NPS - National Pension Scheme - Things to Note

After the budget of 2017, every other person was trying to invest in this new product NPS to save further tax of INR. 50,000. Being a more conservative investor,  I asked around a few people to understand what is this NPS and is tax benefit the only reason to invest in it. Actually, by now I should stop being surprised by the lack of research from people around me. 8 out of 10 people, I knew had invested their money into NPS without knowing all the basic details about it.

What is a Pension Scheme?

NPS is a pension scheme, but what is a pension scheme. Is it Insurance? Is it a mutual fund? What is it? A pension plan is a financial product that ensures a fixed regular income after you retire for a fixed period of time. You invest your money in pension regularly/lump sum till you retire and post-retirement the same corpus is returned to you at regular intervals.

What is NPS?

NPS is the government approved pension plan. It is managed by PFRDA (Pension Fund Regulatory and Development Authority). This product helps you to create retirement corpus.

Any citizen of India (whether resident or NRI) can invest in this scheme. The age of the subscriber must be within 18-60 years of age. However, an individual of unsound mind or existing members of NPS are not allowed to open a new account.

Therefore, an individual can open only ONE NPS account.

NPS subscribers are issued with a Permanent Retirement Account Number (PRAN), which remains unchanged throughout the length of the scheme.

Structure of NPS

Before getting into the details of withdrawals, the difference between Tier 1 and Tier 2 and how the investments made in NPS is managed. It is important to understand the nature of the product.

  1. There are two types of account/ methods of NPS investments with different benefits and features.
  2. As an individual, a regular fixed sum or otherwise is invested by you in the NPS
  3. An equal contribution may (like EPF) or may not be made by your employer.
  4. The entire fund collected is managed by fund managers appointed by PFRDA which invests this pool of fund into various investment products over the period of time.
  5. A fee of 0.25% is deducted from your investment as a fund management fees.
  6. You cannot withdraw the money from NPS as and when you need the money, there are restrictions and limitations on the same.
  7. After retirement, you can withdraw a part as a lump sum; balance would be received as a monthly pension. To do so, one has to buy an annuity plan.
  8. There are No ASSURED RETURN IN NPS (like in EPF there is a fixed return of 8% -12%)

Types of NPS

There are majorly 2 types of NPS

  1. NPS tier 1 – the contributions made in tier 1 NPS have restrictions on withdrawal.
  2. NPS tier 2 – it is more like a savings account, there is no restriction on withdrawal.
  3. Swavalamban scheme or the NPS Lite - was a financial inclusion scheme for the economically backward sections of the society. It was applicable to all employees in the unorganized sector of employment. For Swavalamban accounts, a government made contributions of Rs.1000 for the first four years after enrollment. Swavalamban Yojna is replaced by Atal Pension Yojna.

How to open an NPS account?

  • Fill the application form.
  • Provide the relevant KYC documents at your nearest POP-PS (You will find the list in PFRDA portal) to open a Permanent retirement account (PRA)
  • If you want to open new Tier 2 account, then the process is different. You have to approach POP-PS with a copy of PRAN (Permanent Retirement Account Number) and Tier 2 activation form.
  • The subscriber has to make the first contribution while opening the account.
  • The minimum contribution for Tier 1 is Rs.500 and Rs.1, 000 for Tier 2.

You can also enroll into the NPS online through enps.nsdl.com. You can do so either by using your Aadhar number or through your PAN number and online banking (your bank account and PAN number must be linked) if your bank is enrolled with the NPS. You can check this on enps.nsdl.com.

Note-Now you can open NPS account online and also contribution can be made online through e-NPS portal.

What are the investment options and how should you go about it?

The NPS fund is invested into various investment products and is split into the three asset classes as below:

  • Class E: made in equity market instruments.
  • Class C: made in fixed income investment instruments. These investments do not include government securities.
  • Class G: made in government securities.

The NPS offers two choices: Active and Auto.

You may choose and change into either of the two. However, such a switch is only allowed once a year.

