What is National Pension System (NPS)? Accounts types and invest options under NPS

National Pension System (NPS):

The National Pension System (NPS) is a government-approved pension scheme introduced in India with the aim of instituting pension reforms and encouraging citizens to save for their retirement. Launched on 1st May 2009, the NPS is available to all citizens, including those working in the unorganized sector, on a voluntary basis. This article explores the features, benefits, and various aspects of the NPS in simple and understandable terms.

What is NPS?

The National Pension System is designed to provide financial security to Indian citizens during their retirement years. It does this by offering a structured way to save and invest during one’s working life. Upon enrollment in the NPS, each subscriber is allocated a unique Permanent Retirement Account Number (PRAN), which remains the same throughout their life. This unique PRAN can be used from any location in India, ensuring portability and convenience.

National pension Scheme

Eligibility and Account Types

The NPS is available to all Indian citizens aged between 18 and 60 years. It offers two types of accounts:

  1. Tier I (Mandatory Retirement Account): This is the primary pension account. It is mandatory for NPS subscribers and comes with several restrictions on withdrawals to ensure that the funds are used primarily for retirement.
  2. Tier II (Voluntary Savings Account): This is an optional account that provides more flexibility compared to Tier I. It requires the subscriber to have an active Tier I account. Unlike Tier I, the funds in Tier II can be withdrawn freely without any restrictions, making it suitable for other financial goals apart from retirement.

Key Features of Tier I and Tier II Accounts

  • Bank Account Requirement: A bank account is not mandatory for Tier I, but it is required for Tier II.
  • Liquidity: While Tier I has restrictions on withdrawals, allowing only a certain portion to be withdrawn under specific conditions, Tier II offers complete liquidity with no such restrictions.
  • Fund Transfer: Funds cannot be transferred from Tier I to Tier II. However, transfers from Tier II to Tier I are allowed.
  • Tax Benefits: Investments in Tier I are eligible for tax benefits, making it an attractive option for retirement savings. Tier II investments do not offer any tax benefits.

Investment Options Under NPS

NPS subscribers can choose from various investment options to suit their risk appetite and return expectations. The options are categorized as follows:

  1. E (Equity): This option offers high returns but comes with high risk as it invests predominantly in equity-oriented investments.
  2. C (Corporate Bonds): This medium-risk option invests in fixed income-bearing securities other than government securities, providing moderate returns.
  3. G (Government Securities): This low-risk option invests in pure government fixed income securities, offering low but stable returns.
  4. A (Alternative Investments): This high-risk, high-return option invests in alternative investment schemes, including instruments like Commercial Mortgage-Backed Securities (CMBS), Mortgage-Backed Securities (MBS), Real Estate Investment Trusts (REITs), Alternative Investment Funds (AIFs), and Infrastructure Investment Trusts (InvITs). Note that this option is not available for Tier II account contributions.

Choice of Investment Approach

NPS subscribers have two approaches to choose from for their investment strategy:

  1. Active Choice: Subscribers can actively choose the proportion of their funds to be invested in each asset class. The only restrictions are that the allocation to equity (E) cannot exceed 75%, and the allocation to alternative investments (A) is capped at 5%.
  2. Auto Choice: Also known as the lifecycle fund, this option automatically allocates the subscriber’s contributions among different asset classes based on their age. As the subscriber gets older, the allocation shifts from higher-risk assets like equity to lower-risk assets like corporate bonds and government securities.

Benefits of NPS

The NPS provides multiple advantages to its participants:

  1. Retirement Security: NPS helps build a substantial retirement corpus, ensuring financial security in old age.
  2. Portability: The unique PRAN can be used anywhere in India, making the NPS highly portable.
  3. Tax Benefits: Contributions to Tier I account are eligible for tax deductions under Section 80C of the Income Tax Act. Additionally, an extra deduction of up to ₹50,000 is available under Section 80CCD(1B).
  4. Flexibility: The option to choose between Active and Auto choice provides flexibility in managing investments according to one’s risk appetite and financial goals.
  5. Low Cost: NPS is a low-cost investment option compared to other pension products, with minimal management and administrative charges.

Is NPS a Good Investment?

NPS is considered a good investment for those looking to build a retirement corpus systematically over a long period. It offers a balanced mix of security and growth through its diverse investment options. The tax benefits further enhance its attractiveness as a retirement planning tool. However, the decision to invest in NPS should be based on individual financial goals, risk tolerance, and retirement plans.

Purpose of NPS

The primary purpose of the NPS is to provide a reliable and sustainable pension system for Indian citizens. It aims to:

  1. Encourage Savings: Promote the habit of saving for retirement among individuals, especially those in the unorganized sector.
  2. Provide Retirement Income: Ensure a steady income stream post-retirement to help maintain the standard of living.
  3. Promote Financial Inclusion: Extend pension benefits to all citizens, irrespective of their employment status.

The National Pension System (NPS) is a comprehensive and well-structured pension scheme aimed at providing financial security to Indian citizens in their retirement years. With its flexible investment options, tax benefits, and emphasis on long-term savings, NPS is a valuable tool for retirement planning. Whether you are a young professional just starting your career or someone nearing retirement, NPS offers a viable option to ensure a financially secure future.

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Sachin Chopade
I am a Finance and Tax Analyst, Content Creator, sharing valuable articles and calculators related to Finance, Accounting and Banking industry.