What is the National Pension Scheme and how does NPS work

The government of India has launched many investment schemes to provide masses with safe and economic investment options. Apart from capital growth, building retirement corpus is one of the most significant aspects of financial planning for any individual. Government-backed National Pension Scheme (NPS) is a go-to option for Indians looking to earn adequate income after retirement.

The voluntary scheme enables you to contribute towards retirement throughout your working life regularly. Let us have a look at what this scheme is and how it works.

What is NPS?

As mentioned above, NPS is a government-backed pension scheme launched by the Pension Fund Regulatory and Development Authority (PFRDA) in 2004. While the programme was only launched for government employees initially in 2009, it opened for all the sections including the NRIs.

After subscribing to NPS online or offline, one can regularly contribute to this pension account during their working life. After retirement 60% of the deposited amount can be withdrawn in a lump sum. The remaining 40% is used for purchasing an annuity from a life insurance company to earn a regular pension.

Two types of NPS account

Subscribers are allowed to open two types of NPS account – Tier 1 and Tier II. However, you can only open Tier II account if you already have a Tier I account. The two major differences between the two are the tax benefits and withdrawal limitations. While there are certain withdrawal limitations in Tier I account, Tier II account does not enjoy the same tax benefits as Tier I.

Where does PFRDA invest your money?

The money you deposit in your NPS account is invested by the fund managers regulated by the PFRDA. The investment is mostly made in diversified portfolios that consist of government bonds, company debentures, and shares.

As the investment is made in market-linked securities, the returns or the rate of interest offered by NPS varies as per the market conditions.

Minimum contribution and service charge

Any Indian, between the age of 18 and 65, can subscribe to NPS. The minimum contribution amount in a financial year is Rs. 1000 for a Tier I account. There is no minimum contribution amount for Tier II account, but you have to maintain a minimum balance of Rs 2000 in your Tier II account at the end of each financial year. The investment in both these accounts earns compound interest to help you earn high returns.

As per the NPS details, subscribers are also required to pay a service charge for their investment. For public sector employees, the service charge is 0.0102%. The same for private sector employees is 0.25%.

Tax benefit of NPS

As per the current tax provisions, NPS subscribers can get an additional tax benefit of up to Rs. 50,000 in a financial year under Section 80CCD (1B). This NPS tax benefit is over and above the tax-saving benefit of up to Rs. 1.5 lakh that it receives under Section 80CCE. However, you only get tax benefits on the contribution made towards Tier I account. Tier II account currently enjoys no tax exemption on contribution. However, as per recent announcements made by Finance Minister of India, Tier II accounts with 3-year lock-in will also soon enjoy tax benefits.

Subscribing to NPS

To start NPS investment, you need to get in touch with a POP (Point of Presence) appointed by the PFRDA. Most of the private and public sector banks are appointed as POPs. The POP-SP (Point of Presence-Service Providers) are the authorised branches of a POP that function as collection points.

So, to subscribe to NPS, you can contact a bank that is appointed as a POP. Many of the banks now allow you to start NPS account online.

Retirement planning with National Pension Scheme

It is essential to first understand the investment option or scheme thoroughly before investing. Now that you have a basic understanding of what is NPS and how it works; try to focus on the other essential aspects of the scheme to make a confident investment decision for your retirement.

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