One of the great things about having a feedback page is that you get some great post ideas! I received a message from a reader asking me to break down the National Pension Scheme or the NPS. So without any further ado –
What is the National Pension Scheme?
The National Pension Scheme is a savings scheme wherein you can pay a certain amount of money into a pension account every month during the course of your working life. This money, in turn, will be invested on your behalf. When you reach retirement age (sixty years), the money becomes available to you, under certain conditions.
What Are The Conditions that follow when my National Pension Scheme reaches Maturity?
For starters, you won’t be able to withdraw the entire amount that has accumulated in your account in a single go. You will be able to withdraw a maximum of 60% of the total amount since a minimum of 40% will compulsorily have to be used to purchase an ‘annuity’ scheme from an approved Insurance provider. An annuity scheme is where a sum of money is invested in exchange for a regular income. The idea behind NPS is that you can use the majority of the amount to spend on a big ticket item, like a house or your children’s education, but will still have stability in your later years with a regular income. So you can look at the NPS maturity amount in three parts – a tax free 40%, 40% that needs to compulsorily invested and a 20% which can be withdrawn or invested.
What Are The Tax Benefits of the National Pension Scheme?
The tax benefits of the NPS (or any long-term investment scheme) for that matter should be analyzed in three ways:
On Contribution – Under section 80C, you’re allowed a maximum deduction of ₹1,50,000/- from your total income by way of investments in life insurance, repayment of Housing Loan principals, Equity Linked Savings Schemes, etc. The National Pension Scheme also falls under this bucket, but with an extra advantage. While the other items that fall under this bucket are restricted to that ₹1,50,000/- limit, the National Pension Scheme is allowed an additional deduction of ₹50,000/- under Section 80CCD(1B). So you can get up to ₹2,00,000/- deducted from your total income with NPS, as opposed to ₹1,50,000/- without.
If you are a salaried person and your employer is contributing towards your NPS, the limit is 10% of the sum of your Basic Salary and Dearness Allowance and this does not fall under the 1,50,000/- cap. So if your Basic and DA add up to ₹30,00,000/- for example, 10% is Rs.3,00,000/-. If your employer contributes this sum towards NPS, the entire amount can be deducted.
On Maturity – The NPS is not completely tax-free on maturity. Remember, although 60% of your total proceeds can be withdrawn, only 40% of your total proceeds is tax-free.
On Annuity – 40% of your total funds must compulsorily be invested in an annuity scheme. The income that you receive from this scheme, which effectively acts as a pension, will also be subject to tax.
The NPS is often marketed as an excellent tax saving scheme, but it’s actually taxed in two ways!
How Do I Invest in the National Pension Scheme?
In order to invest in the National Pension Scheme, you need to open an NPS account at a ‘Point Of Presence’ (POP), which is essentially a bank or a financial institution that has been authorized to run NPS schemes. For example, SBI and HDFC banks are Points of Presence. You will need proofs of identity and address. Remember that each POP has its own scheme which has its own rates of return, so if you register with SBI and your friend registers with HDFC for the exact same amount of contribution, you might not have the same amount in your account when it matures.
If you are a salaried person, you can also route your contribution to NPS through your employer.
You can also buy an NPS policy online at www.enps.nsdl.com.
What Are The Minimum and Maximum Amounts for Investment in the National Pension Scheme?
NPS requires a minimum investment of ₹1,000/- per year. However, there is no maximum limit. One way to decide how much to invest in the NPS scheme is to look at your existing tax deductions. If you already have ₹1,20,000/- by way of PF, insurance, etc, for example, you should look to invest ₹80,000/- in a year (so that you get the full benefit of the ₹2,00,000/- deduction). Remember, your contribution is independent of your employer’s.
What Are Tier I and Tier II Accounts in the National Pension Scheme?
When you register for the National Pension Scheme, the account that you open, by default is the Tier I Account. You can open an extra account called Tier II. The difference is that the money in your Tier II account can be withdrawn in full, unlike the money in the Tier I account which is split 40-40-20. You cannot open a Tier II account without having a Tier I account. Since the government knows that there are lots of Idea Manis in our country who will put the minimum amount in Tier I and a bigger amount in Tier II, they’ve removed the tax benefit on contribution for Tier II accounts. So there’s no tax benefit when you contribute or when you withdraw. In my opinion, it’s better to diversify your investments with say, Mutual Funds than to put all your eggs in one basket.
Should I Invest in the National Pension Scheme?
The NPS has both Pros and Cons. The Pros of the Scheme are the tax benefits when you contribute and the fact that you can also choose how the money will be invested. You can program your investment in such a way that you can opt for high-risk securities when you are young and move towards safer investments as you get older. Another significant positive aspect is the tax deduction that those who are salaried can get.
However, the fact that only 40% of the total proceeds is tax-free, coupled with the forced investment into annuities does take the sheen off what could be an excellent investment, especially for those who are salaried. It is entirely likely though, that the government will bring changes to make this scheme more attractive. The NPS is a good way to save for retirement, but it shouldn’t be the only way.