Introduction of NPS: Know About its Basics
In India, the National Pension Scheme (NPS) is a long-term, voluntary retirement savings program. All Indians between the ages of 18 and 65 are eligible. It was first implemented by the Indian government in 2004 and is regulated by the Pension Fund Regulatory and Development Authority (PFRDA).
In this article, we will learn about how to invest in NPS for tax benefits and what the investment strategies are for this with appropriate examples. NPS was initially introduced for government employees afterwards it is also available online portal for people. The CRA (Central Recordkeeping Agency), which is appointed by the government, keeps track of NPS accounts.
Table of Contents
Purpose of NPS & How It Works
- The main goal of NPS is to give people a disciplined method of building a retirement corpus or fund.
- It promotes methodical saving during a person’s working years in order to guarantee retirement financial security.
- An NPS account can be opened by anyone, self-employed or salaried.
- This account receives regular contributions and is invested in a variety of asset classes, including government securities, debt, and equity.
- The investment increases over time, and the fund that has been accumulated is utilized to provide pensions upon retirement.
- Up to 60% of the whole retirement fund can be taken out tax-free when one retires (after the age of 60).
- We have to utilize the remaining 40% to buy an annuity, which pays out on a monthly basis as a regular pension.
How to Invest In NPS for Tax Benefits
Section 80CCD(1): Employee Contributions
- Under this part, you are able to deduct up to 10% of your salary (basic + DA).
- A maximum deduction of up to ₹1.5 lakh can be made in a financial year.
- This is credited to your Tier-I NPS account.
Section 80CCD(1B): Voluntary Contributions
- You have the option to voluntarily pay more money above the 10% cap.
- You can claim an exclusive deduction of up to ₹50,000 per year for this additional contribution.
Section 80CCD(2): Employer Contributions
- Your NPS account is qualified for tax benefits if your employer makes contributions to it (up to 10% of your base pay).
- This is in addition to the employee’s contribution.
Exempt-Exempt-Tax (EET) Regime
The EET taxation model is used by NPS
- Exempt: During the accumulation phase, contributions and growth are free from taxes.
- Exempt: A 25% maximum partial retirement withdrawal is tax-free.
- Taxed: Annuity payments (pension) are taxable.
Long-Term Wealth Accumulation:
- NPS encourages disciplined savings for retirement.
- Tax benefits enhance the effective returns on your investment.
Eligibility & Account Types
Eligibility:
- Individuals: Between the ages of 18 and 65, any Indian citizen, resident or non-resident, may open an NPS account.
- Corporate Workers: Employers are able to help their staff members with NPS.
- Self-Employed and Unorganized Sector: Professionals, independent contractors, and people without a formal job are all eligible to take part.
Account Types:
- The main NPS account is the Tier-I Account (Mandatory).
- Strict withdrawal rules: Only some uses are permitted for partial withdrawals (such education, medical emergency, or property buying).
- Benefits from taxes are provided for contributions.
- Purchasing an annuity is mandatory at retirement.
Optional Tier-II Account:
- A more flexible voluntary account.
- No tax advantages for donations.
- permits an endless number of withdrawals.
- Perfect for extra funds or short-term objectives.
Choosing the Right Investment Option & How to Open NPS Account
The National Pension Scheme (NPS) offers two investing options:
- Equity (E):
- Risk and Return: Investing in equity carries a higher risk profile, but it also has the potential to yield larger rewards.
- Asset Allocation: Up to 75% of your NPS corpus may be invested in stocks under the “Active Choice” option.
- Perfect for: Young investors that can withstand market changes and have a long investing horizon.
- Debt (D):
- Risk and Return: Investing in debt has a lower risk but a moderate return.
- Asset Allocation: You can devote up to 100% of your available funds to debt instruments in the “Active Choice.”
- Perfect for: Stable investments or conservative individuals approaching retirement.
Note: There are two choices in both options in which one is active and other is auto choice. under active choice, we have direct control over asset allocation. In auto choice, assets are controlled automatically based on persons’ age. We monitor our performance and switch to other funds if it is needed.
How to open NPS Account
Online Method:
- Go to the website of a registered Point of Presence (PoP) or the official NPS website.
Select “Open NPS Account” or a comparable option. - Enter the necessary data, such as your name, nominee information, and investing preferences.
- Upload the required files, such as your Aadhaar card and PAN card.
- Select from the Active and Auto Choice investment options.
- Make the initial payment (a minimum is needed).
- We’ll generate your PRAN (Permanent Retirement Account Number).
Offline Method:
- Go to a PoP (banks, post offices, etc.) that provides NPS services in the area.
- Take the form for opening an NPS account.
- Complete it with accurate information.
- Enclose photocopies of the necessary paperwork.
- Send the completed form and the initial donation.
- Your PRAN card and other important details will be included in your PRAN kit, which you will receive.
Case Studies or Examples providing tax saving through NPS
- A Salaried Professional Rajesh, a software engineer in his 30s who makes ₹10 lakh a year, puts ₹1 lakh, or 10% of his base pay, into his Tier-I NPS account. Under Section 80CCD(1), he claims a deduction of ₹1 lakh, saving ₹30,000 in taxes.
- The Employer-Contributor, Vikram: Every year, His employer makes a ₹1 lakh contribution to his NPS account. Vikram is claiming ₹1 lakh in deductions under Section 80CCD(2), which will save him ₹30,000 in taxes.
- An Astute Trader Neha, a 28-year-old marketing professional, divides her NPS account’s allocation 60% into equity (E) and 40% into debt (D) (Active Choice). She maximizes tax benefits and benefits from potential growth, accumulating a sizeable retirement corpus over time.
FAQs
An NPS account can be opened by any Indian citizen, resident or non-resident, between the ages of 18 and 65. Eligible persons include self-employed people, corporate workers, and those in the unorganized sector.
Under Sections 80CCD(1) and 80CCD(1B), contributions are deductible. Under Section 80CCD(2), employer contributions are deductible.