National Pension System (NPS)

National Pension System or New Pension Scheme is a  predefined contributory pension system which is operated by the government of India. Before 2004 , NPS used the defined benefit plan, wherein the benefits available to the pensioner post retirement were pre-defined.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

Tier I Category:

A Tier I account is a basic retirement pension account available to all citizens from 1 May 2009. Although in case of premature withdrawal, one can withdraw only up to 25% after a lock-in period of 10 years and the remaining has to be invested in an Annuity.
It has a minimum contribution of ₹6,000 per year or ₹500 per month. Although it has no maximum investment limit, one can get a Tax exemption of up to Rs. 1.5 Lac per annum as per section 80C and an additional ₹50,000.00 as per section 80CCD (1b).
After attaining the age of 60, a maximum 60% of the accumulated amount can be withdrawn and remaining 40% needs to compulsorily be invested in Annuity.

Tier II  Category:

A Tier II account is a Prospective Payment System (PPS) account that permits some withdrawal of pension prior to retirement under exceptional circumstances, usually related to the provision of health care.
It has a minimum contribution of ₹2,000 per annum and no maximum contribution limit. However one does not get any tax benefit under this category.
There is no locking period given and there are no Tax Benefits as well.

Tax benefits on NPS are available through 3 sections  viz, 80CCD(1), 80CCD(2) and 80CCD(1b).

All the tax benefits, annuity restrictions, exit and withdrawal rules are applicable to NPS Tier-I account only. 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.

Benefits of NPS
NPS has got some major benefits as well.Tax Benefit upto ₹1.5 Lac under section 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 case of Active Choice, the composition of the portfolio matters.Besides these 2 factors, it instills a practice of regularly saving for retirement.

Risks of NPS (Tier I)
NPS has certain risks involved as well, such as :

Once a person has started investing in an NPS, he has to make the minimum contributions every year and can withdraw only 25% after 10 years for specific purposes including children’s higher education or marriage, construction or purchase of first house and medical treatment of self, spouse, children or dependent parents.
There is a minimum contribution of ₹6,000 per annum and only maximum of 50% can be allocated to equities.As of now NPS is EET (Exempt, Exempt, Tax) which implies that the investment and returns won’t be taxed but the redemption amount would be taxed as per the eligible tax slab.

Tax implication on NPS :

In Budget 2016-17, the government rationalized the tax on NPS to make it more attractive. NPS has EET status which means that the investment and returns are not taxable, however a tax will be levy on the redemption amount.Since minimum 40% of the corpus has to be invested to buy an annuity, the taxation on the 40% of the corpus get delayed. In addition, now a person can withdraw up to 40% of the corpus without paying any tax. Therefore, only 20% of the corpus will be taxed.But there has not been any major changes in the Budget of  2018 regarding this scheme.Investors and experts have expected a lot of positive changes in NPS due to its recent continuing popularity.But really all got disappointed as nothing noteworthy has been introduced in the Budget 2018 for NPS.
Let’s take an Example:

Let’s say Mr. Ganguly has an NPS corpus of Rs. 1 crore at the time of retirement. The following two events will happen to him:

  1. He has to buy  compulsorily an annuity of the 40% of the corpus i.e. ₹40 lakh is invested in  annuities.
  2. He can withdrawal the rest ₹60 lakh of the corpus, out of which ₹40 lakh is tax free while ₹20 lakh is taxable as per the income slab of the investor at the year of withdrawal only.

Backdrops of NPS:

This becomes quite painful for those who would retire with NPS due to taxation on the balance amount to be withdrawn as per normal income tax slab.Also the returns earned from Immediate annuity is quite lower as compared to other fixed nature instruments.

Further, the income generated from annuities is also taxable.

Final Word

GOI is making no stones unturned to make NPS a great hit by all means and also its continuous approach towards zero pension liabilities. Also they are contemplating to increase the equity exposure upto 75% for active choice options. But the compulsory annuity purchase of minimum 40% and additional tax burden on the @20% of total accumulated balance if not invested in annuities is giving investors a second thought about this.

NPS has got two investment options as well.One is Auto choice and another one is Active choice.I will discuss about this options in my later post.