Pension is an initiative to provide social security to eligible employees after their retirement. Earlier government of India followed traditional/old pension plans in which employer and employee make regular contributions to the account for a longer period of years. In a traditional pension plan employer commits to make a regular contribution and the fund is set aside to be paid later to the eligible employee after retirement.
On 1st April 2004 government of India stopped the pension benefit for all its employees. Later government of India introduced National Pension Scheme( NPS )scheme in 2004 to provide a retirement benefit to its employees. Initially, it was opened only for government employees but in 2009 it was opened for all citizens of India.
However, pension is still offered to the armed forces of India. So anyone who is serving in army, airforce or navy will get a pension by the Indian government after retirement. They need not opt for National Pension Scheme (NPS).
Eligibility to open an NPS account
Any Indian citizen including NRI who is between the age of 18 – 70 years can open NPS account.
Types of NPS account
To get the benefit of this scheme first an individual need to open an account. NPS account is divided into two types i.e Tier 1 NPS account and Tier 2 NPS account
Tier 1 NPS account- This account target the individual who wants to fulfil their need of pension after retirement. This account focus particularly on retirement plan for the employees of public and private sector.
Tier 2 NPS account- This account provide voluntary saving facility.This account is like saving account where investment is made by the individual to fulfil the other needs.But to open NPS account an individual first have to open Tier 1 NPS account only then Tier 2NPS account can be opened.However, if any individual wants, both accounts can be opened simultaneously.
Difference between Tier 1 NPS account and Tier 2 NPS account
| TIER 1 NPS ACCOUNT | TIER 2 NPS ACCOUNT |
| Minimum account opening amount is Rs 500 . | Minimum account opening amount is Rs 1000. |
| Withdrawl flexibility is low. | Gives more flexibility for withdrawls. |
| Lock- in- period until the individual turn 60 years old. | No Lock -in – period. |
| It focus only to provide pension facility to the individual. | It provide the facility for the individual to invest and achieve other life goals rather than just in retirement. |
| Tax friendly scheme | No tax benefit. |
| Can be opened by anyone who is an Indian citizen including NRI and the age is between 18 – 70 years old. | To open this account first an individual has to open Tier 1 NPS account. Tier 2 NPS account can ‘t be open directly. |
| Minimum contribution of Rs 1000 each year is mandatory. | No minimum annual contribution is mandatory. |
| Called as retirement account | Called as saving cum investment account |
How NPS Works ?
NPS is regulated and authorised by PFRDA (Pension Fund Regulatory and Development Authority) which was established to encourage old age income securities.Its function is to develop and regulate pension funds.
In NPS Pension Fund Managers play an important role.
First an individual has to select Pension Fund Manager who will manage the investment of the individual.These Pension Fund Managers are approved by the government.An individual can choose any as per their choice among 8 Pension Fund Managers to manage their investment.Pension Fund Managers can be changed once in a year.
The 8 Pension Fund Managers for NPS are:
- ICICI Prudential Pension Funds Management Company Limited
- HDFC Pension Management Company Limited
- Kotak Mahindra Pension Fund Limited
- Reliance Pension Fund
- LIC Pension Fund
- SBI Pension Funds Private Limited
- Aditya Birla Sun Life Pension Management Limited
- UTI Retirement Solutions Limited
Now the money contributed by an individual is invested in 4 types of Asset Class.
- Equity – In equity money is invested in stock market.It gives high return but risk is high too.
- Corporate Bonds – In corporate bonds money is lent to public and private sector.It gives moderate return with moderate risk.
- Government securities- In government securities money is lent to government.It gives steady return with lower risk.
- Alternative Investment- This is called a risk asset class where risk is very high. Here money is invested in security like Real Estate Investment Trust(REITs) but only 5% of the investment is allowed to invest.
Secondly comes the part of Asset Allocation.Here it fully depends on subscribers how much risk they can take and as per requirement they can allocate their investment.Here two types of choice is given to the individual for asset allocation-
Active choice- Here the individual has the right to decide the percentage of asset class as per their requirement. It means it fully depends on an individual what percentage of investment should be in equity or in corporate and government bonds.
