National Pension Scheme (NPS) – How It Works, Eligibility, Types of NPS Accounts

The National Pension Scheme or NPS is a retirement saving scheme started by the Government of India. The main aim is to provide a minimum assured pension for people during their retirement life. Every citizen of India can apply for it and get benefits. 

This post discusses how NPS works, eligibility, types and benefits of NPS accounts, how to open an NPS account and things to consider before opening an NPS account. Read on!

What is NPS or National Pension Scheme? 

National Pension Scheme is a voluntary contribution-based retirement benefits scheme introduced by the Government of India in January 2004. It aims to provide a regular and secured pension income to the retired individuals of India. Every person registered under the scheme has to open an NPS account and contribute an amount at regular intervals during their employment years. 

All the invested money is pooled into a pension fund. PFRDA (Pension Fund Regulatory and Development Authority), the apex body, regulates this fund. PFRDA hires professional fund managers to invest this corpus in various financial instruments. Interest earned from these investments is credited to the respective NPS accounts of individuals. Individuals registered under NPS are allotted Permanent Retirement Account Number (PRAN).

Types of NPS Accounts

There are primarily two types of NPS accounts:

1. Tier-I account

A tier-I account is a basic account with a restriction on withdrawal. For example, if you have not crossed 60 years of age, withdrawal of only 25% of the contribution is allowed. However, the other 75% must only be for buying the annuity from a life insurer. Annuity refers to the continuous fixed payments made at fixed intervals by the insurer on maturity or death of the insured. 

If the individual has reached the age of 60 years, they can withdraw 60% of their contribution. However, the remaining 40% must be utilised to buy annuities from approved life insurance providers. 

2. Tier-II account

This is another voluntary savings option that does not have any limit on money withdrawal.  One can only open it if they already have a Tier-I account. There is no minimum yearly contribution requirement in the case of an NPS Tier-II account. That said, the contribution made here must be in multiples of Rs. 250. Furthermore, there is no maximum cap set on the contribution that one can make. 

Parameters	Tier-1	Tier-2
Minimum account opening balance	Rs. 500	Rs. 1,000
Minimum Annual Contribution	Rs. 1000 (Above this amount, the account holder has absolute discretion about the amount)	No minimum annual contribution is required
Tax Benefits on Contribution	Tax deductions of up to Rs. 1.5 lakh under Section 80CCD(1) An additional contribution of up to Rs. 50,000 is also tax free under section 80CCD (1B)	Only government employees are eligible for claiming a maximum tax deduction of Rs. 1.5 lakh
Withdrawal	Only on maturity (Early withdrawals are allowed only under special circumstances)	There is no restriction on withdrawal
Tax Applicable on Withdrawal	The entire corpus amount withdrawn upon maturity is tax-exempt	Any amount taken out at maturity is added to the taxable income and taxed accordingly
Maximum Investment Limit	No limit	No limit

Top Features of an NPS Account

Here are some of the features of an NPS account which you should be aware of:

• Flexibility: You will have the option to change your fund manager, point of presence and investment pattern which if done wisely will maximise your return on investment. Account holders can invest any amount of money at any time in the account.
• Cost effective: NPS has a low cost of investment. 
• Superannuation fund transfer: NPS account owners can transfer their superannuation fund without any tax implications.
• Transparency: NPS funds are closely regulated by PFRDA or Pension Fund Regulatory and Development Authority which monitors closely if the guidelines are being followed properly. 

Also, Your PRAN or NPS account will remain unchanged regardless of a change in employment, city or state.

Also Read: Tax Rebate Under Section 87A Of The Income Tax Act

How does NPS Work?

Follow the below pointers to understand how Government Pension Scheme works:

• Investment limit
  Investors are required to open a pension fund scheme account with a minimum of Rs. 500. There is no upper limit on investment. That said, every subscriber has to pay at least Rs. 1,000 annually.

• Maturity and Early Withdrawal
  Persons registered under the scheme can withdraw only after attaining the age of 60. They can withdraw only 40% of the total corpus available. The remaining 60% will be used for providing regular pension income.
  
  However, there is a provision for premature withdrawal in certain exceptional situations like children’s marriage or education, building a house, and medical treatment. Investors are allowed a maximum withdrawal of 25% of the total sum only after completing 3 years under the scheme. They can make a maximum of 3 early withdrawals.

Benefits of Government Pension Scheme Account

Here are some of the benefits of having a pension fund scheme account:

• Regulatory Assurance
  PFRDA, the statutory body, regulates the NPS. It ensures transparent governance norms, financial reporting, and safeguards the interest of the investors. NPS trusts another government body to supervise whether the standards and norms are followed. 

• Flexibility
  The National Payment System offers flexibility to its subscribers. They can choose the pension funds and fund managers. If investors are not happy with the returns of one fund and the performance of fund managers, they can switch to another fund.

