Retirement

What is National Pension Scheme and How Does it Work [Explained✅]

What is National Pension Scheme (NPS) in India?

National Pension System (NPS) is a pension cum investment scheme initiated by the Government of India to provide old age security to Indian citizens. It is a pure retirement pension plan, in which you can get a stable income with tax benefits after your retirement and it offers you the option to choose from different pension plans based on your risk profile. You can make an annual contribution till you turn 65 years of age and you need to be at least 18 years to invest in NPS.

The money you deposit in NPS is invested by pension fund managers in equity, government securities, corporate bonds, and alternative investment funds.  It also allows you to invest in a mix of asset classes. When the subscriber reaches the age of retirement, this sum is utilized by them to buy an annuity or a monthly pension plan.

NPS is a low-cost pension product, which is professionally managed by pension funds regulated by the central government’s Pension Fund Regulatory and Development Authority (PFRDA).


What are the types of NPS accounts?

Unlike a PPF where you have only one plan, NPS offers various choices starting from two account types.

  • Tier 1 account, the pension account, which gives tax benefit and is mandatory to open for NPS, and
  • Tier 2 account, an optional account with withdrawal flexibility.

The table below explains the two types of accounts in detail:

PARTICULARS TIER 1 TIER 2
Minimum Contribution required at the time of account opening ₹500 ₹1000
Minimum Subsequent Contribution amount required ₹500 ₹250
Minimum contribution required per year ₹1000 NIL
Minimum number of contributions required in a year 1 NIL

Once you open an NPS account, you have to make a minimum annual contribution of ₹1,000 in tier 1 account.

After selecting your account type, you need to choose your fund manager and the type of investment choice. There are eight pension fund managers to choose from such as HDFC Pension Management, Reliance Capital Pension Fund and UTI Retirement Solutions.

In terms of investment choice, you can opt for either active choice or auto choice.

  • In the active choice, you can create your portfolio with a mix of equity (maximum 50%), corporate bonds and government securities.
  • In the auto choice, the fund manager will create a portfolio mix with the same asset classes (as in the active), but the asset allocation will be decided based on your age. For instance, the older you are, the more stable and less risky your investments while for younger investors higher allocation will be towards equity..

Subscribers also have an option to switch their investment options as well as change their fund manager.


How does the National Pension Scheme work?

The scheme is based on a unique Permanent Retirement Account Number (PRAN) which is allotted to each NPS subscriber upon joining. Subscribers contribute towards NPS either directly or through the Employer they are working with during their working life. On retirement or exit from the scheme, the Corpus is made available to them with the mandate that some portion of the Corpus must be invested into Annuity to provide a monthly pension post-retirement or exit from the scheme.


Features & Benefits of Investing in NPS

Tax Benefits of NPS:

Your investment in NPS also qualifies for a host of income tax benefits. Investors can avail of up to ₹1.5 lakh tax deduction under Section 80C through NPS contribution. In addition, there is a deduction of up to ₹50,000 under Section 80CCD(1B).

NPS is a long term investment instrument to save for your retirement. So do not invest in NPS for its tax-benefits or short-term performance. While deciding to invest in NPS, apart from looking at the performance of various schemes, make sure to match your risk profile with the schemes on offer.


NPS Withdrawal Rules

Can you withdraw money from NPS before retirement?

The NPS subscribers can make a partial withdrawal after three years from the date of joining the system under specific circumstances, listed below:

  •  for expenses towards higher education/marriage of children,
  • purchase/construction of the residential house (in specified conditions), and
  • treatment of critical illnesses.

The subscriber can make a partial withdrawal a maximum of three times during the entire tenure of subscription under NPS. The maximum allowed limit for partial withdrawal is 25% of the contributions made by the subscriber as on the date of application for withdrawal.


Should you invest in NPS?

NPS is a great retirement investment tool because it offers multiple investment options coupled with tax benefits. Its long-term approach ensures you will have a considerable sum available at the time of retirement. But don’t depend on it entirely. Have a mix of different investments like mutual funds, stocks, gold and others.


P.S. The rules and regulations on NPS tax benefits, withdrawal options and others are continuously changing. The rules applicable at the time of writing the articles are mentioned in the article. Please check if there has been any update before you decide to invest in NPS. Or call us and ask our advisor.

Arihant Team
The Arihant Team believes everyone deserves access to sophisticated financial advice. From day one, our mission has been to help make investing easier and accessible to every Indian. Our team of experts are curating informative and research-based article on this blog, to help make investing and managing your money easier for you!

If you would like us to discuss a specific topic on our blog, please write to us at research@arihantcapital.com.
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