limited withdrawal prior to retirement and reduces the total pension liabilities of the Government of India.
Categories of NPS:
NPS is primarily divided into two categories i.e. Tier I & Tier II. Sometimes, this causes a lot of confusion among the investors regarding why there are two different categories of NPS.
However, there is nothing so much to worry as the fund charges and investment pattern, asset classes in both types are the same. There are only some regulatory differences that make two categories distinct.
NPS Tier I:
A Tier I account is a basic retirement pension account available to all citizens from 1 May 2009. Contribution to NPS starts with the opening of Tier I account first using the PRAN or Permanent Retirement Account Number.
The invested corpus is compulsorily locked in up to you attain the age of 60. Premature withdrawal is not allowed from this scheme, however, on fulfilling certain conditions (Children higher education, the marriage of children, Treatment of critical illnesses, Construction of House) partial withdrawal can be allowed up to the extent of 25% of employee contribution only.
Here one should keep in mind that premature withdrawal is calculated @25% of the subscriber’s contribution amount and not accumulated corpus. This means you can not withdraw your earnings on investment, only your contribution would be considered at withdrawal.
All the tax benefits, annuity restrictions, exit and withdrawal rules are applicable to NPS Tier-I account only.
Tier I account is mandatory for investment in NPS. Also, income tax deduction benefit is available to NPS Tier I account subscribers only.
Features of NPS Tier I account:
- Registration Cost: The minimum amount required to open an NPS Tier I account is Rs.500/- only.
- PRAN: At the time of investing in NPS you need to have a valid Permanent Retirement Account(PRAN).
- Minimum Contribution: The revised minimum annual contribution to Tier I account is Rs.1000/- only.
- Contribution Rate(%): For Govt. employees both the employers and employees contribution 10% each of their salary(Basic+DA) to NPS Tier I account. Employer’s contribution to Central Govt. employees has been enhanced to 14% w.e.f 01.04.2019. For self-employed person, it is a maximum of 10% of G.T.I.
- Compulsory Lockin: Since the purpose of investing in NPS is creating retirement savings, Tier I account does not permit random withdrawal except certain urgent conditions.
- Tax Benefits of NPS Tier I: Investment in NPS Tier I account only provides income tax deduction benefits U/S 80CCD(1),80CCD(2) and 80CCD(1B). So invest to create long term wealth and also get tax deductions.
- Dual Advantage: Unlike the EPF, both employer’s and employee’s contribution in NPS scheme gets the benefit of income tax deduction. This makes it a dual advantage retirement scheme.
- Withdrawal option: Withdrawal from this account is not permitted. However, on some certain conditions, premature withdrawal is allowed up to 25% of the employee’s contribution.
NPS Tier II:
Investment in NPS Tier II is a voluntary one. However, investment in Tier II account can be made only when there is an active Tier I account. Unlike the Tier I, Tier II account is not so restrictive in nature and has no minimum lockin period.
A Tier II account is a Prospective Payment System (PPS) account that permits withdrawal from this scheme any time a subscriber wants. There is no restriction on withdrawal by what so ever.
NPS Tier-II account is like open-ended ended mutual fund. You can take out the money at any time without any hassle and tax burden due to non-availability of tax exemption.
Features of NPS Tier II account:
- Registration Cost: The minimum amount required to open an NPS Tier II account is Rs.1,000/- only.Tier I: At the time of investing in NPS Tier II account, you need to have an active Tier I account.
- Minimum Contribution: The revised minimum annual contribution to Tier II account is Rs.250/- only.
- Voluntary: Investment in this scheme is completely voluntary.
- Compulsory Lockin: The greatest benefit of the NPS Tier II account is that it has no minimum lock-in period.
- Tax Benefits: There is no income tax deduction available for investment in this Tier II account.
- Withdrawal: Investment in NPS Tier II account is like it is your money and you can withdraw any time you want. There is not a single restriction in withdrawing from this account.
- Taxability on withdrawal: The entire amount withdrawn is chargeable to tax and it will be added to your existing income and tax has to be paid on it accordingly as per the existing income tax slab.
Tax Benefits of NPS Account:
Due to its tax deductibility nature, National Pension Scheme is well ahead of other retirement products and one of the most liked retirement plans right now. Tax benefits for contribution to NPS are available through 3 sections viz, 80CCD(1), 80CCD(2) and 80CCD(1B).
