Over the years, our government has introduced various savings schemes that help its citizens stay invested and secure their retirement goals. The Employees’ Provident Fund (EPF) and Public Provident Fund (PPF) are prime examples of such schemes. However, there is another interesting investment plan that has historically delivered 8-10% returns every year— the National Pension Scheme. Let us learn more about NPS and find out how it works.
What is NPS?
The National Pension Scheme (NPS) is a voluntary and long-term investment plan for retirement offered by the Government of India. It is market-linked and managed by professional fund managers. NPS encourages people to invest a small portion of their income in a pension account at regular intervals. Anyone between the age of 18-65 years can make voluntary contributions to this scheme. These contributions are accumulated until your retirement. At the same time, certified professionals manage and invest the entire amount in different types of asset classes (such as shares, bonds). Thus, NPS helps you to develop a sense of disciplined saving and build a sufficient retirement corpus.
It is always ideal to open an NPS account once you start receiving a regular income. As an NPS subscriber or account holder, you will be eligible to take out 60% of the corpus after your retirement. More importantly, you will be receiving a monthly pension post-retirement. At an average of 8-10% per annum, the earnings potential from NPS is higher when compared to other fixed-income schemes. It also has certain tax benefits, whereby you can even claim a deduction of up to Rs 2 lakh under various sections of the Income Tax Act.
NPS is open to all public sector and private sector employees, as well as those in the unorganized sector. The Pension Fund Regulatory Development Authority (PFRDA) regulates all activities and operations surrounding NPS.
Types of NPS Accounts
There are primarily two types of NPS accounts— Tier-I Account and Tier-II Account. The table given below gives a brief overview of both types.
You can open an account with NPS through the official website of the National Pension System Trust. Alternatively, you can also register/apply offline through a bank or entities known as Point-of-Presence (POPs) appointed by PFRDA.
Where Will Your Money Be Invested?
The amount that you wish to invest periodically will initially be forwarded to a Trustee Bank. Your contribution will then be deployed in a Pension Fund.
Some of the prominent Pension Funds registered under the PFRDA include:
LIC Pension Fund, SBI Pension Funds Pvt Ltd, UTI Retirement Solutions, HDFC Pension Management Company Ltd, and many more. It is these entities that manage and invest all contributions under the NPS scheme.
The fund managers invest your contributions across equity, corporate bonds, government securities, and alternative investments funds (AFIs). [Alternative investments may include commercial mortgage-backed securities (CMBS), REITs, InvITs, etc] As we know, there are varying levels of risk associated with each of these asset classes. At the time of investment, you can select any pension fund manager and choose between the investment options that are available.
Investment Options in NPS
Under active choice, a subscriber can design their own portfolio based on their requirements and risk appetite. You can specify the percentage of your total contributions that should go towards each asset class. If you feel that alternative investments and equity are too risky, you can choose to allocate a major part of your funds towards corporate bonds and government securities. A point to be noted is that a subscriber up to 50 years of age can invest only up to 75% of his portfolio in equity. This limit keeps reducing by 2.5% (every year) as the subscriber gets older. Also, a subscriber cannot invest more than 5% in alternative investments (as the risk associated with AFIs is very high).
If a subscriber does not want to create or design his own portfolio, they can choose any of the options specified under auto choice:
Aggressive Life Cycle Fund – A subscriber can allocate only up to 75% of his total contributions to equity till 35 years of age. This limit keeps reducing continuously as the subscriber gets older. As the name suggests, this option is ideal for aggressive subscribers who are willing to expose their funds to the risks associated with equity markets (due to the prospects of higher returns).
Moderate Life Cycle Fund – A subscriber can allocate only up to 50% of his total contribution to equity investments till 35 years of age. This limit reduces gradually as the subscriber gets older.
Conservative Life Cycle Fund – A subscriber can allocate only up to 25% of his total contribution to equity investments. This limit reduces gradually as the subscriber gets older. As the name suggests, it is ideal for conservative subscribers who are content with returns offered by corporate bonds and government securities.
- As an NPS account holder, you cannot withdraw the entire corpus after your retirement. It is mandatory to keep at least 40% of the corpus aside in order to receive a regular pension (also known as annuity). Thus, after your retirement at 60 years of age, you will be eligible to withdraw only up to 60% of the corpus. NPS has enlisted certain annuity service providers, who will provide the monthly pension as per your requirements.
- If you are below 60 years and have been investing in NPS for at least three years, you are eligible to withdraw up to 25% of the corpus for certain purposes. This could include buying/building a house, medical treatments, higher education of children, and marriage functions of children. Partial withdrawals can only happen a maximum of three times during the entire tenure.
- Now, what if you want to exit or stop investing in NPS? You will not be able to terminate NPS for the initial 10 years. After 10 years, if the total amount in your NPS account is only Rs 1 lakh, you will be able to withdraw the entire amount. If it is more than Rs 1 lakh, you will be able to withdraw only 20% of the total amount. The remaining 80% will be provided as a monthly pension after your retirement.
Generally, NPS can be used by those who are not interested in investing in stock markets or even mutual funds. Weigh out the pros and cons of NPS and compare it with other savings schemes and financial instruments. Thus, you will be able to find if it is the right investment option for you. To learn more about investment options available for all, click here.