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Friday, December 04, 2015

National Pension Scheme (NPS)

NPS (National Pension System) is the much hyped, the much talked about pension system in India. Understand all its merits and demerits before taking a plunge...Read on..

What is NPS
The National Pension System (NPS) is a defined-contribution pension system operated by the Government of India. In 2004, the Government of India decided to move from a defined-benefit pension system to a defined-contribution pension system. Apart from offering a range of investment options to employees, the scheme allows individuals to make decisions about where their pension fund is invested, permits limited withdrawal prior to retirement and reduces the total pension liabilities of the Government of India. 

How NPS Works?
Under the NPS, an individual's savings is pooled in a pension fund. These funds are invested by Pension Fund Regulatory and Development Authority (PFRDA) regulated professional fund managers as per the approved investment guidelines in the diversified portfolios comprising of government bonds, bills, corporate debentures and shares.
These contributions would grow and accumulate over the years, depending on the returns earned on the investment made.
At the time of a normal exit from NPS, the subscribers may use the accumulated pension wealth under the scheme either to purchase a life annuity from a PFRDA empanelled life insurance company or withdraw a part of the accumulated pension wealth as lump-sum, if they choose to do so.

Choose Your Pension Fund Manager
NPS offers a range of investment options and choice of Pension Fund Manager (PFMs) for planning the growth of your investments in a reasonable manner and see your money grow. Individuals can switch over from one investment option to another or from one fund manager to another, subject, of course, to certain regulatory restrictions. The returns are totally market related.
Investors have a flexibility to choose between 8 Fund Managers:
  • ICICI Prudential Pension Fund Management Co. Ltd.
  • HDFC Pension Management Co. Ltd.
  • Kotak Mahindra Pension Fund Ltd.
  • LIC Pension Fund Ltd.
  • Reliance Capital Pension Fund Ltd.
  • SBI Pension Funds Pvt. Ltd
  • UTI Retirement Solutions Ltd

Choose Your Fund Allocation
You have a flexibility to choose between Active and Auto Choice for distribution of your pension fund.
If Active choice is selected, the subscriber must indicate the percentage distribution of his investments between corporate, gilt and equity allocation. The maximum investment allowed in equity is 50%.

Structure of NPS Account
The scheme is structured into two tiers:

Tier 1 NPS Account
The first account is called Tier 1 NPS Account, and the Tier 1 Account. This account has the following features:

  • It is mandatory for all central government employees and state government employees. 
  • It is mandatory for them to contribute 10% of their basic salary plus DA every month towards this account
  • The government matches this contribution.
  • There are severe restrictions on how money can be withdrawn from the Tier 1 account, as it is necessary to invest 80% of your money in an annuity with Insurance Regulatory Development Authority (IRDA) if you withdraw before age 60. You can keep the remaining 20% with you.
  • When you attain the age of 60, you have to invest at least 40% in an annuity with IRDA; the remaining can be withdrawn in lump-sum or in a phased manner.
  • Even if you are not a government employee, you can still open a Tier 1 account, and if you are interested in NPS, you will need to open a Tier 1 account as that’s necessary in order to open a Tier 2 account.
  • There is a minimum amount that you have to commit to investing in NPS, and for the Tier 1 account that minimum is Rs. 6,000 per year.

Tier 2 NPS Account
The Tier 2 NPS account is very similar to the Tier 1 account, and if you are not a government employee who wants to invest in NPS, you would want to invest the minimum of Rs. 6,000 in Tier 1 and then invest the rest of your money in the Tier 2 account.
This is because

  • Tier 2 is quite similar to Tier 1 in all respects except for the harsh withdrawal conditions. You are free to withdraw your money from the Tier 2 account any time that you want without any penalties.
  • Minimum amount for opening Tier 2 account is Rs. 1,000 and minimum balance required at the end of the year is Rs. 2,000. 
  • You need to make at least 4 contributions in a year.

Opening of NPS Account
Opening an account with NPS provides a Permanent Retirement Account Number (PRAN), which is a unique number and it remains with the subscriber throughout his lifetime. 

NPS is distributed through authorized entities called Points of Presence (POP’s) and almost all the banks (both private and public sector) are enrolled to act as Point of Presence (POP) under NPS apart from several other financial institutions. 

To invest in NPS, you will be required to open a NPS account through the Point of Presence (POP) and who will assist the subscriber in opening the account including the filling up of necessary forms, providing the information about NPS and any other relevant information in this regard.

Investment Charges
NPS levies a nominal investment management charge of 0.01% on net assets under management (AUM)

There is a requirement for subscribers who leave the scheme before retirement (or age 60, whichever is the earlier) to invest 80% of their accumulated savings in a life annuity from a life insurance company approved by Insurance Regulatory and Development Authority (IRDA). The remaining 20% is eligible for withdrawal as a lump sum.