  • Active: Under this option, you can actively choose and change your investment amount in either of E, C, and G class. However, please note that you cannot have more than 50% under class E i.e. Equity Instruments.
  • Auto: The Auto choice offers a life-cycle fund, which decides the investment allocation depending on the age of the individual. The allocation to equity and fixed income comes down and the proportion of government securities in the portfolio goes up with the advancing age of the subscriber.
  • At the lowest age of entry (18 years), the auto choice will entail an investment of 50% of pension wealth in “E” Class, 30% in “C” Class and 20% in “G” Class.
  • These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36.
  • From age 36 onwards, the weight in “E” and “C” asset class will decrease annually and the weight in “G” class will increase annually till it reaches 10% in “E”, 10% in “C” and 80% in “G” class at age 55.

Thus, you have to select whether you want an active or an auto option. Well where you select for auto, there is not much you have to do on the investment product side as the same is taken care of. In the case of active, you have to decide how much % of your investment has to go into which asset class.

After selecting the method of investment, you also have to select the fund which will manage your investment.

  • The accounts of government employees are managed by one of the three government fund managers, LIC Pension Plan, SBI Pension Plan and UTI Retirement Solutions,
  • Accounts of others are managed by one of the six fund managers: ICICI Prudential Pension, IDFC Pension, Kotak Mahindra Pension, Reliance Capital Pension, SBI Pension Funds and UTI Retirement Solutions.

What are the charges and fees associated with the National Pension Scheme?

Investors have to pay handling and administrative charges, fund management fees. The fund management fee is 0.0102% for Government employees and 0.25% of the invested amount for the private sector.

Difference between Tier 1 and Tier 2 Investments

After getting a brief idea on the basic of NPS, it is important to know what is tier 1 and tier 2 investments and why do we even have the choice of these 2.

Features Tier 1 Tier 2
Mandatory for NPS Yes No
Requirements to open Any individual Only those with Tier 1
Minimum contributions per annum INR 1000 (by non-government employees) INR 1000 at the time of account opening
10% of basic + DA  with matching from the government (by a government employee)
Minimum amount per contribution INR 500 Nil
Minimum balance at the end of the accounting year NA NA
Bank Account Not mandatory Mandatory
Tax benefits for the investments made and the maturity amount Refer Article - Click here No tax benefits
Withdrawal

 

If the subscriber fails to contribute the minimum amount in a year, the account will become dormant. The subscriber will have to submit the form UOS-S10 to the POP-PS, along with a penalty of R100 and a minimum contribution of INR 500, to reactivate the account. The dormant account will be closed if the account value falls to zero.

Withdrawal/ Exit Rules for NPS

You cannot withdraw the money from Tier 1 account as and when you want to do the same.  It is a pension/retirement plan, thus, there are restrictions on withdrawal from NPS.

  • If you are withdrawing the money at your retirement at 60 years, you have the option to withdraw 40 per cent of the accumulated corpus tax-free.
  • At least 40 per cent of the accumulated corpus must be used to buy an annuity.
  • The remaining 20 per cent can be either withdrawn (it will be taxed as per the Income Tax slab applicable to the subscriber) or use it to buy an annuity.
  • The pension derived from the annuity will be taxed as income.
  • If the total corpus is below R2 lakh, it can be withdrawn entirely.
  • While exiting from the NPS before 60 years, one can withdraw only 20 percent of the corpus as a lump sum and one must use 80 percent of the corpus to buy an annuity.

An example of NPS Investment

Harsh makes a monthly contribution of INR 2000 to NPS which he started at the age of 30 and continued to do so till the age of 60. Assuming that he earned a return of 9% on average over the 30 years (the return in NPS is not fixed or assured).

Harsh will have a corpus of approximately 36.8. at the end of 30 years.

Out of this, 40% i.e. INR 14.72 lakhs can be withdrawn tax free. Balance 60% i.e. 22.08 would be used to buy an annuity product based on his requirements.

NPS may seem a bit complicated due to the fuss created around the product and its features. The cost and the initial tax benefit at the time of investments definitely make it a lucrative retirement product. You as an investor need not invest INR 50,000 per annum just to claim the tax benefits but it is that SIP, you know you will and you cannot ever withdraw.

 

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