How to Secure Your Retirement with National Pension System Returns

Key Takeaways:

• The Tier-1 account is a mandatory retirement savings option with a lock-in period until age 60, offering tax benefits.

• The Tier-2 account is a voluntary savings option with no lock-in period but limited tax benefits for government employees.

• You can claim tax deductions of up to ₹1.5 lakh under Section 80CCD(1) and an additional ₹50,000 under Section 80CCD(1B).

• Upon retirement, 60% of the corpus is tax-free, while 40% must be used to buy an annuity.

• NPS allows investment in equity, corporate bonds, government securities, and alternative funds.

The National Pension Scheme (NPS) is a long-term investment plan for retirement for working individuals. It comes under the Pension Fund Regulatory and Development Authority (PFRDA) and the central government.

The NPS is a social security initiative and is open to employees from private and public firms, except the armed forces. The NPS scheme of India includes tier-1 and tier-2 accounts and also provides NPS tax deductions.

There are two types of NPS accounts: tier 1 and tier 2 accounts. The NPS tier-1 account is suitable for retirement planning in NPS, whereas tier-2 accounts are more like a voluntary savings account.

In the NPS tier-1 account, you cannot withdraw the amount until retirement. However, this does not apply to tier-2 accounts. National Pension Scheme tax benefits include tax exemptions on the contributions you make. These tax exemptions are a part of the national pension scheme tax benefit section, particularly under sections 80CCD(1) and 80CCD(1B) of the Income Tax Act.

As per the eligibility requirements, the minimum entry age for the scheme is 18 years and the maximum entry age is 65 years. The pension starts at the age of 60 years and the withdrawal at retirement is up to 60% of the accumulated amount. The remaining  40% you can use for an annuity purchase.

In a tier-1 account, any Indian resident must make a minimum contribution of ₹500. It also has a lock-in period until you turn 60 years and it provides tax deductions for contributions up to ₹1.5 lakh annually. Additionally, you can also benefit from deductions under section 80CCD(1B) of ₹50,000.

However, you cannot withdraw funds in the first 3 years. After you turn 60 years of age, you can withdraw 60% of the funds and you can use the remaining 40% to buy an annuity.

The tier-2 account depends on the tier-1 account and the minimum contribution you must make starts at ₹1,000. Tier-2 accounts do not have any lock-in period and contributions are not tax-exempt for government employees.

However, if you are a government employee, you are eligible for a tax deduction under Section 80C after the lock-in period. Unlike the tier-1 account, you can make withdrawals and exit from investments anytime.

In this type of account, your withdrawn funds are added to your income and applicable taxes are calculated as per your tax rate bracket.

If you are an investor in the NPS under the tier-1 account, you can claim a tax deduction up to ₹1.5 lakh under Section 80CCE. If you buy an annuity, the invested amount is tax-free, but the annuity’s income is taxed at applicable rates.

• If you are an NPS tier-1 account investor, you are eligible for a tax deduction of up to ₹1.5 lakh under Section 80CCD(1). It is provided under the Income Tax Act of 1961.

• Additionally, you are eligible for an additional deduction of up to ₹50,000 under Section 80CCD(1B).

• In the case of a partial withdrawal, 25% of the withdrawn amount is tax-free. 

• If you buy an annuity, the complete investment amount is tax-free. However, the annuity’s income is taxable as per standard rules.

• Only owners of tier-1 accounts are eligible for these benefits and you must claim them during income tax return filing.

There are four asset classes in NPS, in which you can make contributions. The investment options include corporate debt, equity, alternative investment funds, and government bonds. NPS investment choices allow you to either decide your allocation mix or opt for a pre-defined ratio.

You can go with active choice if you wish to decide your asset mix on your own. Alternatively, you can opt for the auto-choice option if you are a passive investor and want an automatic allocation.

Equity, Corporate Bonds and Government Securities

You can make investments for annuities for the remaining 40% in the following instruments. You can choose to mix these asset ratios or keep them as pre-determined.

Before you make your contributions in the NPS scheme, understand and assess your risk profile. It is necessary to align your risk profile with the investment options as per different asset classes, to ensure retirement horizon and long-term financial goals.

There are three types of risk profiles in the NPS where you fall under three categories- conservative (low risk), moderate (balanced risk) and aggressive (high risk).

• Conservative: The maximum equity allocation is 25% of total assets until 35 years. It is reduced by 1% annually. The remaining amount is invested in corporate bonds and government bonds.

• Moderate: The maximum equity allocation is 50% of total assets until 35 years. It reduces by 2% annually and the remaining amount is again invested in corporate bonds and government bonds. In this option, you get a mix of moderate risks, growth and security.

• Aggressive: The maximum equity allocation is 75% of total assets until 35 years. It reduces by 4% annually and you take higher risks in this profile for more returns.

While the eligibility determines that you can invest in NPS until 60 years old, you can extend it up to 75 years after providing an application. At the retirement age of 60, you can withdraw 60% of the amount tax-free and buy an annuity with the remaining 40%. However if you wish to exit early, you can do it only after 10 years of investment.

In NPS, you are required to invest a minimum of ₹500 in a tier-1 account and a minimum of ₹1,000 in a tier-2 account. However, the maximum limit is not defined for NPS.

Yes. NPS is suitable for aggressive investors as you can choose auto choice or active choice options. They enable higher risk exposure to enable higher returns.

Yes. You can withdraw money from NPS before retirement, but only with a condition of a 3-year lock-on period and partial withdrawals.

The National Pension System returns and contributions are not eligible for tax deductions for the NPS tier-2 accounts.

To choose the right pension fund manager, you must check rolling returns and compare the data for the last 5 years. For this, you can navigate to the official website of the NPS trust to check the performance of all fund managers.

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