On retirement, at age 60, subscribers are required to invest at least 40% of their pension fund in an annuity and the remaining 60% can be redeemed as a lump sum. In the case of government employees, the annuity provides for pension for the lifetime of the employee and his dependent parents and spouse at the time of retirement.

Subscribers may remain in the scheme after their 60th birthday for the purpose of receiving interest on their account, but may not make further contributions after that date. If a subscriber does not exit the system on or before their 70th birthday, the account is closed and the benefits are transferred to the subscriber as a lump sum. If a subscriber dies, the nominee has the option to receive the account total as a lump sum.

As per new regulations wef on May 11, 2015, NPS subscribers will now be allowed to prematurely withdraw^ funds from their Tier I account only if they have been enrolled with NPS for a minimum period of 10 years. This shall be subject to the terms and conditions, purpose, frequency and limits specified in the Regulations. 

The pension scheme is administered on behalf of the government by the Pension Fund Regulatory and Development Authority (PFRDA). PFRDA is a statutory body by an Act of Parliament.

Coverage and Eligibility
NPS is open to all citizens of India between the ages of 18 and 60 on a voluntary basis. It is mandatory for central government employees appointed on or after 1 January 2004, except for members of the armed forces, to have a tier-1 NPS pension. Central and state government employees along with Public Sector employees mandatory contributing in National Pension Scheme are restricted from availing any other form of pension scheme initiated by government of India.

Your Present Age : 30 Years
Your Expected Retirement Age : 60 Years
Investment Amount : Rs.2,000 per month
(To avail maximum tax benefit, contribute 10% of your Basic income + DA towards NPS )
Assumed Rate of Return : 10%
On reaching your retirement at : 60 years
The Principal amount you have paid is : Rs.7,20,000 
Interest earned on your Investment is (on monthly compounded basis) is : Rs.38,38,651 
Total Tax saved is : Rs.2,16,000 
Total Pension Accumulated is : Rs.45,58,651
Monthly Pension Receivable (at annuity rate of 7%) : 26,593 Per Month

Income Tax Treatment
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 that withdrawals are counted as taxable income (EET). These tax benefits apply to all contributions, including those made by employers. 

Tax benefits to employer:
Contributions made by the employer (upto 10% of Basic + DA) is allowed as a business expense under Section 36 (1) (iv) (a) of Income Tax Act 1961

Tax benefit to employee:
Employer’s contribution – Eligible for tax deduction upto 10% of Salary (Basic + DA) contributed by employer under sec 80 CCD (2)

Note that this contribution is not included in overall limit of Rs. 1.5 lakhs as mentioned u/s 80CCE. It means that if any employee has basis salary of Rs. 30,00,000/- and his employer contribution Rs. 3.00 lakhs, he can get a deduction of Rs. 3.00 lacs u/s 80CCD (2). It can provide lot of tax benefit to employees under higher salary brackets.

Employee’s contribution
Eligible for tax deduction upto 10% of Salary (Basic + DA) under sec 80 CCD (1) within the overall ceiling of Rs. 1.5 Lac under Sec. 80 CCE.

Further w.e.f. FY 2015-16, in addition to the deduction u/s 80 CCD (1), deduction of Rs. 50,000 has been on contribution in NPS. (U/s 80CCD(1B)).
Therefore, the total deduction that can be claimed under Section 80C + Section 80CCD is INr 2.0 Lacs.

It is to further clarify that if a corporate has not opted for the corporate plan and employees are making investment under the all citizen model i.e. on their individual basis, even in that case investment made by them can be claimed by the employee and the employer is liable to provide deduction u/s 80CCD (1) and u/s 80CCD (1B) to the employee under form 16.

The Deduction under Section 80CCD(1) is not only available to salaried individuals but non-salaried individuals can also avail deduction for the same. The individual claiming deduction under this section could be an Indian citizen or a Non-Resident Indian(NRI). If you are an NRI, please get in touch with Kotak Mahindra Bank for further details.

Past Investment Returns
In 2014–15, the average weighted return on the fund was 12.5%. As of 15 May 2014, return on investment for private sector employees who opted for Equities was 8.38%. During tax year 2013-14, the eight pension funds used for central government employees showed returns of between 8% and 14%.

Other Terms
  • Investment in NPS is independent of your contribution to any Provident Fund.
  • Interest earned on your Investment is (on monthly compounded basis).

This is the only worthwhile pension scheme in India. Having said that, to me, it is a far cry from what it should be. Mandatory Annuity investment of minimum 40% amount and EET taxation are big dampeners. For financial freedom seekers who want to retire rich, and are already investing in EPF and PPF, I do not see the need for investing in another taxable debt based investment.

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The book "From the Rat Race to Financial Freedom" has many such investment concepts explained in a very simple and uncomplicated manner, especially in the Indian context.


Manoj Arora
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