• Easy of Opening and Accessibility
  NPS accounts can be opened online anytime and from anywhere. This has helped in avoiding the hassles of physical documentation. Individuals can also access their accounts online and make deposits and withdrawals online. 

• Tax Benefits 
  Investments up to a limit of Rs.2 lakh made in the Government Pension Scheme are eligible for tax deductions under Section 80CCD(1) and Section 80CCD(2). Also, for tier-1 accounts, the entire corpus withdrawn at maturity is tax-exempt.

• Stable Returns
  Fund managers who are in charge of these funds are bounded by PFRDA regulations. They cannot invest in very risky assets. The returns from these funds usually hover between 9% and 10%, which is higher than other investment options like PPF. 

• Economical
  It is an affordable investment plan, which is why salaried individuals find this to be a very lucrative and safe investment.

Also Read: Best National Pension Schemes (NPS) in India

How to Open an NPS Account? 

NPS accounts can be opened online and offline. Let’s see how this can be done. 

Offline 

Interested individuals can walk into any government or private sector authorised financial institution and open their government pension fund account by submitting the required documents and depositing the opening amount.

Online 

Investors can open their NPS account by visiting the eNPS website and registering online and through the Aadhaar card. There is also a payment gateway on the website through which individuals can make the opening contribution through various online payment methods. After completing the registration process, the PRAN of the investor will be generated. 

NPS Eligibility Criteria

• The minimum age limit to avail of the benefit is 18 years, and the maximum age for entry is 70 years.
• The applicant must be KYC compliant.
• Individuals should not have a pre-existing NPS account.

NPS Documents Required

You need the following documents to open an NPS account:

• Aadhaar card
• Voter ID card
• Recent photo
• Active bank account details
• PAN or NREGA card

What Are the Tax Benefits Available under NPS?

Tax benefits under the Government Pension Scheme are available for individuals, employees, government employees, and companies. So, for convenience, we have divided them into different sections:

1. Tax benefits for individuals

• A tax benefit of 20% of the income is available to self-employed individuals. However, the amount cannot cross the limit of Rs. 1.5 lakh as per Section 80C.
• There’s also an additional tax benefit of Rs. 50,000 available to NPS tier-I account holders under Section 80CCD(1B). 

2. Tax benefits for employees

• Employees can claim a tax benefit of 10% of their salary or gross income. Here, salary includes both basic and DA. However, this limit should not exceed Rs. 1.5 lakh as per Section 80CCD(1). 
• A deduction of Rs. 50,000 is also available to employees under Section 80CCD(1B).  

3. Tax benefits for government employees

• Central Government employees also get NPS tax benefits under which they can claim around 14% of their income as deductions u/s 80CCD(2). 
• If government employees contribute to NPS, they can also avail an additional tax deduction of Rs. 50,000. 

4. Tax benefits for companies

Employer’s contribution to the government National Pension Scheme (up to 10% of basic salary + DA) is deductible from the taxable income as a business expense. 

5. Other tax benefits

• In case an account holder makes a partial withdrawal, a claim of 25% of the subscription amount is available for a tax deduction. 
• The amount subscribers use to avail of annuity is free of tax. However, the income one gains on it is taxable under the law. 
• There is no tax payable on 60% of the corpus value. Apart from this, if the remaining 40% is used to buy an annuity, the total maturity amount becomes tax-free. But still, your income from the annuity will be taxable. 

What Are the Conditions for Different Withdrawal Options Available to NPS Holders?

There are different withdrawal options available to the government pension fund account holders. However, for each withdrawal option, there are also individual conditions that one must satisfy. It includes:

1) NPS Withdrawal from a Tier-I account 

The following are the rules for different withdrawal options:

At retirement

1. Holders must use 40% of their retirement corpus to buy an annuity. 
2. The maximum period for deferring the annuity purchase extends up to three years only. 
3. Around 60% of the corpus amount can be withdrawn as a lump sum. The amount will be exempted under law. 
4. An NPS holder can defer withdrawing their lump sum amount until the age of 70 or up to 10 years after their retirement, whichever comes early. 
5. There are ten instalments available to holders to withdraw their lump sum amount. 
6. If the retirement corpus of an NPS holder amounts to Rs. 2 lakh or is anywhere below it, he/she can withdraw the total amount. 

Premature exit

1. A premature exit option is only available to NPS holders after ten years have passed from the account opening date. 
2. One can withdraw up to 20% of the corpus, while the remaining 80% must be used in annuity purchases. 

Partial withdrawal

1. There is a maximum limit up to which one can partially withdraw funds from an NPS account, which amounts to 25% of the total contribution. 
2. No NPS holder can withdraw partially before the completion of three years after opening the account. 
3. A holder can make a partial withdrawal from an NPS account up to three times only. 
4. There are specific conditions only under which an account holder can withdraw partially:
   • Child’s marriage
   • Completion of higher education
   • Providing medical expense
   • Purchase or construction of a residential house
   • If any amount is required for starting own business venture

2) NPS Withdrawal from a Tier-II account

There is no restriction on withdrawal from the Tier-II account.

