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A comprehensive guide on NPS

by Abdus Subhan
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Keywords – NPS withdrawal, what is NPS

Three dedicated government employees were engaged in an enlightening discussion linked with the evolving vertical of retirement benefits, especially focusing on NPS or the national pension scheme. As our country steadily transitions from OPS or old pension schemes to NPS, their conversation sheds considerable light on this shift. 

Understanding NPS

What is NPS?” Punit inquires, seeking clarity. Suresh, with his extensive knowledge, explains – 

NPS also called the National Pension Scheme is a long-term and voluntary retirement plan, governed by the PFRDA or Pension Fund Regulatory and Development Authority. Initially, it was exclusive just to the central government employees but now it is accessible to all citizens of India, including those in unorganised or private sectors too, barring armed forces. 

“The scheme,” Ramesh adds, “promotes the habit of saving for retirement. It allows individuals to invest periodically during their working years and then withdraw a portion of the savings at retirement, while the rest is disbursed as a monthly pension.”

Who should invest in NPS?

“It is ideal for individuals who prefer low-risk investments and wish to secure a steady income post-retirement,” Punit notes, highlighting its suitability for private-sector employees and those eyeing 80C deductions.

Benefits of NPS

⮚  Returns/interest

Suresh points out the attractive returns of NPS, usually between 9-12 per cent, which are higher than traditional tax-saving investments like PPF.

⮚  Risk evaluation

The equity exposure is capped, lowering the risk as one nears retirement age.

⮚  Flexibility

PFRDA’s transparent regulation, flexible contributions, and the ability to change fund managers are significant advantages, Ramesh observes.

⮚  Tax benefits of NPS

Discussing tax implications, Punit highlights – 

Tax deductions on employee and employer contributions – 

Employee contributions

As per NPS, the contribution of the employee towards their NPS qualifies for tax deduction as per Section 80 CCD (1). This tax deduction is within the limit of Rs 1.50 lakh as per Section 80 C. Moreover, an exclusive deduction for NPS as per Section 80 CCD (1B) is available, which permits for additional deduction of tax of up to Rs 50,000, over the Section 80 C limit of Rs 1.50 lakh. 

Employer contributions

The contribution of the employer to the employee’s NPS account even qualifies for tax deduction. This NPS contribution is deductible up to the mark of 10 percent of the salary of the employee as per Section 80 CCD (2). Note that this deduction is over the Section 80 C limit. For the employees of the central government, this limit is more at 14 per cent. 

Special advantages for self-employed individuals

Self-employed individuals contributing to the NPS option can claim a tax deduction for the contribution as per Section 80 CCD (1). They can claim up to 20 per cent deduction of their gross overall income, subject to the maximum limit of Rs 1.50 lakh as per Section 80 C. Moreover, like salaried individuals, they even qualify for an additional deduction as per Section 80 CCD (1B) for an amount of Rs 50,000. 

⮚  Tax exemptions on withdrawals

Partial withdrawals

NPS permits the subscriber to make partial withdrawals from their corpus as per specific circumstances. Such partial withdrawals are tax-exempt as per Section 10 (12B). 

Annuity purchases as well as lump-sum withdrawals at retirement

On reaching 60 years of age at retirement time, a subscriber can withdraw up to sixty per cent of the overall pension corpus in the form of a lump sum. This figure is tax-exempt. The rest 40 per cent, which is used to buy an annuity is even not taxable at the purchase point. However, the annuity income in the subsequent years is subject to income tax as per the tax slab of the individual. 

Employer contributions claimed as business expenses

Employers who make a contribution to the NPS on behalf of employees can claim such contributions as business expenditures in their P/L or profit and loss statement. This provision is available as per Section 36 (1)(iv)(a). This advantage is a kind of incentive for employers to contribute towards their staff’s retirement savings, as this lowers their taxable income, thus reducing their tax liability. 

Withdrawal rules and equity allocation

“As for post-retirement withdrawals,” Suresh explains, “up to 60 per cent can be withdrawn tax-free, and the rest must go into an annuity. There’s also provision for early withdrawals under specific conditions.”

“Regarding equity allocation,” Ramesh adds, “NPS allows a maximum of 50 per cent investment in equities, with options for auto or active choice in investment.”

⮚  Eligibility and investment process

“Anyone between 18 and 70 years, complying with KYC norms, can invest in NPS,” Punit states, detailing both online and offline processes for account opening and the distinction between Tier-I and Tier-II accounts.

NPS vs. OPS: Key differences

⮚  Nature 

NPS by nature is market-linked, inferring its returns and performance are subject to the conditions of the market. The returns are not assured and differ depending on the performance of the assets that are underlying where the funds are invested. This structure aligns with contemporary financial practices and caters to an evolving market environment.

In contrast, the OPS offered defined benefits, providing a guaranteed pension post-retirement. The pension amount was typically a percentage of the last drawn salary and did not depend on market fluctuations. This provided a sense of security to the employees regarding their post-retirement income.

⮚  Risk and returns

The NPS comes with market risk as a part of the investment is vulnerable to market-associated securities and equities. But this even infers there is a potential for generating better returns, particularly for those who begin investing early and can withhold market volatility over the long run. 

The OPS offered guaranteed benefits, independent of market risks. The retirees knew exactly what pension amount to expect, providing a stable and predictable post-retirement income. However, this also meant limited potential for higher returns that market-linked investments can offer.

⮚  Withdrawal rules

The NPS offers more structured and flexible NPS withdrawal options. On reaching the age of retirement, subscribers can withdraw a part of their corpus in lump sum form and use the rest amount to buy an annuity. Also, there are provisions for partial withdrawals as per specific conditions before reaching the age of retirement. 

The withdrawal rules under the OPS were more rigid. The pension benefits were typically available only upon retirement, with limited options for early withdrawal or lump-sum benefits.

Concluding their discussion, they collectively appreciate how NPS, with its flexibility, potential for higher returns, and inclusivity, is a robust scheme catering to the contemporary financial environment. They acknowledge the importance of adapting to change and the value NPS brings to the future of retirement planning.

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