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What is the National Pension System (NPS)?

National Pension System (NPS) is scheme of the Government of India to encourage people to save for their retirement. Any Indian citizen within the age group of 18 and 60 can open an NPS account.

How to open an NPS account?

You can open an NPS account with any of the 58 authorized institutions which include leading public and private sector banks, private financial institutions, and the Department of Posts. Upon opening of an NPS account, you will get a unique Permanent Retirement Account Number (PRAN). PRAN is valid for the lifetime, and it can be used anywhere in India to access your NPS account. There are two types of NPS accounts.

  • Tier I account is meant for retirement savings, and it does not allow any withdrawals until retirement.
  • Tier II account is similar to a regular savings account with an option to withdraw money anytime.

At the time of opening an account, it is compulsory to choose any one of the 8 fund managers appointed by Government to manage NPS funds. All funds have given different returns, and you can choose the fund based on their 1-year and 3-year performance.

Where is the money invested?

The money deposited in an NPS account is invested in a combination of equity, government bonds, corporate bonds, fixed deposits, etc.

As an investor, you have two options for managing your NPS contribution.

  • Active Choice: If you opt for an active choice, you will have to specify the percentage for distributing your investment among equity, government securities and fixed income instruments. Note you cannot invest more than 50 per cent in equity.
  • Auto Choice: If you opt for an auto choice, the money is invested as per Government's pre-decided formula, which varies by age.

Swavalamban Scheme

For citizens who are not a part of any other pension or provident fund scheme, the government has launched a 'Swavalamban Scheme' as part of NPS. Under this scheme, the government contributes an additional ₹1,000 every year for every NPS contributor who invests between ₹1,000 and ₹12,000 every year.

Example 1: You are a self-employed professional who does not have access to pension schemes like employees' provident fund scheme. If you open an account with NPS and contribute ₹6,000 every year, the government will add an extra ₹1,000 to your contribution, increasing your contribution to ₹7,000.

Withdrawal from NPS

When you withdraw your money from NPS, you can get only a certain amount as a lump sum. The rest of the amount has to be compulsorily invested with one of the seven annuity service providers, who will provide you a monthly annuity or pension in return.

Withdrawal before 60: You can take 20 per cent as cash, and you have to invest the remaining 80 percent in any one of the annuity schemes.

Withdrawal after 60: You can withdraw up to 60 percent, and you have to purchase an annuity with the remaining 40 percent.

Withdrawal upon death: If the account holder dies, the entire amount can be withdrawn by the nominee without investing in annuity schemes.

NPS for salaried employees

Salaried employees can either open an NPS account on their own or invest through their organization's corporate NPS account (if it has one).

Tax treatment:

Whether you are salaried or self-employed, any NPS contribution of up to 10 per cent of annual income can be deducted from taxable income. The maximum limit for tax deduction under NPS is ₹100,000. Note the tax benefit is available only on Tier I account, and not on Tier II account. Any withdrawals from NPS are fully taxable.

Example 2: Your annual salary is ₹15,00,000, and you invest 10 per cent of your salary in NPS (₹150,000). You can claim a tax benefit of up to ₹100,000, and your taxable income will be reduced to ₹14,00,000.

Use our tax calculator to see how NPS contributions affect your taxable income.

Further Reading:

  1. Employer's National Pension System
  2. Employee's Provident Fund

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