Now, let’s discuss the various entities in the NPS ecosystem that help make the transaction process smoother:

1. The one who helps in opening an account – PoP (Point of Presence):

• PoPs act as your first point of contact. They assist in opening your NPS account, provide information, and help you with transactions and any inquiries about the scheme.
• Usually, banks and other financial institutions take on the role of PoP to sell NPS. They charge a small commission on every contribution you make to the NPS.
• PoPs are available both online and in physical branches. You can find the list of registered PoPs here.

2. The one which administers the NPS transactions and maintains records – CRA (Central Record Keeping Agency):

• CRAs get subscriber information either directly from the individual or through PoPs. Once they receive the details, they assign a PRAN and manage all the backend operations of your NPS account. This includes maintaining records, tracking your contributions, sending regular account updates, and ensuring the smooth administrative functioning of your account. The three CRAs currently are Protean (formerly NSDL e-Gov), CAMS, and KFintech.

3. The one who manages the funds – Pension Fund Managers (PFM):

• PFMs are the fund managers you choose at the time of registration or application, such as SBI Pension Fund, UTI Pension Fund, or others. They handle the actual investment of your NPS contributions, allocating them across asset classes like equity, debt, and government securities, based on your preferred scheme and risk profile.

4. The one which looks after day-to-day fund flow management – Trustee Bank:

• Now, PoPs and CRAs send the contributions received to the Trustee Bank. This bank acts as an intermediary between the CRA and the pension fund managers. The trustee bank takes instructions from the CRA on how to allocate the funds to the pension funds and executes the transfers accordingly. Currently, Axis Bank functions as the trustee bank.

5. The one which helps in the safe-keeping of securities bought by pension funds – Custodian Bank:

• The pension funds then use the money to buy securities, but these are held in the name of the NPS Trust. While the trust technically owns the securities, the real beneficiaries are you, the subscribers. All these securities are managed in demat form by a custodian bank, which ensures their safekeeping. The custodian bank (currently Deutsche Bank) also ensures the receipt of dividends and informs pension funds about any corporate actions related to these securities.

6. The one which looks after all the above activities – NPS Trust:

• The NPS Trust is responsible for managing your assets and ensuring everything follows the rules set by the regulator. They also oversee the accounts and monitor the performance and services of all the intermediaries involved in the NPS.

7. The one which regulates the NPS space – PFRDA (Pension Fund Regulatory and Development Authority):

• PFRDA is the regulator that supervises the NPS, ensuring that all entities comply with the rules and operate in the best interest of subscribers.

Now, all these entities charge some notional fee to the customer –

Source: Compiled from NPS Trust as at the time of publishing this article

Choosing Between a CRA or a PoP 

You can open an account with NPS either through CRA directly or POP, which acts as an intermediary. Whether you open your NPS account through a CRA or a PoP, the CRA charges are standard since this entity handles all the administrative work. On the other hand, the PoP acts as a distributor, so if you go through them, an extra commission will be charged on each transaction.

As shown in the table, this extra commission can be up to 0.5% of your contribution, with a minimum of ₹30 and a maximum of ₹25,000 on every contribution. So, this is an additional cost to consider.

However, you can open your NPS account with a PoP and later choose to make future contributions directly through the CRA platform (called eNPS). Even in this case, the PoP commission will still apply to your contributions, though the charges are slightly lower when using the CRA platform than going through the PoP for every transaction, as shown in the table.

• If you’re confident in managing your NPS investments as a DIY investor, you can avoid extra commissions and go directly through the CRA.
• But, if you feel you need some guidance or hand-holding with understanding the NPS rules or managing your transactions, and you’re okay with paying a bit more for that help, then choosing a PoP might be a better option.

It’s similar to investing directly in mutual funds versus using a distributor. In one case, you save on commissions but manage things on your own, while in the other, you pay a bit more for extra support.

The process to open an NPS account

• Opening an NPS Account Directly with CRA (eNPS)

To open an NPS account directly through a CRA—called the eNPS account opening—just head to their websites (KFintech, CAMS, or Protean) and start the registration process.

You’ll need your PAN number, mobile number, email ID, and date of birth for the initial registration. After that, you can proceed with Aadhaar-based registration.

