National Pension System

National Pension System (NPS) is a pension plan managed by the Pension Fund Regulatory and Development Authority (PFRDA) and is gaining popularity among investors primarily because of some tax modifications made in the scheme and the returns generated by the pension fund managers. 

Earlier, the introduction of Section 80 CCD (1B) gave it an edge over other tax-saving investments, and later on, making the entire 60 percent of the corpus on maturity tax-free has made several investors consider NPS as a long-term investment for their retirement needs. The NPS withdrawal on maturity enjoys a 100 percent tax-free status. One of the major advantages of NPS is that it is a low-cost investment option and is a dedicated scheme for post-retirement needs. 

Let’s explore some features, how NPS works and see its suitability and the watch-outs:

Anyone between 18 and 60 years can open an NPS account and start saving till retirement. However, Pension Fund Regulatory and Development Authority (PFRDA) had increased the maximum age of joining under NPS - Private Sector i.e. under the All Citizen and Corporate Model from the existing 60 years to 65 years of age. It means anyone between 60 and 65 can now join NPS and continue till age 70.

For those joining after 60, the investment options and the pension fund manager, etc remain the same. The normal exit will be after 3 years when the subscriber is allowed to withdraw a maximum of 60 percent of the corpus while the balance 40 percent will have to be compulsorily annualized. It means the subscriber has to purchase pension or annuity from any of the life insurance companies using 40 percent of the NPS corpus. In case, one decides to exit before completion of three years, only 20 percent can be withdrawn while pension will be paid on the balance 80 percent of the corpus. 

For those joining NPS after the age of 60, the advantage is in terms of better annuity rates as compared to younger individuals. The annuity rates for someone age 65 is better than annuity rates for someone age 45. 

NPS is a market-linked product with contributions exposed to equities and debt needs time to perform. Saving tax should not be the sole objective to invest in any tax saving investment. So, senior citizens should evaluate properly before opening the NPS account. 

Anyone joining NPS after age 60 should be clear on three things – 

• Till what age will he be contributing regularly in NPS? For a longer period, it helps else money gets locked in with limited use. 

• Opting for debt funds, both corporate and government securities with a speck of equity should help. But again, the holding period should be long for optimum results. Even debt can be volatile over short to medium term sometimes. 

• Finally, do not treat NPS merely as a tax-saving tool. NPS scheme is a long term investment and for someone, it could be as long as 60 years to be associated with the scheme. Imagine someone starts NPS contributions from age 30. He or she will have to keep contributing for another 30 years till age 60. With increasing life expectancy, on average, if one continues to live till 90, it will be nearly 30 years of post-retirement association with NPS during the annuity-phase. Remember, under one option, the spouse gets pension after NPS account holder dies and later on legal heirs get the corpus.

What you invest in NPS along with the growth it makes, the corpus gets accumulated on maturity at age 60. While a maximum of 60 percent is allowed to be withdrawn on maturity, on the balance compulsory pension is paid to the annuitant i.e the investor. Being a retirement-focused scheme, NPS rules do not allow full withdrawal of the corpus on maturity. While only 60 percent can be withdrawn, one has to invest the balance 40 percent of the corpus in an Immediate Annuity scheme of a life insurance company. The pension will be paid by the life insurer depending on which pension option one chooses. 

The maximum that NPS allows to invest in equities is 75 percent of one’s contribution and that too till the age of 50. As one age, the allocation to equities tapers off. Therefore, if you wish to allocate a higher percentage of your savings into equities for a long term goal such as retirement, act accordingly. 

In NPS, fund management is more of a passive approach and the pension fund managers have to replicate the index structure. While active fund management has the potential to outperform the index it also carries an element of risk to underperform. 

The contribution made in the National Pension System (NPS) qualifies for tax benefits under the Income Tax Act, 1961. On the amount invested in NPS, one can avail tax breaks under Section 80CCD (1), Section 80CCD(1B) and Section 80CCD (2). Importantly, as per Section 80CCE, the aggregate amount of deduction under sections 80C, 80CCC and Section 80CCD(1) cannot exceed Rs.1. 5 lakh in a financial year. Such investments by the NPS subscribers have to be made into the NPS Tier I account in order to avail Deduction from income and save tax. 

NPS has two accounts – Tier I, and Tier II account – while the former is the default account that one has on opening NPS account into which the initial contribution goes into. The Tier II is, however, an optional account and one can additionally open it to park savings in it as it has no lock-in period. 

However, this is true only for non-government individuals. The NPS tax benefit for government employees has an advantage over the other subscribers. If a Government employee contributes towards Tier-II of NPS, the tax benefit of Section 80C for deduction up to Rs. 1.50 lakh will be available to them provided that there is a lock-in period of 3 years.

For all Government employees joining Government service on or after 1-1-2004, the pension is based on the National Pension System which works on a defined contribution basis. While the monthly contribution by the government employee will be 10 percent of the basic pay plus DA into Tier I, for the central government, it will be 14 percent of the basic pay plus DA. 

For a non-government individual, the tax benefits are applicable for investments in the Tier I account only. The investments in NPS Tier I qualifies for tax benefits under Section 80 CCD (1) Section 80CCD (1B) and Section 80CCD (2) as per the conditions of the Income Tax Act.

For the money invested in the Tier I account, there will be a lock-in period while there is no such lock-in period for funds in the Tier II account, other than those for government employees if the tax benefit is sought by them. One can withdraw funds anytime from the Tier II account similar to open-ended mutual fund investment. 

From Tier, I account, partial withdrawal for a maximum of 25 percent of my own contribution may be made anytime after three years. Such partial withdrawal is allowed only for meeting specific needs such as education, marriage, medial, house ownership, etc. As a subscriber, one is allowed to withdraw only a maximum of three times during the entire tenure of subscription under the National Pension System. The fund options and investment choices are largely the same in both Tier I account and the Tier II account. However, one may opt for different fund managers or fund options in Tier-II account if needed. Presently, in NPS, there are different pension fund managers (PFMs,) two investment options (Auto or Active), and different Asset Classes. The Subscriber first selects the PFM, and post-selection of PFM, the subscriber has an option to select any one of the Investment Options. The National Pension

Conclusion:

System (NPS) is a market-linked deferred pension scheme that comes with several tax benefits. One can get the tax benefit not only at the time of investment but even on the partial withdrawals made during the tenure and also on the maturity amount at the vesting age. The vesting age is the age when the annuity i.e. pension begins. The pension that one gets from the vesting age is, however, taxable in the hands of the individual as per one’s tax slab in the year of receipt.

By: Sanjeev Puri

Published on: Investors India, August 2020 Edition