6 Reasons to Investing in the National Pension Scheme (NPS)

The National Pension Scheme or NPS provides a steady income source, attractive returns, and better tax savings. It is a flexible and affordable retirement investment option with lower risks as compared to the other choices in the market². For individuals planning for long-term financial security, understanding is NPS a good investment can help in evaluating its suitability.

Having a suitable retirement plan is essential to balanced financial planning. Among the various available options, the National Pension System (NPS) presents many investment options and the flexibility to select pension fund schemes, simplifying the process of retirement planning.

The National Pension Scheme (NPS) offers an excellent option for those who wish to start planning for their retirement early and have a conservative risk tolerance. This article highlights six reasons why you must invest in NPS, a scheme launched by the Central Government of India. 

The NPS is a social security initiative accessible to employees across many sectors, except the armed forces. Similar to a retirement plan, this program encourages people to make periodic contributions to a pension account throughout their careers.

Upon retirement, you can withdraw a portion of your gathered savings, while the remainder is disbursed as a monthly pension. So, in case you are wondering “Should I invest in NPS?”, note that the NPS is regulated and overseen by the Pension Fund Regulatory and Development Authority (PFRDA).

It operates as a well-defined, voluntary contribution scheme, linked to the financial markets and managed by experienced fund managers.

You will find two sorts of NPS accounts: Tier I and Tier II. Let us briefly understand both:

NPS Tier I: The Tier I account is mandatory and allows withdrawals only upon meeting specific exit conditions as outlined in the NPS regulations. Any Indian citizen between 18 and 65 can start an NPS Tier I account with a minimum investment of ₹500. Your funds in this account are lock-in till you turn 60. However, after the initial lock-in period of 3 years, you can partially withdraw funds (up to 25% of the fund value) from here for certain causes. When you turn 60, you can receive up to 60% of the maturity amount as a lump sum and rest must be used to buy an annuity plan.

NPS Tier II: On the other hand, the NPS Tier II account is voluntary and serves as an additional savings option for Tier I account holders, permitting them to withdraw their savings at their discretion. Any Indian citizen with a running Tier I account can open a Tier II account with a minimum investment of ₹1000. However, you will not get tax exemptions on your Tier II account maturity amount unlike the Tier I account.

The National Pension System (NPS) is a retirement-focused investment option that combines long-term market-linked investing with a structured withdrawal framework. Contributions are invested across asset classes such as equity, corporate debt and government securities, based on the subscriber's selected investment choice.

The following features can make NPS relevant for long-term retirement planning.

1. Tax benefits on eligible contributions

One of the key NPS benefits is the tax treatment available to eligible Tier I contributions.

• Section 80CCD(1) allows eligible individuals to claim a deduction within the overall ₹1.5 lakh limit under Section 80CCE, subject to applicable conditions.
• An additional deduction of up to ₹50,000 can be claimed under Section 80CCD(1B).
• Eligible employer contributions can qualify for deduction under Section 80CCD(2), subject to the applicable limits.
• At exit, up to 60% of the accumulated corpus can qualify for tax exemption as per Section 10(12A).
• The amount used to purchase an annuity at exit is exempt at the time of purchase, while the subsequent annuity income is taxable according to the applicable tax provisions.

Tax treatment depends on the applicable tax regime and prevailing provisions, so the current Income Tax rules should be checked before making a decision.

2. Choice of investment options

NPS provides exposure to different asset classes. Depending on the applicable NPS model and investment choice, subscribers can allocate their contributions across equity, corporate debt, and government securities.

This allows the investment strategy to be aligned with the subscriber's risk tolerance and retirement horizon.

3. Professional fund management

NPS investments are managed by Pension Fund Managers (PFMs). The selected PFM manages the allocation of the pension fund according to the applicable investment guidelines and the subscriber's chosen investment option.

This provides a structured approach to managing long-term retirement contributions.

4. Flexible contribution options

Subscribers can contribute to their NPS account according to their financial capacity, with contributions made through online and other permitted channels. PFRDA currently states that there is no upper limit on the amount that can be contributed to Tier I or Tier II accounts.

Regular contributions can help maintain consistency in retirement savings, while the contribution amount can be reviewed as income and financial circumstances change.

5. Structured retirement income

NPS is designed primarily for retirement planning. At exit, the accumulated pension wealth can be divided between a lump-sum component and an annuity component, subject to the applicable exit rules.

For the current All Citizen Model, PFRDA provides for up to 80% lump-sum withdrawal and at least 20% annuitisation at normal exit under the revised framework, subject to applicable conditions.

The annuity component can provide a regular income after retirement, although the eventual income depends on the annuity selected and applicable rates.

6. Online accessibility and account management

NPS can be managed through online channels, including the eNPS platform and NPS mobile application. Subscribers can make contributions and monitor their accounts through the available facilities.

This accessibility can make it easier to maintain and review retirement savings over the long term.

NPS offers several national pension scheme benefits, but it also has features that may not suit every investor. Understanding these limitations is important when understanding is NPS good investment option for your retirement needs.

Withdrawal restrictions

NPS is primarily designed for retirement savings, so withdrawals are governed by specific rules.

Partial withdrawals are permitted only under prescribed conditions and limits. The applicable rules also differ according to the subscriber's age, NPS model, and circumstances.

This means NPS may not be suitable for someone who needs unrestricted access to their retirement savings.

Market-linked returns

NPS investments are exposed to market movements because contributions can be invested in market-linked asset classes. The value of the accumulated corpus can therefore fluctuate.

NPS does not provide a fixed or guaranteed investment return. The eventual corpus depends on contributions, investment allocation, market performance, charges, and the investment period.

Annuity-related conditions at exit

A portion of the NPS corpus may need to be used to purchase an annuity at exit, depending on the applicable exit category and current rules.

Under the revised All Citizen Model, normal exit permits up to 80% as lump sum and requires at least 20% for annuity, subject to applicable conditions.

The annuity income received after purchase is taxable according to the applicable tax provisions.

Limited control over individual investments

NPS provides choices regarding pension funds and asset allocation, but subscribers do not directly select individual shares, bonds or other securities within the NPS portfolio.

The investments are managed within the framework prescribed for NPS.

Exit rules can be complex

The amount that can be withdrawn as a lump sum and the portion that needs to be used for annuity can vary depending on the type of exit, age, accumulated corpus and applicable NPS model.

For example, premature exit under the All Citizen Model can involve at least 80% annuitisation, subject to the applicable conditions.

Tier II does not receive the same tax treatment

Tier II is an optional investment account linked to an active Tier I account. Unlike Tier I, Tier II does not generally offer tax benefits on contributions and its investment gains do not receive the same special tax treatment. 

NPS can form part of a long-term retirement strategy by offering structured contributions, professional fund management, investment choices, and specific tax benefits. However, its market-linked nature, withdrawal conditions, annuity requirements, and tax treatment should also be considered. Whether national pension scheme is good or bad depends on your retirement objectives, investment horizon, liquidity requirements and overall financial plan.