The National Pension Scheme (NPS) is a market-linked voluntary contribution scheme aimed at creating a retirement corpus. This is available to all citizens of India aged between 18 and 70 years.
The Pension Fund Regulatory Development Authority (PFRDA) regulates and administers the NPS, which is emerging as a credible investment option for retirement. This has undergone several improvements since its launch in December 2023.
The NPS framework
The NPS has two tiers:
Tier 1: this is a permanent retirement account in which regular contributions are made by the subscriber and / or the employer.
Tier 2: this is a voluntary / optional withdrawable account, and is only allowed if the contributor has an active tier 1 account. It is an attempt to reduce the product’s lock-in.
There are four asset classes which one can invest in under the NPS:
1. Equity and related investments.
2. Corporate debt and related investments.
3. Government bond and related investments.
4. Alternative investment funds.
A contributor can decide whether to invest in an active manner (choose asset and asset allocation) or invest under the auto route, where the funds are allocated automatically among asset classes per a pre-defined matrix, based on the age of the subscriber.
Advantages of investing through NPS
The NPS is beginning to get some traction as it has several benefits. Here’s a short list:
a) Low cost — it is among the lowest cost pension funds.
b) Portable — across employment, location, geography.
c) Tax efficient — there are several tax benefits for contributors as well as employers.
d) Transparent — data is easily available on how the portfolio is performing.
e) Optimum returns — It offers market-linked returns.
f) Maximum age at entry — 70 years.
However, the NPS is not very well understood as many people treat it just as a means to maximise tax deductions and reduce the tax payable. The fact is, it is becoming even more competitive as it now also allows some unique features, including:
a) Flexibility
· This is unique, as one can withdraw 60 percent of one’s investment post retirement in tranches, based on a systematic withdrawal plan (SWP) — monthly, quarterly, half yearly, or annually, up to the age of 75 years. This is beneficial as one does not have to decide where to re-invest the lump sum amount (if 60 percent were to be received in one shot).
· Further, the SWP would be tax efficient as withdrawal of up to 60 percent of the corpus is tax-free. Whereas, if one took the lump sum and for regular income, invested it in mutual funds and initiated an SWP, then the proceeds would be subject to capital gains tax from day 1.
c) Choice of annuity
NPS offers a choice of annuities for 40 percent of the corpus, aligned to different goals. For example, annuity can be for life or you can also opt for return of the purchase price at the end of a tenure (legacy).
The advantages clearly establish that NPS is a worthy contender for some of the allocation towards your retirement portfolio. Mutual funds should also be used to supplement the retirement corpus as they offer even more flexibility and useful diversification.
Don’t put all your eggs in the NPS basket
The NPS’s low-cost structure is a significant benefit, especially in debt investments under the scheme. You can consider increasing your debt allocation through NPS.
You can take advantage of the unique benefits of NPS to build a portion of your retirement corpus. However, ensure that not all your funds are in the NPS, as you may not have liquidity (due to the lock-in) when you need funds in the interim.
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