Understanding National Pension System (NPS): A Tax-Saving Instrument

As we dream of a peaceful and leisurely life post-retirement, the key to turning those dreams into reality lies in thoughtful planning and choosing the suitable investment for retirement. In this regard, the National Pension System (NPS) emerges as a dedicated investment plan tailored for retirement, promising a regular pension during your golden years. It is a voluntary retirement savings account enabling you to build a substantial corpus return with its market-linked return, that too with tax benefits.

What is National Pension System (NPS)?

NPS stands for National Pension System. The NPS, overseen by the Pension Fund Regulatory and Development Authority of India (PFRDA), was introduced by the central government in 2004. It was initially exclusive to central government employees, providing them with a platform to invest and accumulate returns for their retirement. Subsequently, in 2009, the PFRDA expanded its reach, making it accessible to all Indian citizens. Moreover, investments made in the NPS qualify for tax deductions under Section 80C and Section 80CCD.

Types of NPS Accounts

Tier I NPS Account: This retirement account provides numerous tax benefits, but your contributions remain locked until you turn 60. However, under specific conditions—such as completing three years of service or facing critical illness, educational expenses for children, wedding costs, or house-related expenditures—you can make partial withdrawals. Additionally, after 25 years of service, you can withdraw up to 50% of the corpus. Tax benefits can be claimed under Section 80CCD (1), Section 80CCD (1B), and Section 80CCD (2) when you open an NPS account. The Tier I account is mandatory and automatically activated upon opening to ensure a substantial fund at retirement.

Tier II NPS Account: This voluntary account functions like a regular investment account and requires a Tier I account for eligibility. You can open a Tier II account with an additional application form. Unlike the Tier I account, you can withdraw funds at any time without restrictions. The minimum contribution per installment is ₹250, and there is no minimum balance requirement. Investments in the NPS Tier II account do not qualify for tax benefits, and the returns are taxable. There is no lock-in period, and you can have a separate scheme preference and nomination for the Tier II account. The primary advantage of the Tier II account is its liquidity, allowing unlimited withdrawals, making it a valuable resource during emergencies.

How does NPS Work?

The NPS is a structured retirement savings plan designed to provide financial security during old age. NPS offers two types of accounts: Tier 1 account and Tier 2 account.

A Tier 1 account is the primary NPS account, which comes with a mandatory lock-in period of 60 years of age and also provides you with the tax benefit. However, a Tier 2 account is a voluntary account with no lock-in period, meaning you can withdraw it anytime. There are no tax benefits in the Tier 2 account.

When you invest in NPS, your contributions are invested in different asset classes, such as Equity (E), Corporate Bonds (C), Government Securities (G), and Alternative Investment Funds (A). NPS offers flexibility in asset allocation through two choices: Active Choice and Auto Choice.

In the Active Choice, you decide how much money is allocated to each NPS asset class based on your risk tolerance and financial goals.

In the Auto Choice, the allocation is determined based on your age, providing a more hands-free approach.

The funds within NPS are market-linked, meaning their performance depends on market fluctuations. This allows the potential for growth over the long term.

Upon reaching 60, your NPS account matures, and you can withdraw 60% of the total corpus as a lump sum payment. The remaining 40% is used to purchase an annuity, providing a regular pension based on the type of plan chosen.

National Pension Scheme: Eligibility Criteria

Any individual who satisfies the following eligibility criteria can invest in the scheme:

• You should be between 18 and 70 years of age on the application date.
• Should be a resident, non-resident, or an Overseas Citizen of India.
• Should comply with KYC (Know your customer) regulations.

By understanding the National Pension System (NPS), you can make an informed decision about investing in this tax-saving instrument, ensuring a secure and comfortable retirement.

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