Planning for retirement is an important step in financial planning, so it’s crucial to approach retirement investing with a well-thought-out plan that aligns with your financial goals, risk tolerance, and time horizon. One such investment tool for retirement is NPS, which is specially designed for retirement planning. We will discuss more about it in this article.
NPS (National Pension System) is a voluntary defined contribution pension system in India. It is a retirement savings scheme that aims to provide financial security to individuals in their old age. Under the NPS, individuals can contribute towards their retirement savings through a pension account. The contributions made by individuals are pooled and invested in various financial instruments such as government bonds, corporate bonds, and equities. The investments are managed by Pension Fund Managers (PFMs) appointed by the PFRDA.
The NPS has two tiers – Tier I and Tier II. The Tier I account is mandatory and comes with a lock-in period until retirement. The contributions made to the NPS Tier I account are eligible for tax deductions. The Tier II account is a voluntary account that allows individuals to make investments and withdraw funds as per their requirements. The Tier II account does not come with any tax benefits.
The NPS is a low-cost retirement savings option that offers flexibility and portability. Individuals can choose their own pension fund managers and investment options based on their risk appetite and retirement goals. Upon retirement, individuals can withdraw a portion of their corpus as a lump sum and the remaining amount is used to purchase an annuity, which provides a regular income stream during retirement.
Diversification in NPS
- Equity Funds: These funds invest a significant portion of the corpus in equity or equity-related instruments, and thus, carry higher risks but also offer higher returns in the long term. The equity portion is capped at 75%.
- Corporate Bonds: These funds invest in debt instruments issued by private companies, and thus, offer moderate returns with relatively lower risks.
- Government Securities: These funds invest in debt instruments issued by the government, and thus, offer lower returns but are considered safer than other investment options.
Tax benefits of NPS
The income Tax Act allows benefits under NPS as per the following sections:
Tax deduction on contributions: Contributions made to NPS are eligible for tax deduction under Section 80CCD(1) of the Income Tax Act. An individual can claim a deduction of up to 10% of their gross total income, subject to a maximum of ₹1.5 lakh per financial year. Additionally, an additional deduction of up to ₹50,000 can be claimed under Section 80CCD(1B). This is within the overall ceiling of ₹1.50 Lacs under Sec. 80 CCE of the Income Tax Act.
Exclusive tax benefits for salaried employees: Salaried employees can avail additional tax benefits under Section 80CCD(2) of the Income Tax Act. Under this section, the employer’s contribution towards NPS is eligible for tax deduction up to 10% of the employee’s basic salary plus dearness allowance. This rebate is over and above 80 CCE limit of ₹1.50 lacs.
- Voluntary Contribution: Employee can voluntarily invest an additional amount of ₹ 50,000 (or more) to the NPS Tier I account and claim tax deduction on the same under section 80 CCD 1(B), subject to a maximum of ₹50,000.
What is Anuaity?
An annuity is a mandatory requirement for a subscriber to receive a regular income stream after retirement. At least a minimum of 40% & 80% in the case of Superannuation & Pre-mature Exit respectively of the accumulated corpus at the time of retirement must be used to purchase an annuity from an Annuity Service Provider.
Withdrawal from NPS
Upon reaching the age of 60/Superannuation: At the age of 60, an individual can withdraw up to 60% of the accumulated corpus as a lump sum. The remaining 40% of the corpus must be used to purchase an annuity, which provides a regular income stream during retirement. Subscriber can claim 100% Withdrawal if the total accumulated corpus is less than or equal to ₹5 Lakhs at the time of Superannuation.
Early withdrawal: In case of early withdrawal (before the age of 60), an individual can withdraw up to 20% of the accumulated corpus as a lump sum. However, this withdrawal is subject to certain conditions such as a minimum investment tenure of 3 years. One needs to hold an NPS account for at least 10 years to be eligible for NPS withdrawal before retirement. According to new NPS premature withdrawal rules, a subscriber can withdraw the entire amount if the corpus is less than or equal to ₹2.5 Lakhs.
Exit from NPS: In case of exit from the NPS before the age of 60, an individual can withdraw up to 20% of the accumulated corpus as a lump sum. The remaining 80% of the corpus must be used to purchase an annuity, which provides a regular income stream during retirement. If the total accumulated corpus is less than or equal to ₹2.5 Lakhs, the Subscriber can avail the option of complete Withdrawal. However, you can exit from NPS only after the completion of 5 years.
Partial withdrawals: NPS also allows partial withdrawals for specific purposes such as higher education, marriage, medical treatment, etc. A subscriber can withdraw up to 25% of the accumulated corpus after the completion of 3 years of investment, subject to certain conditions and limitations. This withdrawal can happen a maximum of three times during the entire tenure of the subscription.
Death of the subscriber: In case of the subscriber’s death, the entire corpus is paid to the nominee or legal heir of the subscriber.
Advantages of NPS
- NPS provides a structured way for individuals to save for their retirement. It is a flexible and low-cost retirement savings.
- NPS provides tax benefits. Contributions made in NPS are eligible for tax deduction under sec 80 CCD (1), 80CCD (2) and 80 CCD 1(B).
- NPS provides the flexibility of choosing the investment mix and the pension fund manager. Investor has option to choose from multiple investment options, including equity, corporate bonds, government securities, depending on their risk appetite and retirement goals.
Disadvantages of NPS
- There are some disadvantages of the NPS, one of the disadvantages is the mandatory requirement to purchase an annuity in case of superannuation/Exit from NPS.
- The invested amount in NPS cannot be easily withdrawn. There are some conditions under which the invested amount can be withdrawn such as higher education, marriage, medical treatment, etc.
Words of Wisdom
“A budget is more than just a series of numbers on a page; it is an embodiment of our values.” ― Barack Obama
Conclusion
NPS is a cost-effective, flexible and retirement savings scheme. It provides tax benefits to the subscribers, and they can choose from multiple investment options based on their risk appetite and retirement goals. Overall, the NPS is a viable option for individuals looking to build a retirement corpus.
Thank you for taking the time to read this blog post! I hope you found the information helpful and informative. If you have any thoughts or feedback, I’d love to hear from you in the comments section below. You can also follow me on social media to stay up to date with my latest posts and updates.
Reference
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