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What is National Pension System, Benefits, Eligibility, & Returns

Written by: CHETNAA GOYAL Posted on: 1 December, 2022

National Pension System (NPS)

The National Pension System (NPS), launched by the Government of India for its citizens to brings an attractive long term savings avenue to effectively plan for your retirement through safe and reasonable market-based returns. NPS is regulated by the Pension Fund Regulatory and Development Authority (PFRDA).

What is NPS?

National Pension System (NPS) is a voluntary, defined contribution retirement savings scheme designed to enable the subscribers to make optimum decisions regarding their future through systematic savings during their working life. NPS seeks to inculcate the habit of saving for retirement amongst the citizens. It is an attempt towards finding a sustainable solution to the problem of providing adequate retirement income to every citizen of India.

Under NPS, individual savings are pooled in to a pension fund which are invested by PFRDA regulated professional fund managers as per the approved investment guidelines in to 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 normal exit from NPS, the subscribers may use the accumulated pension wealth under the scheme to purchase a life annuity from a PFRDA empaneled Life Insurance Company apart from withdrawing a part of the accumulated pension wealth as lump-sum, if they choose so.

Types of Accounts under NPS?

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. The scheme is structured into two tiers

Tier-I account
This is the non-withdraw able permanent retirement account into which the regular contributions made by the subscriber are credited and invested as per the portfolio/fund manager chosen of the subscriber.
Tier-II account
This is a voluntary withdraw able account which is allowed only when there is an active Tier I account in the name of the subscriber. The withdrawals are permitted from this account as per the needs of the subscriber as and when required.

How to Open NPS Account ?

Option I - Any citizen of India, who meets the stipulated eligible conditions, can open his/her NPS account through online facility eNPS. Through this facility NPS account holders can also make subsequent contributions to their account hassle free using Net Banking/ Debit Card/ Credit Card.

Option II - Entities called as Point of Presence (POP) are appointed by PFRDA for servicing the individual subscribers, including their registration and acceptance of further contributions. The registration form for joining NPS can be collected from any of the Point of Presence - Service Providers (POP-SP).

Once your account is opened, you will receive a "Welcome Kit"containing a Permanent Retirement Account Number (PRAN) Card andother related details. This PRAN is unique and portable - it remains unchanged even if you change your location or job and as long as you are associated with NPS.

Government / Corporate Sector

To enroll under Central Government / State government Sector, you may approach your HR Dept./ Pay and Accounts Office (the Nodal Office for NPS). The formalities to be completed, in guidance and through of the Nodal Office.

Why NPS to invest in ?

NPS allows you to choose from any one of the Pension Fund Managers (PFMs) appointed by the PFRDA to manage your pension fund. Further, NPS also offers you two approaches to invest in your account:

Active Choice

Unlike traditional rigid investment products, NPS offers you with the flexibility to design your own portfolio. Depending on your risk appetite, you can design your portfolio by allocating your funds among the following three asset class.

Equity or E

A high return-high risk fund that invests predominantly in equity market instruments.

Corporate Debt or C

A medium return-medium risk fund that invests predominantly in fixed income bearing instruments

Government Securities or G

A ‘low return-low risk fund that invests purely in fixed income instruments. If you are a conservative investor, you can choose to invest your entire pension wealth in C or G asset class. However, if you want to have exposure to equity, you can allocate upto 50% of your asset to asset class E.

Auto Choice - Life Cycle Fund

Designing your portfolio can be a little delicate and time consuming at times. NPS gives you the flexibility to opt for a dynamic allocation of your portfolio in case you do not want to exercise an Active choice. This option is called the Auto choice, wherein your money will be invested in all three asset classes - E, C and G in defined proportions based on your age. When you are younger, a larger share will be in the higher risk-higher return option; and as you approach retirement, the proportion in the lower risk- lower return option becomes maximum.

What is Minimum Contribution Requirement under NPS ?

Tier-I (pension account)

Start investing in Tier-I account with at least Rs. 500. Minimum contribution in Tier-I account is Rs. 6,000 per financial year. Over and above this mandated limit, you can contribute any amount at any frequency as per your convenience.

Tier-II (investment account)

During opening / activation of Tier-II account, you need to pay the Initial contribution of only Rs. 1000. Tier-II gives you the flexibility to invest anytime also the account balance (value of holdings) at the end of the FY must not be less than Rs 2,000 and/or at least one contribution is made in FY otherwise account will be freezed.

What are the ways to get money back?

When you are 60 years

You will have to use at least 40 percent of your accumulated Pension wealth to purchase an annuity that provides you with a monthly pension. The remaining corpus is given to you as a lump sum. You have the option to allow the lump sum to remain invested and collect it anytime till the age of 70 years.

