Retirement can be a beautiful phase in life when you could have all the time in the world to do things you love without the stress of work life. In current times, we see more and more people not wanting to quit their work-life but assume positions that give them enough time and flexibility. Though flexible work options may offer some kind of income; the genuine joy of retirement can be experienced only when you know that you have adequate funds to meet all your needs.
Retirement gets easier if you start early because you never know what befalls in the future. So how do you start? What could you possibly do effortlessly to save for your post-retirement days and not depend on other family members?
While there are many other options that you could use as an instrument to save for your retirement, the National Pension Scheme(NPS) might be one such product that could meet your retirement needs. Let’s find out how.
What is National Pension Scheme (NPS)?
National Pension System or the NPS as we popularly know it as was introduced in the year 2004 for Government employees as a mandatory option. The scheme was later allowed for the public including the unorganized sector and the self-employed from 2009 onwards.
The first thing that one needs to be aware of about NPS is that it is governed by Indian laws and hence protected by them which makes it one of the most secured investment schemes in India and can be very beneficial.
How does NPS work?
By opting in for NPS, subscribers can contribute to the scheme at durations suitable to them during their working years. These funds are managed by chosen and established fund managers who invest them in various financial products like debt and equity to generate returns for the subscribers. So investment in NPS is also subject to market risk like other products like mutual funds.
At the end of the term of investment, 60% of the accumulated funds can be withdrawn as a lump sum and the remaining 40% goes into an annuity. An annuity is a product that will keep giving you monthly pensions for a fixed term or till your death as per the terms of the contract.
NPS may be a wonderful product for the private sector, the self-employed, and others who have no system of receiving pensions for their old age. There is no bar on minimum or maximum subscription amounts on NPS accounts, so the subscribers can channel their savings as and when convenient.
Investing in NPS – The basics
All you need to be eligible for investing in the National Pension Scheme is proof of ID and address proof. You should be over 18 years of age and less than 70 years of age (earlier it was 65). You could open an NPS account offline with many of the banks, financial institutions that are designated as Point of Presence, or on the eNPS website. NRIs are also allowed to invest through NPS.
Types of accounts to choose from
There are 2 types of accounts for NPS that an individual may subscribe for:
- Tier 1: It is a mandatory account for all those who opt for NPS. The Government employees have to contribute 10% of their salary (salary = basic + DA), and the government will make equal contributions as well. For others, opting for this scheme, the initial contribution is Rs. 100/- at the time of account opening and the minimum contribution per year is Rs 1000. The government does not contribute anything to the NPS accounts of individuals working in the private sector.
- Tier 2: Not a compulsory account like Tier 1. You can withdraw funds at any time, and hence, it provides high liquidity. There are no contributions from the government or the employers and include no tax exemptions either. There are some critical points to make a note of – The minimum amount required to open this account is Rs. 1000/- and the minimum yearly contribution required is Rs 250. The withdrawal amount is subject to Income Tax. But there are no exit loads.
You get two options for investing in NPS – Active-choice and Auto choice.
With the active-choice investment option, an investor gets to mix equity, corporate debt, and government securities as per his/ her choice. However, the allocation of equity can be a maximum of 75%. Earlier, the maximum allocation of equity was capped at 50%.
Auto- choice Allocation is done based on the investor’s age, and the investor has no say in the investment allocation. The standard investment mix for various age profiles are as below:
|Equity||Till the age of 35, the equity portion is 50%, post which it reduces 2% yearly till it becomes 10% by the age of 55.|
|Corporate Debt||Till the age of 35, the corporate debt is 30 %, post which it reduces 1% every year until it becomes 10% by the age of 55.|
|Other Options||1. Aggressive life-cycle fund – begin with an equity allocation of 75% and reduces to 15% by the age of 60.
2. Moderate life-cycle fund- begins with an equity allocation of 50% and reduces to 10% by the age of 60
3. Conservative life-cycle fund – starts with an equity allocation of 25% and reduces to 5% by the age of 60.
When can you withdraw from NPS?
Unlike other investment products that have lower lock-in periods, NPS is an investment specifically catered to meet your retirement requirements, hence, comes with a longer lock-in period. The specific cases under which you could make a withdrawal are:
- Superannuation: On attaining the age of 60, you could withdraw 60% of your corpus and use the other 40% to purchase an annuity plan from approved Insurance companies. There are various options that you could choose for the annuity.
