No Income Security
No Income Security

In this article, we will discuss how to open NPS account, its features, benefits, drawbacks, and whether it is a good option for you. I am sure that you will understand the basics, some new tax saving options, and it will help you make the correct choice for your future.

NPS Basics

NPS (National Pension System) was launched by the government to combat the issue of rising income insecurity after retirement. NPS provides incentives and enforces restrictions to ensure discipline for retirement savings. NPS is regulated by PFRDA (Pension Fund Regulatory and Development Authority of India)

NPS Tier 1 & NPS Tier 2

NPS has 2 tiers of investments – Tier 1 is mandatory and most tax benefits that are outlined in the article apply to it. Consequently, the withdrawal restriction also applies to that.

Tier 2 is a voluntary savings account that does not provide tax benefits and also does not have withdrawal restrictions. Tier 2, however, can provide tax relief under 80C to central government employees but then that amount is locked for 3 years.

How to open NPS account

You can visit eNPS website and open an NPS account online. You can find the detailed process there. You can also open the account in specified banks or offline but online verification and opening seems to be the easiest.

PRAN card will be delivered to the address mentioned in Aadhaar Card (if verified that way). While it takes quite a bit of time, it doesn’t stop you from investing.

How to open NPS account
How to open NPS account

NPS Tax Benefits

There are a lot of benefits to investing in NPS. Some may seem like an outright benefit while others might feel like restrictions but all in all, it seems that all the features work in conjunction with the aim of securing a person’s retirement

Let’s start with the most obvious benefit of NPS tax savings. Currently, the amount invested in NPS can save you income tax under 3 buckets:

Most people are aware of 1.5L of 80C – Actually NPS investment also qualifies for tax saving under this bucket. Through NPS you can save up to 1.5 lacs under Section 80CCD(1). For Section 80C, Section 80CCC and Section 80CCD(1), combined limit is 1.5Lacs

Second, many people are also aware of Section 80CCD(1b) where 50,000 is exclusively reserved for NPS investments

And, which many people are not aware of is that you can save up to 10% of Basic and DA, (14% in the case of central government employees) under Section 80CCD(2). This can form a huge part of savings.

From FY20-21, a cap of 7.5L has been introduced on employer’s contribution to EPF, NPS and Superannuation fund. Contribution above that would be taxable in the hands of the employee. This is applicable to both old and new tax regimes.

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NPS Withdrawal Rules: Forced Discipline

There are a lot of constraints on the withdrawal of the amount invested under NPS. Now, many people consider this as shortcomings. However, if you consider that the aim of the product is retirement savings, you would agree that letting easy withdrawal might actually be counter productive.

Partial withdrawal is not allowed but for specific purposes, you can withdraw 25% of the contribution (from employee) without any tax liability. These purposes are higher education or marriage of children, treatment of critical illnesses, buying a house, etc.

NPS account can be closed before retirement but you can only withdraw only 20% of the corpus and have to put 80% in annuity. However, 20% withdrawal is tax free.

On reaching retirement, 60% of the corpus can be taken out tax-free, however, the rest of 40% needs to be invested in an annuity (again at this point it is tax-free). However, the yearly proceeds from the annuity are taxable to the marginal tax rate of the individual. If the corpus is less than 2L, 100% can be withdrawn tax-free.

Full tax-free withdrawal is allowed by the nominee on death. However, if annuitized, the pension would be taxed as per the tax slab of the nominee.

NPS investment options

When a subscriber opts for NPS, they are given 2 options – Auto and Active. These options and the percentage allocation in Active choice can be changed 2 times in a year.

Auto Choice

In Auto Choice, the funds are distributed among Equity, Corporate Bonds, and Government Bonds. It adopts a lifecycle-based approach where the equity portion decreases with age. Subscribers can choose Aggressive (max 75% equity exposure), Moderate (max 50% equity exposure), or Conservative (max 25% equity exposure).

In Auto choice, the rebalancing happens automatically once every year on the birth date of the subscriber.

Active Choice

In Active choice, subscribers can choose the percentage of allocation in Equities, Corporate and Government bonds however the maximum equity portion can be 75%.

Charges in NPS

While the charges in NPS are one of the lowest in the industry, and there is no need to think twice about this, the detailed charges can be found here. Ideally, because of the low charges, one can also invest in Tier 2 through this mode.

NPS vs PPF

NPS vs PPF
NPS vs PPF

This is probably the most interesting comparison when it comes to investing in NPS. This is because NPS and PPF, both are retirement schemes. While there are some similarities between both, lets talk about the most important differences and which is better for you

  1. The Lock-in period for PPF is 15 years while NPS is till the age of 60 years. While there are some limited withdrawal options, and both are long-term, for younger people this might still be a difference of 15 years and 35 years.
  2. Both offer 1.5L tax exemption under 80C however, with NPS you can get an additional 50K under 80CCD(1B) and an additional 10% or 14% of basic under 80CCD(2) without an upper cap. Hence the upper limit of tax that can be saved is quite large.
  3. The returns on PPF are fixed and are declared by the government from time to time. The current rate is 7.1% and has been on a decreasing trend.

    The returns on NPS are market-linked and since this is a long-term investment and it has been seen that in long-term markets beat the fixed return.

    Hence while PPF can give near risk-free return which can’t be expected from NPS, from return expectations NPS wins big time.

    If we were to take a period of 30 years where A and B both invest 1.5L in NPS and PPF (at the end of years – realistic!) and we assume a 10% return for NPS and a 7.1% return for PPF, the corpus at retirement would be 2.5Cr and 1.4Cr respectively.

    Hence we can see that the return differential between the 2 schemes is huge and if one is willing to take the risk and bear a long-term lock-in, NPS would be the better option.

By the way, quick tip while you saw the power of compounding above – if it were 35 years instead of 30 years, the NPS amount would be 4.1Cr. So start investing early.

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Conclusion

I believe that NPS is a wonderful product that is credible as it is being managed by a government institution, offers a variety of tax incentives to promote retirement savings, provides discipline, and is cheap to invest in.

If there is no scarcity of cash and you are looking to invest money for the future this can be a great way to do it, especially if you want to save on income tax.

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Categories: Investment

Ravi Maheshwari

Ravi is an IIM ranker with over 9 years of work experience and has helped optimize the financial performance of companies like BPCL, Sun, Ola, Swiggy, and Curefit. In this blog, he explains how to improve personal finance and also gives insights into financial models of companies.

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