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All You Need To Know About The New Pension System

ICICI Securities 28 Mar 2022
  • NPS equity fund has returned 13% in the past 10 years and 9-11.90% over the past one year
  • NPS corporate debt category has returned more than 9% in the past 10 years and 6.5-7.5% in one year
  • You can invest a minimum of Rs 1,000 per year in the Tier I account
  • NPS offers up to Rs 2 lakh of tax benefits under Section 80C and Section 80CCD (1b)

The National Pension System (NPS) was recently in the news as a few state governments raised the issue of reverting to the old pension scheme. However, one of the key arguments in favour of NPS has been that the instrument gives equity exposure, which can give a return kicker to the retirement corpus. Moreover, since it is not paid out of the government coffers, it’s a more sustainable system in the long run. The product is also available for private sector employees, who in most cases do not get a retirement corpus building option from their employers. 

Here are some key features about NPS that you should know if you want to build a retirement corpus in a well-regulated product.

 

Who Can Invest?

Any Indian citizen, including non-resident Indians (NRIs) can open an NPS account. Contributions made by NRIs are subject to regulatory requirements as prescribed by the Reserve Bank of India and the Foreign Exchange Management Act.

Categories such as Overseas Citizens of India (OCI) and Persons of Indian Origin (PIO) and Hindu Undivided Families (HUFs) are not allowed to open an NPS account.

The subscriber needs to be 18-70 years at the time of applying. It may be noted that the age limit has recently been increased from 65 to 70 years.

What’s The Structure?

NPS has a two-tier structure, wherein the Tier I account is mandatory to open, while the Tier II account is optional. Tier II account offers greater flexibility as compared to the Tier I account. For example, Tier II account allows withdrawal at any time unlike Tier I account which comes with a lock-in and has strict withdrawal rules. There is no additional maintenance charge in a Tier II account, and you can transfer the funds to the Tier I account at any point if you wish to.

Investment Options

NPS offers four investing options ranging from equity to debt. These are equity (E), which is considered a high-risk instrument; corporate debt (C), which is seen to have medium risk; government securities (G), which is a low-risk instrument; and alternative investment funds (A) which invests in instruments such as real estate investment trusts (Reits) and infrastructure investment trusts (Invits).

Further, NPS offers two modes of investment—active and auto choices.
Under the active choice, you can divide investments among the four options as per your risk appetite, life stage and goals. You can invest up to 75 per cent in equities and up to 5 per cent in alternative investment funds, subject to certain conditions. You can choose to invest your entire saving in C or G, which have lower risk.

Under auto choice, you let NPS on your behalf in various investment options. The proportion of investment in different investment options depends on your life stage. For instance, here your equity exposure is automatically tapered down as you grow older.

You can choose among seven pension fund managers that manage the NPS corpus. These are Aditya Birla Sun Life Pension Management Ltd, HDFC Pension Management Co. Ltd, ICICI Prudential Pension Fund Mgmt Co. Ltd, Kotak Mahindra Pension Fund Ltd, LIC Pension Fund Ltd, SBI Pension Funds Pvt. Ltd and UTI Retirement Solutions Ltd.

How Much Can You Invest?

The Tier I account can be opened with Rs 500. However, the minimum contribution allowed per year is Rs 1,000, while there is no maximum limit for the salaried. For the self-employed, up to 20 per cent of the gross annual income is allowed as maximum contribution.
The Tier II account needs to be opened with a deposit of Rs 1,000. Thereafter, there is no mandatory minimum annual contribution limit. Moreover, there is no cap on the maximum you can invest in a Tier II account. However, contributions, if any, have to be made in multiples of Rs 250.

How Have Been The Returns?

Since its inception, the equity schemes offered by the seven fund managers has given returns in the range of 10-14 per cent, according to the latest data from NPS dated March 11, 2022. Over 10 years, the returns have been around 13 per cent, while in the past one year, the returns have been between 9 per cent and 11.90 per cent. The benchmark return over the past 10 years was 13.12 per cent and 11.40 per cent in the past one year.

Similarly, the corporate debt category has given around 10 per cent since inception, more than 9 per cent in the past 10 years across fund managers and 6.5-7.5 per cent in the past one year. The benchmark return over 10 years have been 9.77 per cent and 7.38 per cent over the past one year.

Expected corpus and returns (Just for Illustration purpose)

If you are a 25-year-old investing Rs 1,000 for 50 years, your retirement corpus will grow to Rs 1,74,68,761 at an estimated rate of return of 10 per cent. Out of this, 40 per cent or Rs 1,04,81,257 will go into buying annuities. At an estimated return of 6 per cent, the regular monthly income will be Rs 34,938.

When And How Much Can You Withdraw?

The withdrawal rules of NPS are something that have drawn criticism from some quarters as only 60 per cent of the corpus can be withdrawn as a lump sum at the time of retirement. The remaining 40 per cent needs to be invested in an annuity product specified by NPS.

However, there is an exception: if the total corpus is less than or equal to Rs 5 lakh, NPS allows 100 per cent withdrawal as lump sum and there is no need for investment in annuity.

NPS discourages premature withdrawal but allows it subject to certain conditions and only for specified reasons. Any withdrawal before retirement or before the age of 60 years is limited to 20 per cent of the corpus, with the subscriber required to invest the remaining 80 per cent in an annuity instrument. However, if the corpus is less than or equal to Rs 2.5 lakh, premature withdrawal of up to 100 per cent of the corpus is allowed.

What Are The Tax Benefits?

Tax deduction up to Rs 1.5 lakh is available for investments in NPS under Section 80C of the Income-tax Act, 1961. Further, an additional deduction of Rs 50,000 is available under Section 80CCD (1b); this benefit is exclusively available to NPS investments.
For private sector/corporate subscribers, another tax benefit is available under Section 80CCD (2). The employer’s NPS contribution (for the benefit of the employee) up to 10 per cent of the salary (constituting basic salary and dearness allowance) is deductible.
However, tax benefits are available for investments only in Tier I account of NPS.

*All data mentioned above is as per the NPS Trust Website(https://www.npstrust.org.in/return-of-nps-scheme)

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