NPS:A Scheme for Your Golden Years

Written on Saturday, June 18, 2016
By Mr. Kapil Rangwal

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As we head towards retirement, building a substantial corpus to lead a secure life in old age is an important aspect of financial planning. In order to lead a life where you will have complete financial security in an age where your regular income will stop, you require to plan carefully, so that you live independent and content life.

When we are young, we work to live our present as well as accumulate funds for future by investing in a mix of assets proportionate to our appetite and capacity to undertake risk. We try to get regular income, which can help us pay-off expenses of present and also invest in a scheme that will help in building a sizeable corpus for our golden years. But, we must remember that the size of income post-retirement, in turn, depends on the size of the corpus built during young age.

During this time, an important question that hovers on our mind is how to build a corpus that can take care of our lives post-retirement?
The solution to this question which can be simple and reliable is National Pension System, popularly known by its acronym NPS.


What is NPS?

The National Pension System (NPS) is a defined-contribution pension system operated by the Government of India, in which the contributions are invested in a mix of assets and the retirement corpus is dependent on the returns from those assets. The scheme is open to citizens of between the ages of 18 and 60, on a voluntary basis.

The returns in NPS are market-linked. Dedicated pension fund managers are entrusted with the task of managing the investors’ money. The benefit of NPS is that it offers range of investment options to employees so that he can go ahead with the option most suitable for him. The advantage of NPS is that it is transparent and cost effective system, wherein the pension contributions are invested in the pension fund schemes and the employee will be able to know the value of the investment on day to day basis.


Classification of NPS:

NPS comes in two tiers categories. The Tier-1 account is a basic retirement pension account available to all citizens. It is a strict pension fund scheme that does not promote withdrawal of funds prior to retirement. The minimum contribution in Tier I account is Rs 500 for all transactions and Rs 6000 for a year.

And the second class of the scheme, the tier-2 account which is also known as a Prospective Payment System (PPS) account that under exceptional circumstances allows some withdrawal of pension before retirement, usually related to the provision of health care. For Tier II account, the minimum contribution for opening an account is Rs 1000 and Rs 250 is charged for subsequent transactions.


Allocation Prefernce:
Another beneficial feature of NPS is that an investor in NPS can avail choices preferences, known as Auto choice and Active choice.

The Auto choice allocates the assets on a predetermined formula based on the age of the investor. The allocation is made in three asset classes, namely Equities (E), Corporate Bonds (C) and Government Securities (G).

The Active choice gives the choice of allocation to the investor. There is however a cap of 50% for investment in equity. For government sector, the cap on equity is increased to 15%.


NPS: Tax Benefit & Liability
NPS is currently subject to the Exempt Exempt Tax (EET) structure. The scheme permits subscribers to benefit, as applicable, under the Income Tax Act (1961). As of 2015, this means that up to a variable limit, contributions to the scheme are tax-exempt, but the lump sum withdrawn on exit from NPS is taxed (EET).

From the A.Y. 2015-16 NPS contribution are exempted from tax up to 50 thousand. This is over and above the deduction of Rs 1.5 Lakh available under section 80 CCE of Income Tax Act 1961. This is an exclusive tax deduction available only for investment under NPS and not available for any other investment. Hence, the total tax benefit for investing in NPS amounts to Rs 2 lakhs. Only an investor in Tier I account can claim these tax benefits.


Reaching the age of 60, an investor can exit from the NPS, but the condition to fulfill is that 40% of pension wealth has to be utilized for the purchase of an annuity. If an investor withdraws the corpus before reaching 60 years of age, he will have to invest 80% of the accumulated corpus for buying an annuity. These exit conditions only apply to the NPS Tier I account, which is a pre-requisite for having a Tier -II account in NPS.

The amount that is used to buy the annuity is however not subject to tax. This means that if an investor uses 100% of the accumulated corpus for buying annuity, then, there will be no tax liability. Only the pension income that he gets will be taxed like any other pension.

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