Retirement planning is an important aspect of personal finance that often gets less attention. In an era of increasing life expectancy and uncertain financial landscapes, it is essential to have a solid retirement plan in place. The Government introduced a retirement tool for Government employees in 2004 then they made it for all Indian Citizens in 2009. In this blog, we will explore the National Pension Systemin detail and discuss its benefits.
What is the National Pension System (NPS)?
The National Pension System (NPS) is a Government organized voluntary, defined contribution retirement savings scheme and Pension Fund Regulatory and Development Authority (PFRDA) is the body that is governing NPS. It was initially introduced for government employees, but it was later extended to all citizens of India in 2009, including the unorganized sector and self-employed individuals. The NPS operates on the principle of accumulating savings during the working years of an individual’s life, which can be utilized to generate a regular income stream post-retirement.
How does the National Pension System work?
The NPS functions through a network of entities, including the Central Recordkeeping Agency (CRA), Pension Fund Managers (PFMs), and Trustee Bank. Individuals who wish to participate in the NPS can open an account called Permanent Retirement Account Number (PRAN) with any authorized Point of Presence (POP) or through online registration. Once the PRAN is generated, contributors can choose between different investment options offered by PFMs to allocate their contributions.
Types of NPS
There are 2 types of accounts under NPS: Tier-I and Tier-II. Tier-I is a mandatory pension account with restrictions on withdrawal until the individual reaches the age of 60. On the other hand, Tier II is a voluntary investment account with no withdrawal restrictions, providing flexibility to withdraw funds as and when required.
Benefits of the National Pension System
1. Retirement Planning: The NPS encourages individuals to plan and save for their retirement. Every Indian citizen from the age of 18 can start contributing regularly during their working years so that they can accumulate a significant corpus to ensure a comfortable and financially secure retirement.
2. Diversification: The NPS scheme allows the investors to diversify their hard-earned money under various asset classes such as Class E [Equities], Class G[ Government Securities], Class C [Corporate Bonds] and Class A [Alternative Funds] providing flexibility to choose between different investment options. This enables individuals to align their investments with their risk appetite and financial goals.
3. Professional Fund Management: The NPS allows individuals to select their Pension Fund Managers (PFMs) from a list of authorized entities given below:
- SBI Pension Funds Pvt. Ltd.
- LIC Pension Fund Ltd.
- UTI Retirement Solutions Ltd.
- HDFC Pension Management Co. Ltd.
- ICICI Prudential Pension Fund Management Co. Ltd.
- Kotak Mahindra Pension Fund Ltd.
- Aditya Birla Sunlife Pension Management Ltd.
- Tata Pension Management Ltd.
- Max Life Pension Fund Management Ltd.
- Axis Pension Fund Management Ltd.
Source: npstrust.org.in
These Fund Managers are experienced professionals who manage the investments and aim to maximize returns while maintaining an appropriate risk level.
4. Flexibility: NPS has 2 modes of investments: Active Choice and Auto Choice.
Active Choice:
In active choice, you can choose your fund manager and design your NPS portfolio on your own.
For Ex: If you’re an investor below the age of 35, your NPS asset mix can be as follows.
Class E – 50% | Class G – 30% | Class C – 15% | Class A – 5%
The overall asset allocation in the active choice should be equal to 100%.
Auto Choice:
The fund managers will choose the asset classes based on your risk preferences and age.
Three life cycle(LC) modes:
- Aggressive mode (LC 75) – Maximum equity investment is 75%
- Moderate mode (LC 50) – Maximum equity investment is 50%
- Conservative mode (LC 25) – Maximum equity investment is 25%
| Age | Aggressive | Moderate | Conservative | ||||||
| % of asset classes | |||||||||
| E | C | G | E | C | G | E | C | G | |
| Up to 35 years | 75 | 10 | 15 | 50 | 30 | 20 | 25 | 45 | 30 |
| 45 years | 35 | 20 | 45 | 30 | 20 | 50 | 15 | 25 | 60 |
| 55 years | 15 | 10 | 75 | 10 | 10 | 80 | 5 | 5 | 90 |
Source – npscra.nsdl.co.in | The total mix of asset allocation should be 100% | Class A is not available under an auto choice
If you’re a new NPS investor, it is best to start with auto-choice, and then when you are familiar with the market and investment strategies, you can transition to active choice.
5. Tax Benefits: The NPS offers attractive tax benefits to investors. Under Section 80C of the Income Tax Act, individuals can claim a deduction of up to Rs. 1.5 lakh on their contributions to Tier-I NPS accounts. Additionally, under Section 80CCD(1B), an exclusive deduction of up to Rs. 50,000 is available for contributions to the NPS, over and above the limit of Section 80C. So totally, an investor can utilize the tax benefits of up to Rs. 2,00,000 with NPS investments and these tax benefits are applicable only under the old tax regime.
On maturity, individuals can withdraw up to 60% of the accumulated NPS corpus as a lump sum, which is tax-free. The remaining 40% must be used to purchase an annuity, which also offers tax benefits. NPS is an investment with EEE status [i.e.] Tax-exempt at every stage of investment.
6. Transparency: The NPS operates on a transparent system where individuals can track their investments and contributions online through a dedicated portal. This transparency enhances trust and allows for better monitoring of retirement savings.
7. Portability: The NPS offers portability, which means individuals can continue their NPS account even if they change jobs or locations. This ensures that retirement savings remain intact and do not get fragmented during career transitions.
8. Annuity Options: At the time of retirement, individuals can utilize the accumulated NPS corpus to purchase an annuity from an authorized insurer. The annuity provides a regular income stream throughout the individual’s retirement years, ensuring financial security.
9. Liquidity: NPS has an option for partial withdrawals. This option can be utilized only after the completion of 3 years of account opening and the maximum withdrawal limit is 25%. Also, the partial withdrawal option can be availed 3 times with an interval of 5 years between withdrawals. The partial withdrawal option is available only for a few scenarios such as constructing a house, children’s education, medical emergencies, and a few more.
Also, there is an early exit option in NPS which allows the investors to exit their NPS investment after the completion of 10 years of account opening. Under the early exit option, an investor can only withdraw up to 20% of their corpus and the remaining 80% should be invested in any annuity schemes.
To Wrap Things:
The National Pension System (NPS) is a valuable retirement savings scheme that provides individuals with a structured and regulated platform to plan for their post-retirement years. With its flexibility, tax benefits, and professional fund management, the NPS offers a holistic approach to retirement planning. By starting early and contributing regularly, individuals can build a substantial corpus that ensures a comfortable and financially secure retirement. You can also use an online NPS calculator to understand the contribution required to achieve your retirement financial goals. It is essential for every individual to explore the NPS and consider it an integral part of their long-term financial planning.