3) Withdrawal on death 

On the unfortunate demise of the holder, the nominee will get an outstanding amount of the corpus. Also, this amount gets full exemption under the law. 

Risk Factors Associated with NPS

You should be aware of the drawbacks of NPS before opting for it. The following are some of the risk factors associated with NPS that you should consider:

1. Tax implications

As per the latest tax regulations, 60% of the accumulated retirement sum is taxable. It doesn’t enjoy the EEE benefits unlike PPF or EPF.

2. Unable to beat inflation

An NPS account holder is forced to buy a life annuity from a life insurance company. Annuities do not offer enough return to put a barrier against inflation.

3. Lock-in period

NPS account has a longer lock-in period as compared to other investment instruments. One can only withdraw the corpus completely after reaching the age of 60 years.

4. Premature withdrawal

While the lock-in period is fixed, NPS offers 3 options for premature withdrawal. They are as follows:

• If you wish to withdraw the corpus before the age of 60 years, you can withdraw 80% of the amount only if the corpus exceeds Rs. 1 lakh.
• In case of the sudden demise of the account holder, the entire amount will be transferred to the legal heir or nominee and will be tax-free.
• At the age of 60, you can withdraw only 60% of the entire corpus, the remaining 40% must be invested in a life annuity. You can withdraw 60% as a lump sum amount or in instalments up to the age of 70 years. However, if the entire amount is less than Rs. 2 lakh, you are allowed to withdraw the whole amount. 

Comparison of NPS with Other Tax-saving Schemes

The other tax-saving schemes available in the market are PPF or Public provident fund, ELSS (Equity-linked saving schemes), and tax-saving fixed deposits. So, to understand how beneficial NPS can be over other options, a comparison is made in the following table:

Investment	NPS	ELSS	PPF	FD
Interest	9% to 12%	12% to 15%	Guaranteed 8.1%	Guaranteed 7% to 9%
Lock-in period	Up to retirement	3 years	15 years	5 years
Risk profile	Market risk	Market risk	No risk	No risk

Also Read: Income Tax: Allowances, Exemptions And Deductions

Who Should Consider Investing in NPS?

If you want to accumulate funds for retirement and have a steady flow of income, you should consider investing in a government pension scheme. Any citizen within the age group of 18 to 60 years is eligible for investing in government pension schemes such as the National Pension Scheme.  

Things to Consider Before Investing in NPS

• Investment Goals
  NPS mainly aims at securing a decent post-retirement life. Investors who want a stable and regular income after their employment years might go for this investment. Individuals who have long-term financial objectives, such as building a retirement home, and funding children’s higher education, can consider opting for this scheme.

• Risk Appetite 
  The cap of equity exposure in the case of NPS can range anywhere between 50% and 75%. The higher the equity allocation, the higher the potential returns and financial risk. Hence, it is vital for investors to consider their risk tolerance level before making a decision regarding asset allocation.  

Also Read: 9 Best Monthly Income Plans To Invest In 2022

How to Select the Right Pension Scheme Fund?

You should consider the following pointers before opting for the right pension scheme fund:

• There are multiple savings instruments to invest in. That said, you should consider investing in a diversified portfolio for security and stability. Also, you should not think that you will be able to live the rest of your life on the amount that you will withdraw from your PPF or EPF account. The funds will not be enough if there is no active source of income.
• You should be careful that your retirement age is in accordance with the vesting age. If you plan to retire early, you should go for plans with an early vesting age. On the other hand, if you plan to retire late, you must go for a plan that has a late vesting age.
• The sum assured and the withdrawal amount is what you should primarily care about. There are many plans which won’t let you withdraw the entire sum assured upon maturity. Read the terms and conditions carefully and try to invest in plans which provide 100% withdrawal upon maturity or upon the sudden demise of the policyholder.
• A quality pension scheme will cover you and your spouse as well. Living a financially independent life while there is no active source of income is what you should consider while looking out for each other.

There is no waiting period when it comes to savings. You should start saving for your retirement as soon as you get your first salary. Be it a nominal amount, but the younger you start saving the more secure your future will be. Also, don’t forget to check the tax benefits available for the pension scheme you choose to opt for. 

Role of National Pension Scheme Fund Managers

Fund managers play a crucial role in managing the National Pension Scheme Fund. They will allocate the assets to diversify the portfolio so that you get a stable return. They will also periodically review the portfolio to see if the assets are performing well and make changes accordingly if required. The expertise of a fund manager indicates how your fund is going to perform.

Final Word

NPS scheme offers financial security after retirement. The tax benefits, stable returns and strict monitoring of the working of these funds make it a lucrative investment option. You can easily open an NPS account online or offline and start securing your retirement years starting today!

FAQs on National Pension Scheme (NPS)

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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.