Employee’s own Contribution: Contribution by employees to NPS Tier I account is eligible for tax deduction up to 10% of Salary (Basic + DA) U/S 80 CCD(1) within the overall ceiling of Rs.1.50 Lakh U/S 80 CCE.
Employer’s Contribution: The employer’s contribution to NPS Tier I account is eligible for tax deduction up to 14% (w.e.f 01.04.2019) of Salary (Basic + DA) U/S 80 CCD(2) within the overall ceiling of Rs.1.50 Lakh U/S 80 CCE.
Tax benefit for self-employed: A self-employed person is eligible for tax deduction up to 20% of gross total income under Sec 80 CCD(1) within the overall ceiling of Rs.1.50 Lakh U/S 80 CCE.
Additional Deduction U/S 80 CCD (1B): An NPS subscriber is allowed an additional income tax deduction of maximum Rs.50,000/- per year in addition to the deductions allowed U/S 80CCD(1) & (2) for additional contribution to his NPS Tier I account as per Section 80CCD (1B). This deduction is over and above the overall deduction of Rs.1.50 Lakh claimed U/S 80C.
NPS Withdrawal Rules
NPS Tier I account is primarily a non-withdrawable retirement savings scheme. Withdrawal is permissible at the time of maturity i.e. attaining 60 years of age.
Partial withdrawal from NPS: However, PFRDA allows partial withdrawal of NPS contribution on fulfilling certain conditions. Only 25% of the own contribution is eligible for withdrawal before maturity. Further, this withdrawal can be done a maximum of 3 times during the maturity of the NPS account.
There is no restriction on withdrawals from Tier-II account, the following conditions are to be satisfied before withdrawal of funds from NPS Tier I account:
- The investor must have invested in the NPS scheme for at least 3 years.
- Only 25% of the own contribution can be withdrawn as partial withdrawal from an NPS account.
- A maximum 3 partial withdrawal from the NPS account during its tenure i.e. till the subscriber reaches the age of 60 is permissible.
- Partial withdrawals from NPS are allowed only on certain contingencies such as medical emergencies, higher education of children, the marriage of self and children, buying or construction of the first house.
- The time interval between two corresponding partial withdrawal must be 5 years from each other. But, in case of a medical emergency, the investor can make a successive withdrawal before the completion of 5 years from the last withdrawal.
- partial withdrawal is eligible for establishing a start-up venture or for self-development.
- These partial withdrawals are not subjected to tax i.e. tax exempted.
Exit from NPS Account before maturity
PFRDA allows an NPS subscriber to exit from the NPS account before maturity i.e. before turning 60 years of age. However, this comes with a hefty annuity burden.
I mean in that case, the subscriber has to buy annuity @80% of the accumulated corpus to get monthly pension and the balance 20% can be withdrawn which is further taxable as per the existing income tax slab of the subscriber.
Is NPS exempted from tax?/ NPS Withdrawal Rule at maturity?
In order to make NPS more attractive, the Central Govt. has made 60% withdrawal at the time of maturity completely tax-free in Budget 2019.
So, at maturity one can withdraw 60% of the accumulated corpus without paying any tax. For the balance 40%, one has to buy a pension annuity plan from the notified pension funds.
Before 2019 this tax-free withdrawal limit was 40% of the accumulated corpus. This is indeed a very great move for the NPS account holders.
Tax implication on NPS Withdrawal :
Therefore now, NPS is E E E T (Exempt, Exempt, Exempt, Tax) category instrument which implies that the investment, returns and 60% withdrawal are exempt from tax but the pension earned on 40% annuity would be taxed as per the existing tax slab of the subscriber.
Let’s take an example: Say Mr Ganguly has an NPS corpus of Rs. 1 crore at the time of retirement at 60 years. The following two events will happen to him.
- He has to buy compulsorily an annuity of the 40% of the corpus i.e. ₹40 lakh is invested in notified annuity plans.
- He can withdraw the balance 60% of the accumulated corpus i.e. ₹60 lakh which is completely tax-free as per the Budget 2019 announcements.
Authorised Pension Funds: The following NPS pension fund managers are authorised by the PFRDA for managing NPS pension funds.
- SBI Pension Funds
- LIC Pension Fund
- UTI Retirement Solutions
- HDFC Pension Fund
- ICICI Prudential Pension Fund
- Kotak Pension Fund
- Birla Sun Life Pension Management Ltd.