How does NPS work?

If you're planning for your retirement in India, you've likely heard about the National Pension System (NPS). It's one of the country's most powerful retirement schemes, designed to offer financial security in your golden years. In this article, we'll discuss how NPS works in 2024 and what it could mean for your future

What is NPS?

NPS, governed by the Pension Fund Regulatory and Development Authority (PFRDA), is a voluntary pension scheme that allows Indian citizens to invest in pension funds to secure their retirement. It's open to all Indian citizens(including NRIs & OCIs) between 18 and 70 years old, and it provides a mix of equity, fixed deposits, corporate bonds, liquid funds, and government funds.

How Does NPS Work?

When you join the NPS, you're assigned a unique Permanent Retirement Account Number (PRAN). This number is used to access your NPS account, where you can contribute funds regularly. These funds are then invested in your chosen pension fund schemes.

You can choose between two types of NPS accounts: Tier I and Tier II. Tier I account is a mandatory account that acts as the primary account for your pension. offers tax advantages. A Tier II account is an optional account with more flexibility in terms of withdrawals, but it doesn't offer the same tax advantages.

Here's how the National Pension System works:

The NPS allows subscribers to invest in select professionally managed pension funds in different asset classes linked to markets. These asset classes include:

- Asset class E : Equity and equity-related instruments

- Asset class C : Corporate debt and debt-related instruments

- Asset class G :Government bond and other government back securities

- Asset class A : Alternative investments like Commercial Mortgage-Backed Securities (CMBS), Real Estate Investment Trusts (REITS), Infrastructure Investment Trusts (InvIts), venture capital funds etc.

This means that the returns from the NPS will be dependent on how these markets perform. You can choose the amount you wish to invest, providing flexibility in terms of your financial planning.

The NPS offers a range of tax benefits* which make it as good as an EEE (exempt, exempt, exempt) investment. Firstly, you can claim a tax deduction of up to Rs. 50,000 under Section 80 CCD (1B) which is over and above 80C and up to Rs. 1,50,000 under Section 80 CCE. This sums up to a total tax rebate of Rs. 2 lahks (under Old tax regime). Also, the 60% lump sum withdrawal and annuity on exit are tax-exempt. Furthermore, if you're a salaried individual, you're eligible for tax benefits* on your employer's contribution to your NPS account. The tax deduction for this is up to 10% of salary (Basic + DA) under Section 80 CCD (2) under old Tax regime and 14% of Salary (Basic + DA) under new tax regime.

The Pros of NPS

Let's delve into why NPS is considered an attractive retirement planning tool.

Powerful Retirement Scheme : NPS is a potent retirement savings tool. You can select professionally managed pension funds linked to markets and enjoy exclusive tax benefits*, good returns, and fund security.

Exclusive tax benefits* : NPS is as good as EEE (Exempt, Exempt, Exempt) when it comes to tax benefits*. You can enjoy tax deductions on self-contribution, employer contribution, as well as corpus growth. Even the lumpsum withdrawal and annuity on exit are tax-exempt.

Cost-Effective : Compared to other equity-linked market products, NPS comes with a lower management cost, and the exit and withdrawal expenses are capped, making it a cost-effective long-term investment option

Diversification & Flexibility : NPS offers flexibility in terms of the choice of fund manager, asset allocation, and portability. You can choose from various fund options and switch as per your preference.

FAQs

1.How does NPS work?

In the NPS, you can invest in select professionally managed pension funds linked to markets. The returns will be dependent on how these markets perform. The amount you wish to invest is flexible, which aids in financial planning.

2.What are the tax benefits* of investing in NPS?

There are many tax benefits* of investing in NPS. Section 80 CCD (1B), which is over and beyond Section 80C, allows you deduction of up to Rs. 50,000 under Section 80 CCD (1B) which is over and above 80C and up to Rs. 1,50,000 under Section 80 CCE. This sums up to a total tax rebate of Rs. 2 lahks (under Old tax regime). Also, the 60% lump sum withdrawal and annuity on exit are tax-exempt. Furthermore, if you're a salaried individual, you're eligible for tax benefits* on your employer's contribution to your NPS account. The tax deduction for this is up to 10% of salary (Basic + DA) under Section 80 CCD (2) under old Tax regime and 14% of Salary (Basic + DA) under new tax regime.

3.What are the management costs of NPS?

The management costs of NPS are generally lower than other equity-linked market products. The initial subscriber registration is Rs 200 to Rs 400 while subsequent contributions are charged at 0.50% of the contribution subject to minimum of INR 30 and maximum of INR 25,000.

4.Can I choose my fund manager in NPS?

Yes, NPS offers the flexibility to choose your fund manager and asset allocation. Aditya Birla Sun Life Pension Fund Management Limited is a great option with returns upwards of 15% for 5 years.

5.Are there any withdrawal restrictions in NPS?

Yes, NPS comes with a lock-in period and restrictions on withdrawal amounts. The first withdrawal can be made only after 5 years of the account.

6.Can I open more than one NPS account?

No, only one NPS account can be opened by a single individual.

7.Is annuity mandatory in NPS

Yes, NPS account restricts the withdrawal of account holders from Tier 1, which is the main account for savings for pension. At maturity, the NPS account allows the withdrawal of 60% of the funds, while the remaining 40% is used to buy an annuity.

Disclaimers

*Tax benefits are subject to changes in tax laws. Kindly consult your financial advisor for more details.