Revisiting NPS in 2022

Pension payments are a huge burden for Governments around the world. As populations age, this burden continues to grow. In the past, India (like several other nations) followed a defined benefit cum assured pension plan. Once you retired, a predefined pension was made available regularly for your post retirement needs.

Over time, the realisation dawned on the govt that this is not sustainable. A new system was devised with the defined contribution plan. Here the contribution towards pension fund is defined but the final amount of pension depends on how much you contribute and the performance of your pension fund. There are NO guarantees, unlike the previous defined benefit system.

National Pension System (NPS) is the result of this thinking. It was created to provide a retirement planning option for all the citizens of India.

NPS is administered by the NPS Trust and funds are managed by various managers under the guidelines issued by the regulator, PFRDA.

Let’s revisit some of the facts about NPS.

NPS has been touted as the lowest cost retirement / pension schemes in the world with tax benefits to induce people to subscribe to it.

Your NPS contribution is invested in a mix of assets that include –

1. Asset Class E – Equity / Shares of companies listed in Futures & Options Segment

2. Asset Class G – Govt Securities and State Development Loans

3. Asset Class C – Corporate Bonds which are listed and rated A or above

4. Asset Class A – Alternative Assets such as Perpetual Bonds.

NPS also offers 2 investment choices to investors.

One, Auto Choice, where the age of the investor decides the allocation to various assets. You can choose between Aggressive, Moderate and Conservative allocations. The max allowed in equity is 75% (with Aggressive) and reduces with age. At age 55, equity allocation will be 15% max. Basically, reduce risk as retirement comes closer.

See details for the Corporate NPS here

Two, Active Choice, where you can choose your own allocations with the equity allocation capped at 75% and Alternate Assets at 5%. You can put 100% in Govt Securities and/or Corporate Bonds.

The main NPS account is Tier 1, which also gets all the tax benefits and is subject to restrictions of withdrawal.

There is a Tier 2 account, which functions like a regular investment account and has no tax benefits and no restrictions.

You need to have a Tier 1 account to open a Tier 2 account. You can even switch from a Tier 2 account to Tier 1 account but not vice versa.

Any Individual (Resident, NRI OR salaried, self-employed) can open an NPS account. There are no restrictions on the amount you can contribute towards the retirement plan. Want to add Rs. 1 crore to NPS in one shot? Go ahead and do it.

Taxation / Withdrawals

However, the tax benefits are limited and defined under various sections of the Income Tax Act.

Under Sec 80(C), within the overall Rs. 1.5 lakh limit (including EPF, insurance, etc.), you can use the NPS investment as a deduction. There is another Section 80(CCD)1 (B), where an additional Rs. 50,000 per year can also be claimed specifically for NPS contribution.

If your employer offers NPS as a retirement scheme option, then employer contribution upto 10% of the basic is allowed for tax deduction. The overall exemption is capped at 7.5 lakhs a year (including EPF, VPF and NPS).

For Central and State Govt Employees, this is allowed upto 14%. For self-employed, 20% of the gross income within the limit of Rs. 1.5 lakhs under Sec 80 (C) is allowed as deduction.

NPS account matures at age 60. However, you can continue to hold and not withdraw till age 75. At age 75, the account has to be closed.

When you withdraw, upto 60% of the value at the time can be withdrawn tax – free. You can choose to withdraw this amount in parts over several years and not in one go.

Minimum 40% of the NPS amount has to be compulsorily be converted into an annuity with one of the enlisted insurance partners with PFRDA. No one stops you if you want 100% amount to be converted into annuity. There are several annuity options that you can chose from (limited years to full life, to increasing by 3%, return of principal or not, etc.). You cannot defer annuity for more than 3 years.

The annuity income, as and when received, becomes a part of your taxable income and is taxed at your marginal tax rate. (To clarify, the total amount sent towards annuity is not taxed, only the income received via the annuity is.)

In case of death of subscriber, the nominee or legal heir can withdraw the entire accumulated corpus. S/he also has the option to start annuity.

Should you invest in NPS?

NPS was designed as a retirement solution (regular contributions, lock ins, withdrawal limits, annuity, etc.) but people found their own draw towards it – tax savings.

“Let me save more tax by investing Rs. 50,000 per year! “

I have written a lot in the past about NPS and if it makes for a good tax savings/investment option. My view about hasn’t changed. My point – it is too small an amount to make any substantial difference to the portfolio overall, specially for the people who were asking.

So, why trade off the lock in and inflexibility with low equity in later years for some immediate tax benefit? But, hello immediate gratification!

There may be certain benefits for the salaried who are making NPS contributions via their employer as well as those who would want this low cost, lock in driven way to ensure that they have some income at their retirement.

For the rest, you can take a call based on facts. (Overweight rationality!)