NPS – Why do we need it?
We all have a standard of living that we maintain and for most of us the cost to maintain it increases with time due to many reasons (inflation, marriage, education, kids, vacations, etc). To take care of it, we expect our income to rise and work hard to achieve it. But what when the income stops? Don’t get afraid when you hear about retirement and what should you do to get money during those days. This article would help you to plan your retirement with minimal effort by understanding one of the retirement schemes known as NPS.
Post retirement, we still would love to go on vacations, give gifts to our children, buy house and so on! How do we build a corpus to achieve all such dreams and plan decades before? This is the reason we all should start investing little but early.
NPS is a voluntary retirement scheme managed by PFRDA (Pension Fund Regulatory and Development Authority) and available to all Indian citizens (resident or non-resident) between 18 and 65 years old. One can join the NPS as late as when they are 60 years old and continue to contribute until they are 70 years old.
NPS is specially attractive to those who are in private sectors and not enrolled in EPF scheme.
Let’s understand how important it is to create a retirement corpus and why we should start early by using the Class X math of calculating compound interest!
Example
Mr. X has a monthly expense of Rs 50,000/- and he is currently 30 years old. By his retirement (@60), his monthly expenses would soar to Rs 2,16,000/- per month assuming an inflation of 5%.
Wooah!! How would he manage? Obviously his income is also expected to rise to manage his expenses but how much would he need at retirement? Let’s do the math again.
So, Mr. X would need Rs. 2,16,000/- per month or Rs. 26 lakh annually.
You need roughly 18-35 times of annual expense at the age of 60 as retirement corpus.
Using our thumb rule, Mr. X would need Rs. 4.7 Cr as the retirement corpus to maintain his standard of living as well as build some assets for his children. It is a big amount, isn’t it? But again as I said earlier, a small & early investment habit to build retirement money can achieve all your ambitions even at 60. Again some math time 😛
Mr. X starts investing Rs. 20,000/- per month in an investment scheme which gives him annual return of 10%. With the power of compounding this would fetch him a a retirement corpus of Rs. 4.6 Cr and he can now enjoy his retirement peacefully 🏝
Where does NPS fit with respect to returns? We look at it in the next section.
NPS Historical Returns
As we can see that for Tier I, NPS has beaten our expectation of 10% return if we look at more than 5 year horizon. Although, different schemes in NPS have given different returns and the above diagram shows a balanced allocation between Equity and Bonds.
Let’s now try to understand what is NPS in detail and what do we mean by Tier I and Tier II.
NPS – Tier I vs II
| Tier I | Tier II | |
| Eligibility | Between age 18 & 65 | Tier I members only |
| Lock-in | Till 60 but you can extend it to 70 | Nil (For private sector employees), 3 years (For Government Employees) |
| Minimum number of contributions in a year | 1 | Nil |
| Minimum amount for opening account | Rs 500 | Rs 1,000 |
| Minimum contribution amount | Rs 500 | Rs 250 |
| Tax Benefit | 80C: Rs 1.5 Lakh 80CCD (1B): Rs 50,000 additional | No tax benefit except for Govt. employees for 3 years lock-in |
| Tax on withdrawal | 60% is tax free | Taxable |
Investments are managed by 8 pension fund managers in the country and when registering you have the option to choose among them as well as change these over time (maximum once in every financial year). You can choose from the following fund managers.
- Aditya Birla Sun Life Pension Management Limited
- HDFC Pension Management Company Limited
- UTI Retirement Solutions Limited
- SBI Pension Funds Private Limited
- ICICI Prudential Pension Funds Management Company Limited
- Reliance Pension Fund
- Kotak Mahindra Pension Fund Limited
- LIC Pension Fund
Note: SBI, LIC and UTI are the only fund managers for government employees under NPS
NPS fund managers invest in the following asset classes-
- Equity (E)
- Corporate Debt (C)
- Government Securities (G)
- Alternative Investment Funds (A)
Visit https://enps.nsdl.com/eNPS/NationalPensionSystem.html for online registration. There are 2 ways to register, using PAN and using Aadhaar XML. Once registered online, send the complete application form to after which you would receive the kit in 10 working days.
