In the last three pieces of this series on NPS, we had understood the basics like objectives of NPS, who can invest in it as well as some of its features in part 1.
Part 2 was about investment choices, subscriber base & assets under management under NPS.
Part 3 dealt with registered pension funds, opening of NPS account and IT benefits on NPS contributions (links given below):
- National Pension System (NPS) - Part 1: Click Here
- National Pension System (NPS) - Part 2: Click Here
- National Pension System (NPS) - Part 3: Click Here
In this final piece, we will try and learn about the exit process and attempt to solve a hypothetical problem to understand the computation of pension. In the end, we will also understand whether NPS is a better choice for investment.
First, let us understand about withdrawal or exit from NPS.
Withdrawal from Tier1 account is subject to restrictions (as elucidated below) whereas no such restrictions have been imposed on withdrawal from Tier2 account. Here one should note that there are no tax benefits provided on contributions made towards Tier2 account. Also, upon exit from Tier1 account, Tier2 account automatically gets closed.
As far as taxability of withdrawals from Tier2 account is concerned, there appears to be no specific provision in law in respect of the same. Several experts have expressed different opinions regarding its taxability like treating it as a savings account, taxing entire withdrawal, taxing gain on withdrawal etc. In my opinion, taxing gain as short/long term capital gain would be logical.
Now let us try and understand the exit provisions under Tier1 account.
The subscriber can exit from NPS on attaining the age of 60 years on superannuation (may defer up to 70 years). Upon exit, the subscriber can withdraw from Tier1 account, a lump sum up to 60% of accumulated wealth which is also tax-free. The balance 40% has to be compulsorily utilized for purchase of an annuity from Annuity Service Providers empaneled by PFRDA. 40% is the minimum limit and one may buy more than the prescribed limit. The annuity provides a monthly pension. The annuity per se is not taxable and only the monthly pension would be taxable according to the rate as applicable to one’s slab.
However, if the accumulated corpus at the time of exit is <= Rs.2 lacs, then the entire corpus can be withdrawn.
In case of death of the subscriber, the entire accumulated wealth will be paid to the nominee or legal heir. However, the nominee (or legal heir) has an option to purchase annuity if s/he so desires.
The subscriber can exit from NPS (or close the account) after a minimum period of 10 years. However, the subscriber can withdraw only 20% of accumulated wealth (tax-free) and annuity has to be compulsorily purchased for balance 80%. If the accumulated corpus at the time of exit is <=Rs. 1 lac, then the entire corpus can be withdrawn.
However, in case of disability/incapacitation of the subscriber, a lump sum up to 60% of accumulated wealth can be withdrawn and annuity to be purchased for the balance 40%, subject to satisfaction of specified conditions.
The subscriber can withdraw up to 25% of own contributions after a period of 3 years from date of joining. Such withdrawals are allowed for 3 times during the lifetime of subscription. Partial withdrawal is also tax-free.
Specified purposes for which partial withdrawal is allowed include, inter alia, higher education or marriage of children, purchase/construction of house, treatment for specified illness of the subscriber (or of spouse/children/dependent parents) etc subject to specified conditions.
Features of NPS for those who join after the age of 60 years
PFRDA vide circular No. PFRDA/2017/35/PD/1 dated 1st Nov 2017, has increased the max age for joining NPS scheme from 60 to 65 years. This special scheme is open only under All Citizen and Corporate Models.
For ease of reference, this scheme is referred to as the special scheme and the former as the regular scheme.
The subscribers opening NPS account after the age of 60 years are eligible to continue as well as contribute up to the age of 70 years. S/he will have the same choice of pension fund and investment options as are available to subscribers under regular scheme. Income tax benefits would be same as that under the regular scheme. However, the scheme differs with respect to exit provisions which are discussed below:
The subscriber can exit after completion of 3 years since joining. Similar to the regular scheme, the subscribers under this scheme too can withdraw a lump sum up to 60% (tax-free) of accumulated wealth. The balance to be used for buying an annuity which in turn provides monthly pension and the same is taxable according to one’s tax slab.
However, if the accumulated corpus at the time of exit is <=Rs. 2 lacs, then the entire corpus can be withdrawn.
An exit before completion of 3 years is treated as a pre-mature exit. Under this route, minimum 80% to be utilized for purchase of annuity and only 20% can be withdrawn which is tax-free.
However, if the accumulated corpus at the time of exit is <=Rs. 1 lac, then the entire corpus can be withdrawn.
In case of death of the subscriber, the entire corpus will be paid to the nominee (or legal heir).
Let us consider a hypothetical situation to understand the computation of pension:
A person aged 25 years joins NPS and starts contributing a fixed sum of Rs. 5000 pm. Calculate the following at the time of retirement (@60 years) of the subscriber:
- Total Investment
- Total Corpus
- Lump sum Value
- Annuity Value
- Monthly Pension
- Return on investment @10% pa
- Annuity purchased for 40% of corpus
- Expected rate of return on annuity @6% pa.
Yearly Contribution x No. of years
(forget about the formula if you don’t want to delve into it)
Lump sum Value
60% of Total Corpus
@6% ROI pa
Is NPS a better choice to consider for investment?
A precise answer to such a question is nearly impossible and also highly subjective. However, I can try and list out some of the aspects to help make a rational judgment in this regard.
The answer would be YES:
- If you are looking for a retirement plan with pension benefits which is relatively safe
- If you are willing to invest in a long-term SIP-like plan
- If you are moderately risk-averse.
The answer would be NO:
- If you are risk-averse (as investments under NPS are market-linked)
- If you are not at all risk-averse (in that case, investing in stocks would best suit you)
- If you are not looking for a long-term investment/retirement solution.
I have tried my best to take into consideration relevant amendments while preparing this article. In case anything is left out or if there are any discrepancies, I urge the readers to educate me.
Disclaimer: The objective of writing this piece is to share knowledge and create awareness. The views expressed are personal in nature and under no circumstances can this piece be construed as a legal opinion. The readers are requested to exercise caution while forming any opinion or judgment based on the views expressed in this article.
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