Before the Age of 60 years

You will have to use at least 80 percent of your accumulated pension wealth to purchase an annuity that provides you with a monthly pension. The remaining corpus is given to you as a lump sum.

Is Partial Withdrawal allowed under NPS ?

Partial withdrawal will be allowed subject to fulfillment of following conditions:-

Subscriber should be in NPS for 10 years
Amount to be withdrawn should not exceed 25% of the contributions made by the subscriber
The withdrawal can happen only against specified reasons
Withdrawal will be allowed maximum three times during the entire tenure of subscription with a gap of at least five years between two partial withdrawals

What if Death before the start of pension i.e 60 years.

The entire accumulated pension wealth (100 percent) will be paid to the nominee / legal heir

The claimant shall also have the option to purchase any of the annuities being offered upon exit of an existing subscriber, if they so desire, while submitting the claim.

What are The Tax Benefits under NPS?

Under NPS, tax deduction can be claimed up to 10% of salary (Basic + DA) subject to overall ceiling of Rs. 1.50 lakh u/s 80CCE of Income Tax Act. 1961. Exclusive Tax Benefit for any NPS subscribers u/s 80CCD(1B) An additional deduction for the investment up to Rs. 50,000 in NPS (Tier | account) has been introduced under sub- section 8OCCD(1B).

This is over and above the deduction of Rs. 1.5 lakh available under sec 80CCE. This is an exclusive tax deduction available only for investment in NPS and not available for any other investment. Tax Benefit to Subscribers under Corporate Sector

Under 80CCD(2) of Income Tax Act, the employer's NPS contribution (towards the employee) upto 10% of salary (Basic + DA), without any monetary limit is also deductible from taxable income in addition to above mentioned benefits.

What is the Taxability at the time of withdrawal from NPS A/c ?

Tier -I NPS Account

a. Tax benefits on partial withdrawal
Subscriber can partially withdraw from NPS Tier I account for specified purposes. Amount received from partial withdrawal to the extent 25% of the amount of contribution are tax exempt u/s 10 (12B) of Income Tax Act.

b. Tax benefit on Annuity purchase
Amount invested in purchase of Annuity, is fully exempt from tax. However, annuity income that you
receive in the subsequent years will be subject to income tax.

c. Tax benefit on lump sum withdrawal
Upto 60% (40% up to A.Y 2019-20) of the total corpus withdrawn in lump sum is exempt from tax.

d. Death
In case of death entire accumulated pension wealth paid to the nominee / legal heir is tax free.

For example: If the total corpus at exit is 10 lakhs, then 60% of the total corpus i.e. 6 lakhs, you can withdraw without paying any tax. So, if you use 60% of NPS corpus for lump sum withdrawal and the remaining 40% for annuity purchase, you do not pay any tax at that time. Only the annuity income that you receive in the subsequent years will be subject to income tax as per the applicable tax slab.

Tier II NPS Account

Investments in Tier II accounts doesn’t qualify for any tax benefits u/s 80C of the Income Tax Act. However, government employees can avail of a tax benefit up to INR 1.5 lakhs u/s 80C, provided they keep their investments locked-in for three years. Furthermore, this exemption is not available under the new tax regime.

Taxability on withdrawal of amount from Tier II NPS Account

All withdrawals from the Tier II account are taxable. Withdrawals within three years (36 months) attract short-term capital gain tax and are taxed as per the investor’s tax slab rate. Furthermore, after three years, they have a long-term capital gains tax of 20% with indexation benefit.

However, the other, opposing view is that the absence of a government notification on NPS Tier-II tax treatment leaves scope for ambiguity. The tax treatment for NPS Tier-II gains should be similar to that of mutual funds.

Now, long-term gains made on equities or equity mutual funds held for more than one year attract a 10 percent tax if they exceed Rs 1 lakh in a financial year. Short-term capital gains are taxed at 15 percent. "However, NPS Tier-II gains cannot be treated at par with capital gains on equity assets as these are exempt from Securities Transaction Tax (STT).

This would mean that NPS Tier-II investments would attract the tax treatment of debt mutual funds. In the case of debt fund units purchased after April 1, 2023, the gains - even when units are held for over three years - no longer enjoy long-term capital gains tax (LTCG) rate of 20 percent or indexation benefits. Such gains are simply added to your taxable income and taxed at the marginal rate applicable to you.

If you made these investments prior to April 1, 2023, then your NPS Tier-II long-term capital gains (held for more than three years) at redemption will attract a tax of 20 percent with indexation.

For more details, Please watch our video

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CHETNAA GOYAL

Chetnaa Goyal one of the co-founder of TaxSmooth. An Qualified Chartered Accountant. More than 12 years of Experience in Direct Taxation. having own Taxation Practice in Delhi. Expertise in Income Tax Cases, Return filing, Tax Planning, Tax Advisory etc.