During registration, you’ll need to choose a fund manager and decide whether you want the active choice (where you allocate assets yourself) or auto choice (where it’s done based on your age). You’ll also provide your bank details. You’ll be asked to fill in FATCA (Foreign Account Tax Compliance Act) details. This is mandatory for all NRIs and Persons of Indian Origin (PIOs) based in the United States. FATCA compliance ensures that the US government tracks foreign accounts held by US residents or citizens. The procedure for this is called self-certification, where Indian financial institutions ask NRI account holders to verify certain information about themselves. After this, the financial institutions perform due diligence and verify the self-declaration.

Additionally, you’ll need to provide your nomination details (who will receive the NPS benefits in case of your untimely demise).

You might be asked to upload your signature, and the process usually involves Aadhaar authentication. Once that’s done, you can make your initial contribution to NPS—both for Tier 1 and Tier 2 accounts.

In about two days, you should receive your PRAN number (generated by the CRA), which you’ll use going forward. Just keep in mind that it usually takes T+2 days for your contribution to show up in your account.

Once that’s all set, you’re good to go! You can also use the eNPS app to manage everything more easily. This whole process is fully online through the CRA.

• Opening an NPS Account Through PoPs

Alternatively, you can open an account through a PoP. There are over 80,000 branches of PoPs across India, all ready to help you open an account. If you’re already a PoP customer (like SBI), KYC and banking verification might be faster since they already know you. Just like they offer insurance or mutual funds, they handle NPS accounts too.

You typically have three options: 1. Completely online; 2. Online form with submission at a branch; 3. Fully in-person at the branch for the entire registration process.

Once you provide all the required details (including nomination information), the registration begins. The time it takes to generate your PRAN varies, but online registrations are generally quicker. If you’re doing it in physical mode, it’s recommended to wait for PRAN generation before making your initial contribution. You’ll get an SMS or email once the PRAN is generated, so don’t worry.

You’ll receive two receipts—one for registration and one for your contribution.

In the future, you can switch to a different PoP. Also, if you started with the eNPS mode (via CRA), you can switch to PoP later. But the reverse—starting with a PoP and switching to eNPS—is not allowed.

• Opening an NPS SIP

Generally, NPS transactions take T+2 days to be processed. To speed up the process, a relatively new facility called D-remit has been introduced. The D-Remit (Direct Remittance) facility allows you to transfer funds directly from your bank account to your NPS account without needing intermediaries like CRA or POP platforms. 

For this, you need to have a NPS Vitual id. You ca check the steps to create a virtual id here.

Once the virtual ID is created, you can add this number to your net banking facility as a beneficiary to transfer the amount to your NPS account. You can also transfer money to NPS via UPI by adding this virtual ID to your app.

D-remit gives you the advantage of same-day NAV. This means that if the markets drop on a particular day and the net asset value (NAV) of your NPS units falls, you can make a contribution at those lower levels, provided you make your contribution before the cut-off time. By doing so, you’ll get the allocation on the same day instead of having to wait for two days, during which the markets might rise again. 

This feature is especially useful if you’re looking to automate your NPS contributions and prefer to use a Systematic Investment Plan (SIP). Just add your virtual ID to give standing instructions to your bank to deduct a certain amount every month from your account towards NPS. 

Grievance Redressal

If you have any issues with your NPS account, you can first raise a complaint with your POP (Point of Presence). They should help resolve your issue through their grievance redressal system. If needed, you can also visit their branch in person to file your complaint.

Additionally, you can raise a grievance on the CRA website you’re registered with. Each CRA has its own Central Grievance Management System (CGMS), and once you submit your issue, it gets forwarded to the relevant office or intermediary. You’ll receive updates via email. 

The entity you raise the grievance against should resolve it within 30 days. Whenever you submit a complaint online, you’ll get a token number, which you can use to check the status later.

You can also track the status of your complaint online.

If the subscriber is unhappy with the grievance, he/she can escalate the complaint to the next higher level. Here is the escalation matrix. You can find email IDs of each level online. 

Source: NPS Trust

Key takeaways

• Several entities work together in the NPS ecosystem, including POPs, CRAs, pension fund managers, trustee and custodian banks, the NPS Trust, and PFRDA. Most charge a nominal fee.
• You can open an account either through a POP or directly with a CRA. POPs act as intermediaries and charge a commission on every contribution.
• PRAN (Permanent Retirement Account Number) is your unique NPS identifier and remains with you throughout your account’s lifecycle.
• The NPS D-Remit facility allows you to set up a SIP through your bank for easy contributions.
• If you have any complaints, you can lodge them with your respective CRA via the Central Grievance Management System (CGMS), and they should be resolved within 30 days.

