The National Pension Scheme (NPS) is a social security initiative by the Central Government. It is open to employees from the public, private and unorganised sectors, except those from the armed forces. The scheme encourages people to invest at regular intervals during their earning years.
After retirement, the subscribers can take out a certain percentage of the corpus. The remaining amount will be received as a monthly pension. The money deposited in NPS is invested in a variety of securities and investment avenues, including the equity market.
The two types of accounts which can be opened under NPS, which are the Tier 1 and Tier 2 accounts. The Tier 1 account has a fixed lock-in period until the subscriber reaches the age of 60 years. Only partial withdrawals are allowed and under certain prescribed conditions. The contributions made to Tier 1 accounts are tax-deductible under the Income Tax Act.
The second type of account is the Tier 2 account. This is a voluntary savings account, and subscribers are allowed to make withdrawals from these accounts. However, the contributions made are not eligible for tax deductions. A condition to open a Tier 2 account, is that the subscriber has to open a Tier 1 account first.
The NPS has been a great option to invest in and obtain retirement benefits from, through the years, and continues to be one of the top investment options. The systematic investment made during a person’s earning years will help them enjoy the golden years of their life without any financial worries. Here are five reasons why it is beneficial to make NPS a part of your retirement portfolio.
- Tax benefits
The NPS gives taxpayers one of the best tax benefits available under the Income Tax Act, with a total tax deduction of Rs.2 lakh. Section 80CCD(1) of the Income Tax Act, covers the subscriber’s self-contribution, which falls under Section 80C of the Income Tax Act, and is restricted up to Rs.1.50 lakh. Any additional self-contribution made can be claimed up to a further Rs.50,000 under section 80CCD(1B) of the Act. However, the deduction claimed cannot exceed 10% of the employee’s salary (basic + DA) or 20% of the gross income for self-employed taxpayers.
Further tax benefits are available under Section 80CCD(2), which does not form a part of Section 80C. This additional benefit cannot be availed by self-employed taxpayers, as it covers employers’ contribution. The maximum amount eligible for deduction under this section will be the lowest of the actual NPS contribution by the employer, 10% of basic salary + DA received (14% for government employees), and the total gross income.
- Low cost of investment
It is one of the cheapest pension schemes available as compared to other countries. While the contributions can be minimal each year according to the investor’s income levels, the power of compounding gives the investor a significant return on his retirement.
Besides this, the NPS is a voluntary subscription. Hence, the amount of contribution can be changed from year to year, as well as the contributions that can be made at any time during the year.
- Assured returns
While a portion of the NPS contributions is invested in equity, this part may not offer guaranteed returns. However, the overall returns from NPS investments are guaranteed and typically much higher than other investment options such as PPF or fixed deposits.
The monthly payment that subscribers receive on exit from the NPS is called an annuity. It is compulsory to purchase an annuity product from a list of Annuity Service Providers (ASPs) at the time of superannuation and premature exit. The ASP would be responsible for delivering the annuity to the subscriber for the rest of his life.
NPS offers investors the flexibility to design their portfolio. Depending on their risk appetite, they can allocate funds amongst four available asset classes. This is called an active choice. If the investor finds that designing his portfolio is a daunting task, the NPS also gives investors the flexibility to opt for dynamic and automatic allocation of their portfolio. This option is called an Auto choice.
As subscribers are given the flexibility to choose their investment options and pension funds under the NPS, if the subscriber is unhappy at any point in time with the performance of his fund, he could always change his fund manager.
- Comparatively low risk
There is a risk cap of the range of 50% to 75% on equity exposures under the NPS. For government employees, as well as other employees over the age of 60, the risk is capped at 50%. For investors up to 50 years of age, the risk exposure is 75%, and thereafter it decreases by 2.5% each year until the investor reaches the age of 60.
The equity exposure gives NPS a higher earnings potential, with a comparatively lower risk involved due to the equity exposure cap.
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