What is NPS?
National Pension System (NPS) is a government-backed retirement savings scheme. It's a defined contribution pension plan where you invest during your working years and receive a pension after retirement. NPS offers flexibility in asset allocation and significant tax benefits.
How NPS Works
You open an NPS account and contribute regularly. Your money is invested across equity, debt, and government securities based on your choice. At retirement (age 60), you can withdraw 60% tax-free and use the remaining 40% to buy an annuity (pension).
Types of NPS Accounts
1. Tier-I Account: Mandatory, long-term retirement account. Lock-in till age 60, tax benefits available.
2. Tier-II Account: Voluntary, flexible savings account. No lock-in, but no tax benefits.
Asset Allocation Options
1. Active Choice: You decide allocation between Equity (E), Corporate Bonds (C), Government Bonds (G), and Alternative Assets (A). Maximum 75% in equity for those under 50.
2. Auto Choice: Automatic allocation based on your age. More equity when young, shifts to debt as you age.
Tax Benefits
- Section 80C: Up to ₹1.5 lakhs deductible (Tier-I contributions)
- Section 80CCD(1B): Additional ₹50,000 deduction (over and above 80C)
- Employer Contribution: Up to ₹7.5 lakhs deductible under Section 80CCD(2)
- Maturity: 60% withdrawal is tax-free, 40% used for annuity
Tax Implications
Contributions: Deductible under Section 80C (₹1.5L) and Section 80CCD(1B) (additional ₹50K).
Withdrawal: 60% of corpus is tax-free. Remaining 40% must be used to buy annuity (pension), which is taxable as per your slab.
The 60% tax-free withdrawal makes NPS attractive, but the mandatory 40% annuity purchase reduces liquidity. Annuity income is fully taxable.
Key Considerations
- Lock-in: Money locked till age 60 (with some exceptions)
- Annuity: 40% must be used for annuity, reducing flexibility
- Market Risk: Returns depend on market performance
- Low Charges: Very low expense ratios compared to other products
- Portability: Can transfer account if you change jobs or locations
Who Should Invest in NPS?
NPS is ideal for retirement planning, especially for salaried individuals who can maximize tax benefits. It's suitable for those who want a disciplined, long-term retirement corpus with professional fund management and low costs. The additional ₹50K deduction makes it attractive for high-income earners.