But, if your total corpus is less than Rs 2 lakh, you could withdraw the entire corpus.
- Premature withdrawal: You could opt for premature withdrawal of the accumulated fund. 80% of the accumulated amount will have to be used for the purchase of an annuity. Exit from NPS is possible only after 10 years. If you have joined the scheme after the age of 60, you could withdraw it after 3 years.
- Partial withdrawals: After completing 3 years with the scheme, subscribers can withdraw up to 25% of their contributions for approved reasons like self-marriage, starting a business, illness, construction or buying a house, disability, education needs of children, etc.
- On the death of the subscriber: The entire corpus of accumulated pension contribution is paid to the heir or next of kin.
Taxation on NPS investments and withdrawals
This is not all, NPS also has major tax benefits: Based on Union Budget 2019, NPS now qualifies to be an Exempt-Exempt-Exempt (EEE) category product. This means that NPS tax is exempted at all 3 stages. Here is how you benefit from it:
- Contribution to NPS gets tax deductions up to 1.5 lakh per annum under Section 80CCD of the Income Tax Act.
- Additional tax deduction of up to Rs. 50,000 is also allowed under Section 80CCD(1B) in a financial year. (only Tier 1 accounts are eligible, not Tier 2)
- Your employer could also contribute up to 10% of your basic salary (including DA) to your NPS account with no monetary limit. You can also claim this as a tax deduction under Sec 80CCD(II).
- At term completion or 60 years, 60% of the corpus received as lumpsum is free from tax, while the rest 40% has to be invested in the annuity.
How much of your portfolio should be invested in NPS?
NPS is a tool to build your retirement funds, so your age and your risk tolerance should guide the allocation of NPS in your portfolio.
Factors to consider while investing in NPS
- Do not let the tax deductions be the only reason to invest : Often, the enormous tax benefits offered for investments in NPS acts as a magnet to open and maintain an NPS account. If you invest just the bare minimum amount required to earn tax deductions, then that amount may not grow up to a substantial sum on retirement. Let the tax deductions alone not determine your retirement and investment planning.
- Liquidity of investments: Another factor to consider here is that NPS is an illiquid product. You cannot use the investment amount in case of any emergencies, as pre-mature withdrawals will also have to wait for a minimum of 10 years for Tier 1 accounts. Though liquid, Tier 2 accounts are not tax-efficient.
- May not be suitable for an aggressive investor: For an individual in the late 20s and early 30s, the lock-in period may act as a deterrent. Also, they could afford to be more aggressive in portfolio allocation towards equities, considering their retirement is at least 30-40years away. This could help them build a bigger retirement portfolio with lesser amounts.
- Have a good understanding of your choice of investment: If you choose an Active Choice portfolio where you have better control over your NPS portfolio, it is important to have a basic understanding of the working of various products like equities, government securities, corporate debt, etc.
Choosing portfolio allocation in NPS
NPS can bring the much-required discipline in investing in your retirement funds. The tax exemptions attached to the scheme are always an added benefit.
Your age and existing investment portfolio should act as a guiding factor towards deciding on subscribing to NPS. The pension scheme should complement your overall asset allocation plan towards retirement planning, which should also have other investment products like equities, PPF, EPF, etc.
For a new investor: If you are someone who hasn’t started investing for your retirement and has a tough time keeping track of the markets, opening an NPS auto-choice account may be the best option, as the asset allocation is decided according to your age. With the lowest fund management charges at 0.01%, NPS works well for new investors.
For an existing investor: If you already have sufficient funds earmarked for retirement and are looking to invest in NPS for the tax gains, then you could make the allocation in NPS that complements your existing investment plan: For Ex: If you are equity heavy in your existing investment portfolio, you could choose to invest in active choice NPS with more allocation towards the debt. The vice versa could be true if you have more investments in traditional debt products in your portfolio.
So, you not only plan a financially happy retirement but also save on taxes while doing so. NPS works as a great instrument to save up for retirement given the current scenario where pension or other social security benefits are non-existent especially for the private sector employees and the self-employed.
Use NPS to make your actual free time in life comfortable.