What is NPS? Know all about the government-backed scheme

Pension fund regulator PFRDA is expected to come out with a new NPS scheme by August to provide balance to risk and returns to subscribers. According to Pension Fund Regulatory and Development Authority (PFRDA) chairman Deepak Mohanty, the new NPS scheme will allow 50% of contributions to equities and the rest 50% to debt assets.

“July-September new NPS balance lifecycle scheme will be launched. The new scheme will have a 50% investment in debt and equity each. It will balance the return and risk due to age factors,” Mohanty had said.

What is NPS?

The National Pension System (NPS) (earlier known as the New Pension Scheme) is a social security initiative by the Central Government. It is open to employees from the public, private, and unorganised sectors, except those from the armed forces.

The Pension Fund Regulatory and Development Authority (PFRDA) regulates the pension scheme.

The market-linked contribution scheme is an attractive option for retirement planning as it provides a host of benefits like flexible investment options, professional fund management and tax benefits.

As NPS is a contributory scheme, subscribers make regular contributions—monthly, quarterly, or yearly. These funds are invested in various assets such as equity, debt, and government securities.

A lump sum amount, which includes the fund invested and returns earned over the years, is returned to the subscriber at retirement age. At present, rules allow only up to 60% of the lump sum amount to be withdrawn by a subscriber, while the rest is used to purchase an annuity from a pension plan provider.

For government employees, a certain portion of their monthly income is paid to the pension account, and the government makes a matching contribution on their behalf.

NPS, which was implemented in place of the old pension scheme in 2004, is mandatory for government employees. However, it is voluntary for individuals such as private salaried persons, corporates, NRI/OCIs and employees of autonomous bodies, small businessmen and others.

The assets under management of NPS were around ₹33,034 crore as of December 31, 2023, compared to ₹26,700 crore on March 31, 2023.

What are Tier 1 and Tier 2 in NPS?

The National Pension System Trust, set up by the PFRDA under the Indian Trusts Act of 1882, takes care of the assets and funds under the pension scheme and additional fund accounts.

The NPS Trust offers two types of accounts for subscribers – Tier 1 and Tier 2.

What is Tier 1

The Tier 1 account is a simple pension account. An individual must mandatorily open a Tier 1 account to subscribe to the NPS. The account is long-term, and certain conditions related to investment and withdrawals need to be fulfilled to operate it. A person must invest a minimum ₹500 to open a Tier 1 account and a minimum ₹1000 contributions per year to maintain it.

Also, one can keep contributing till the age of 60 to the Tier 1 account and can remain invested till 70 years of age. Only one Tier 1 account can be opened by a person.

Also, a subscriber can withdraw funds partially from the Tier 1 account to meet urgent requirements such as medical emergencies, education expenses and marriage.

Tax benefits under Section 80 CCD for investments in a Tier 1 account are offered by the government.

What is Tier 2

The NPS Trust offers a Tier 2 account as an add-on account to those who have opened a Tier 1 account. The Tier 2 account offers more flexibility with respect to contributions and withdrawals. The main feature of a Tier 2 account is related to withdrawals which can be made at any time.

A person can invest additional funds in a Tier 2 account to earn returns and use those funds for urgent requirements. There is no lock-in period or exit load in a Tier 2 account. Tax deductions are not allowed under the Tier 2 account. The NPS Trust also allows transfers of funds from a Tier 2 account to a Tier 1 account but not vice versa.

What is annuity in NPS?

An annuity in the National Pension System refers to a monthly or regular income offered by an annuity plan provider to a subscriber. Under the NPS, contributions made by a subscriber are invested in various assets and returns earned on those investments are credited to the pension account. At the maturity or retirement age, subscribers to allowed to withdraw certain portion of those funds as a lump sum amount and the rest are used to buy an annuity from an insurance company empanelled by PFRDA such as LIC, HDFC Life and others.

The NPS Trust does not provide annuity plans. It offers services related to fund management at a low cost. Annuity depends on the funds invested.

Tax benefits of NPS

The NPS offers tax benefits under Section 80 CCD(1) of the Income Tax Act, 1961, on the contributions. Tax deductions on contributions up to 10% of the salary are allowed. Government employees can avail additional tax deductions of up to 10% of their salary under Section 80 CCD(2) but these are subject to ₹1,50,000 limit under 80C of the I-T Act.

Individuals other than government employees can avail additional tax benefits of up to ₹50,000 under section 80 CCD (1B). These benefits are over and above ₹1,50,000 limit under 80C.

Benefits of NPS

NPS offers various benefits such as market-linked returns, flexible investment options, low fund management charges and exit load as well as tax deductions.

Market-linked returns

NPS funds are invested in various market-linked assets like bonds equities, and government securities. These assets hold the potential to give better returns than traditional tools like EPF, PF and PPF instruments.

Flexibility in investment

NPS offers flexibility in fund investment. An investor can choose instruments based on the risk appetite. A mix of these asset classes is offered to subscribers for high and stable returns.

Professional fund management

Professional fund managers empanelled by the PFRDA manage NPS funds to ensure prudent and responsible investments. Also, subscribers can track their investments at any time.

Portability

NPS offers the benefit of portability as a salaried person can carry on with the pension account even in case of a job change.

Low fund management cost

NPS offers the lowest find management charges to subscribers.