Every individual ultimately plans to retire with a healthy corpus. This money will not only guarantee stress-free golden years, but the person will also be self-sufficient in case of emergency situations. The best way to ensure that is to build a pension scheme.
What is NPS?
The National Pension System (NPS) is a government approved pension scheme which was initially launched in 2004 for central government employees. The scheme was later opened to all in 2009. The returns obtained from this scheme are market linked. Pension fund managers are entrusted with the task of handling the investor’s money. The system is controlled by the Pension Fund Regulatory and Development Authority. Anyone between the age of 18 and 60 years is eligible to opt for this scheme.
Tiers of NPS
The NPS essentially has 2 tiers. It also has another version called the NPS Lite which can be availed by those below poverty line.
TIER I: In this type of account, no withdrawals are allowed to be made. The employers also contribute to this account. The minimum contribution amount in this account is Rs 500 for all transactions and Rs 6,000 for a year.
TIER II: This account can be opened only if one has an existing tier I account. It is a voluntary withdrawal account. Money can be withdrawn from this account after 5 years. The minimum contribution amount for this type of account is Rs 1000 and Rs 250 is charged for subsequent transactions.
A minimum of Rs 6,000 must be contributed towards this scheme yearly. It offers an annual compound interest which increases the value of your fund. A service charge is applicable on this scheme. Those belonging to the government sector must pay 0.0102% and private sector investors 0.25% of the entire amount invested in the fund as service charge.
As NPS is a market-linked scheme, the rate of interest isn’t fixed and will vary according to market conditions.
Components of NPS
NPS has three components, namely, Equity, Credit Debit and Government Annuity. It offers a mix of high risk products as well as conservative, low risk products.
The investor can choose to contribute in an active account, or else the investment is done automatically each month when the money is auto-debited from the linked account. As the age of the investor increases, the ratio of investments done in each component differs. For example, as the age increases, the money invested in the high-risk equity decreases and more money is sent towards annuity.
After the age of 55, 80% of the amount is put towards government annuity and only 10% is earmarked for equities.
Investors of tier I accounts can claim tax benefit under Sections 80CCD(1), 80CCD(2) and 80CCD(1B) provided it does not exceed 10% of basic salary + dearness allowance .
The amount that is invested over the years is not taxed, but the lump sum that is withdrawn at maturity is taxed. Upon exiting the scheme, the amount used to buy annuity is not taxable either.
If the investor wishes to withdraw money from the scheme before it matures at 60, only 20% of amount is allowed to be withdrawn. When the contributor reaches the age of 60, he/she can exit from the scheme on the condition that 40% of the pension corpus must be used to purchase an annuity. If the investor wishes to withdraw from the scheme before the age of 60, they must spend 80% of the fund amount to purchase an annuity. The conditions are applicable to those holding a tier I account and is a pre-requisite to upgrade to a tier II account.
In case the amount in the scheme is less than Rs 2 lakh, then it can be withdrawn as a lump sum. In the event that the investor dies before the age of 60, 60% of the amount goes to the nominee whereas 40% is spent on annuity.