What is New Pension Scheme(NPS)?

Everyone has a retirement plan for travel, leisure, meeting daily expenses, only one can enjoy retirement if one has available funds. Retirement is the condition when there is no active income, unlike developed countries, there is no Government support. With increasing, medical advancement life expectancy after retirement is about 25-30 years. It means if retirement planning is not done in an efficient way then one has to work post-retirement.

So, in order to relieve the retired person, as well as reduce the cost to the government, NPS or the New Pension Scheme was introduced in the year 2004 for government employees and from 2009 for all Indian citizens.

NPS is a voluntary retirement scheme and available for Indian citizens for the age group of 18-65 years. It is regulated by PFRDA or Pension Fund Regulatory and Development Authority. Its primary functions are to develop and regulate pension funds and to protect the interest of NPS subscribers. NPS is managed by fund managers which is government approved. Presently there are 7 fund managers – Aditya Capital, HDFC pension fund, ICICI Prudential, Kotak Mahindra, SBI pension fund, and UTI.

Where does the NPS money get invested?

The money that a subscriber contributes is invested in 4 assets classes: -

1.  Equity.
2. Government Bonds.
3. Corporate Bonds.
4. Alternative Investment Funds-like REIT, INVIT, etc.

These assets classes are divided into 4 categories of risk.

1. Low Risk-Government Bonds
2. Moderate Risk- Corporate Bonds.
3. High Risk-Equity.
4. Very High Risk-Alternative Investment funds.

NPS gives the options to the subscriber to choose what amount of money gets invested in which assets classes for this there are 2 options: -

1. Active Choice.
2. Auto Choice.

Assets allocation can be changed 2 times during a year.

For Active choice

Maximum equity allocation till the age of 50 is 75%

Then for the last 10 years, the equity allocation is reduced by 2.5% every year, in order to minimize the risk.

Till the age of 60 years, the equity allocation can only be of 50%

Maximum AIF investment can be of 5%.

For Auto Choice.

It is based on age what proportion of money is invested in which assets classes. For this the subscriber has will be given 3 life cycle fund options, so in order to determine the starting allocation and how it is going to be changed. The 3 life cycle funds are: -

Aggressive life cycle fund

In this equity exposure can be of a maximum of 75% till the age of 35, which decreases by 3% every year till the age of 55 which comes down to 15%.

Moderate life cycle fund

 In this equity, exposure can be of a maximum of 50% till the age of 35, which decreases by 2% every year till the age of 55 which comes down to 10%.

Conservative life cycle funds

In this equity, exposure can be of a maximum of 25% till the age of 35, which decreases by 1% every year till the age of 50 which comes down to 5%.

Minimum Investment under NPS

An Indian citizen can open an NPS account with a minimum of Rs 500 with the minimum contribution in a year of Rs 500. If not contributed for 2 years then it will become dormant account which can be activated by contributing Rs 1000.

Withdrawal limit under NPS

The contributed amount cannot be withdrawn until the age of 60.

After completing 60 years of age one can withdraw 60% of the fund value, which can be withdrawn in 10 installments till the age of 70, and the remaining 40% is invested in annuity products in which investors receive a fixed amount every month.

Partial withdrawal

Partial withdrawal is allowed only in special circumstances like serious illness, children higher education, etc, which can be withdrawn only 3 times (gap of 5years) during the lifetime of the fund up to 25% of the amount contributed by the subscriber (not on the amount contributed by the employer). This is allowed after the initial contribution of 3 years.

Premature exit in NPS Scheme

For premature exit, accounts should be a minimum of 10years old. In which one can withdraw 20% of the fund value and the remaining 80% is invested in annuity products. 

If the invested amount is less than Rs 1 lacs then 100% withdrawal is allowed.

Taxation of income from NPS

There are only 3 investment policy in Indian which enjoys EEE category, which means amount invested is allowed as a deduction, interest earned is exempt, income generated on investment is not taxed on withdrawal, they are: -

1. Public Provident Fund.
2. New Pension Scheme.
3. Sukanya Samriddhi Yogona.

U/S 10(44)- Any income generated by the NPS fund is exempt from tax.

Conclusion

While it can be seen the average return from the NPS scheme generates around 8-10% return, which is more than the PPF return which presently 7.1%. NPS is somewhat market-linked as there are 3 asset classes apart from Government Bonds that can be volatile, but if go by the historic data, if we stay invested for a longer period of time chances that return will be on the higher end. Also, NPS gives the option to switch between schemes and investors can change the investment structure according to their choice.