NSDL e-Governance Infrastructure Limited, 1st Floor, Times Tower, Kamala Mills Compound, Senapati Bapat Marg, Lower Parel, Mumbai – 400 013 Fax (022) 2495 2594/ 2499 4974.
Ways to invest
There are multiple ways to invest in NPS schemes and this is the flexibility which most of the other retirement schemes don’t have (not to compare with mutual funds).
- You can ask you employer to register for NPS instead of EPF. Yes, you can switch to NPS if you and your employer have an agreement to redirect your salary contribution to NPS instead of EPF. You get deduction under 80C for this.
- If your employer doesn’t support NPS, you cans till open Tier I account and voluntarily contribute to NPS. Here, you get additional Rs 50,000/- deduction under 80CCD (1B)
- Once you have opened Tier I account, you can also open Tier II account where there is no lock-in and you still enjoy the good returns of NPS except the withdrawal tax benefit
Withdrawal
Tier I allows a maximum of 60% withdrawal at the age of 60 while the rest 40% is reserved for annuity plan (describe in the next section). However, you can do a premature withdrawal after 3 years of account opening up to 20% before retirement which is taxable. The remaining 80% would go in purchasing annuity. In the event of the accumulated amount being less than Rs 1 lakh, an individual can choose to withdraw the complete amount.
Partial Withdrawal rule
- Partial withdrawal of 20% allowed for marriage, education, purchase/construction of house, critical illness, etc.
- Subscriber can withdraw only 3 times during the tenure of his/her subscription and upto 25% of his contributions towards this scheme
- A subscriber should maintain a minimum gap of 5 years between any 2 withdrawals. This gap can be reduced only during medical emergencies
Tier II has no limit on withdrawal except for Government employees who have a lock-in period of 3 years. One needs to submit a duly filled UOS-S12 form at the nearest Points of Presence-Service Providers (POP-SP) and receive amount in T+3 days
Annuity/Pension Scheme
Minimum of 40% amount has to be kept in annuity at retirement while you can keep the full amount also. Pension is given from annuity amount and its rate can vary depending on annuity provider as follows:
- Payable for life at a uniform rate to the annuitant only.
- Payable for 5, 10, 15 or 20 years certain and thereafter as long as you are alive.
- For life with return of purchase price on death of the annuitant (Policyholder).
- Payable for life increasing at a simple rate of 3% p.a.
- Pension (Annuity) for life with a provision of 50% of the annuity payable to spouse during his/her lifetime on death of the annuitant.
- Pension (Annuity) for life with a provision of 100% of the annuity payable to spouse during his/her lifetime on death of the annuitant.
- Annuity for life with a provision of 100% of the annuity payable to spouse during his/her lifetime on death of the annuitant and with return of purchase price on death of the spouse. If the spouse predeceases the annuitant, payment of annuity will cease after the death of the annuitant and purchase price is paid to the nominee
Before retirement, in the unfortunate event of death of the subscriber, the entire accumulated pension wealth (100%) would be paid to the nominee/legal heir of the subscriber and there would not be any purchase of annuity/monthly pension. This amount would be tax free.
- Default Annuity Service Provider – Life Insurance Corporation of India
- Default Annuity Scheme – Annuity for life with a provision of 100% of the annuity payable to spouse during his/her life on death of annuitant’ and under this option, payment of monthly annuity would cease once the annuitant and the spouse die or after death of the annuitant if the
spouse pre-deceases the annuitant, without any return of purchase price.
Costs
- Initial subscriber registration charge of Rs.100/- and transaction charge of 0.25% of the initial contribution amount from subscriber subject to a minimum of Rs.20 and a maximum of Rs. 25,000/-.
- Any subsequent transaction involving contribution – 0.25% of the amount subscribed by the NPS subscriber, subject to minimum of Rs.20/- and a maximum of Rs.25000/-
- Any other transaction not involving a contribution from subscriber – subject to a charge of Rs.20/- which includes change in subscriber details, change of investment scheme/fund manager, processing of withdrawal request.
Disclaimer
- I am not a financial advisor nor do I hold any qualification in the field. I am sharing my personal opinion and thoughts and everyone should do his/her own research prior to making any investment decision.
- There are other retirement schemes such as EPF, Mutual Funds, PPF and you can also look at them.
- I am not promoting any particular gender by taking example of Mr. X who is a male. I always support gender equality 😀