But one condition is applied here- Till the age of 50 an individual can invest maximum of 75% of their investment in equity and after that for 10 years 2.25% will be deducted from the individual equity exposure. So at the age of 60 and above equity investment will be 50%.It can be understood through the table below-
| Individual Age | Individual Investment in Equity |
| Up to 50 years | 75% |
| 51 years | 72.5% |
| 52 years | 70% |
| 53 years | 67.5% |
| 54 years | 65% |
| 55 years | 62.5% |
| 56 years | 60% |
| 57 years | 57.5% |
| 58 years | 55% |
| 59 years | 52.5% |
| 60 years | 50% |
- Auto Choice – If any individual is unable to allocate their investment they can go for auto choice.Auto choice automatically decide the percentage of equity and bonds .It is decided on the basis of your age and requirement.However an individual don’t have to stick to the choice. Individual has the option to change the choice and the risk depend on individual choice.
Here 3 Life Cycle Fund Option is given to the individual for the asset allocation:
- Aggressive Life Cycle Fund Option- This is for the investors who are ready to take high risk.If the age of an individual is 35 or less he\she can invest 75% of their investment in equity after that 4% of equity exposure is automatically deducted every year till the age of 55. It can be understood through the table below
| Individual Age | Individual Investment in Equity |
| Up to 35 years | 75% |
| 40 years | 55% |
| 45 years | 35% |
| 50 years | 20% |
| 55 years | 15% |
It means at the age of 55 individual equity exposure will be only 15%.The percentage deducted from the equity will be transferred and will be invested in corporate Bonds and Government Securities.
- Moderate Life Cycle Fund Option– This is for the investor who wants to take moderate risk. Here maximum investment of an individual in equity is 50%. So at the age of 55 individual maximum investment in equity will be 10% . The condition of the age of an individual and the percentage deduction in equity exposure is same.It can be understood through the table below
| Individual Age | Individual Investment in Equity |
| Up to 35 years | 50% |
| 40 years | 40% |
| 45 years | 30% |
| 50 years | 20% |
| 55 years | 10% |
- Conservative Life Cycle Fund Option- This is for the investors who want to keep their investment safe and invest mostly in corporate and Government bonds.Here the percentage of equity exposure is very low.Maximum 25% of investment can be invested in equity .So at the age of 55 individual maximum investment in equity will be only 5%.
| Individual age | Individual Investment inequity |
| Up to 35 years | 25% |
| 40 years | 20% |
| 45 years | 15% |
| 50 years | 10% |
| 55 years | 5% |
NPS withdrawl rules for Tier 1 & Tier 2
Tier 1 NPS withdrawl rule
- Since Tier 1 NPS Account is a retirement plan it can only be withdrawl till the individual turn the age of 60. Even after turning 60 years of age an individual can’t withdraw the total amount nor can transfer the whole amount to their bank account.
- Individual can withdraw 60% of the total amount or can transfer in bank account . Rest 40% of the amount is given to the annuity provider which can be selected by the individual. Annuity providers are the insurance companies who ask the individual to choose an annuity plan according to their requirements.They invest the money and give 5 to 6% return to the individual on the investment.Investment return depends upon what type of plan is chosen by the individual.Then a fixed money is given as pension every month to the individual.
Tier 2 NPS withdrawl rule
Since Tier 2 NPS Account is a saving cum investment account there is no rule of withdrawl here.Individual can withdraw anytime as per their requirement.But for government employees there is a lock-in period of 3 years.
Tax Benefit in NPS
- Individual can save upto Rs 2 lakh in Tax deduction.
- Under section 80 C individual can claim deduction up to Rs 1.5 lakh
- Under section 80CCCD(1B) individual can claim deduction up to Rs 50,000.
- NPS qualifies for EEE(Exempt Exempt Exempt) tax benefit.
There are many other pension scheme which are considered best pension scheme in India. Then why to select NPS . To understand this few features and benefits of NPS are described below-
- Individual can invest their money in retirement plans and at the same time plan for other investment options in the same scheme.
- Individuals can operate their account from any other city or state. Need not worry if he/she changes their city or employment.
- It is regulated by PFRDA which provides transparent investment norms and regular monitoring and review of the Fund managers to the individual.
- PRAN(Permanent Retirement Account Number) is given to the individual on successful registration where the individual savings will be reflected.