The post NPS structure, fees, how to open an account, and start a SIP appeared first on Varsity by Zerodha.

The worry of not having saved enough by the time of retirement or the fear of depending on someone in the future—nothing beats the motivation of saving a few bucks on taxes today. I guess that’s the power of ‘now.’

When it comes to taxes, whenever the government wants people to behave in a certain way, they use taxation as a tool. Just like cigarettes carry the highest GST to discourage smoking, tax benefits work the opposite way—encouraging people to save for the future.

It is certainly in the government’s interest for people to save for their retirement, which is why all retirement products, such as NPS, EPF, and PPF, offer tax benefits both when investing and when withdrawing.

At the time of investing

Let’s first talk about the taxation aspects at the time of withdrawing from the NPS. 

There are three sections you need to remember that give you tax breaks when investing in NPS—80CCD (1), 80CCD (1B), and 80CCD (2) of the Income Tax Act. These sections offer tax deductions, meaning the amount invested in NPS can be reduced from your taxable income, which reduces your tax outgo.

Section 80CCD (1): This section allows a maximum deduction of 10% of salary (basic + DA) or ₹1.5 lakh, whichever is lower, for investments made in NPS Tier-I in a financial year. Remember Section 80C of the Income Tax Act—everyone’s favorite section that reduces taxable income for investments in life insurance, ELSS savings schemes, PPF, or home loan repayments? The NPS deduction is also covered under the same section, and the ₹1.5 lakh limit includes all these investments.

If you are self-employed, you can claim a tax deduction of up to 20% of your gross income, within the overall ceiling of ₹1.5 lakh.

This benefit is available only under the old tax regime.

Section 80CCD (1B): If the above ₹1.5 lakh limit under 80C is exhausted, you can use another section to claim a deduction. This section offers an additional deduction of up to ₹50,000 over and above the Section 80C deduction. This deduction is also available only under the old tax regime and for NPS Tier-I contributions.

Section 80CCD (2): This section provides tax benefits for those under corporate NPS, where both employer and employee contribute to the NPS account.

For an employee, any amount you receive directly or indirectly becomes part of your salary and is subject to tax. However, contributions to your NPS account are not considered taxable if the contribution is up to 10% of salary (basic + DA). The good news is that this deduction is available under both the old and new tax regimes, with the limit being higher at 14% of salary in the new regime.

For example, if your basic + DA is ₹20 lakh per annum, employer contributions of up to ₹1 lakh and ₹1.4 lakh will not be taxed as your income in the old and new tax regimes, respectively. You can claim this as a deduction under Section 80CCD (2). Any contribution above this limit becomes part of your salary, and you’ll have to pay tax on that.

There’s another conditional rule: if an employer’s contribution to NPS, Employees’ Provident Fund, and superannuation fund combined exceeds ₹7.5 lakh in a financial year, the excess will be taxable in the employee’s hands, irrespective of the above limits.

At the Time of Withdrawal

You know by now that after the age of 60, you can withdraw up to 60% of the corpus, while the remaining amount must be used to purchase an annuity plan.

At this point, you have no tax implications in your hands. You don’t have to pay any taxes—this is a huge benefit.

However, the annuity plan you buy, which gives you regular income, is taxable. The total annuity you receive each year is chargeable to tax at your slab rate.

While this applies to withdrawals from the Tier I account of the NPS, we already discussed in the previous chapter that withdrawals from NPS Tier II don’t offer any special tax benefits. The gains are either taxed at your slab rate or as capital gains—though the rules are unclear about which applies.

The same uncertainty applies to premature exits from the NPS, where you can withdraw up to 20%. The taxation rules are not clear, but it’s likely that this will be taxed. Check with your tax advisor when you make such withdrawals.

Partial withdrawals available under the NPS for marriage, education, etc., however, are exempt from taxation.

These rules apply regardless of which tax regime you choose—new or old.

Key takeaways

• NPS Tax Breaks on Investment: The three sections of the Income Tax Act—80CCD(1), 80CCD(1B), and 80CCD(2)—provide tax deductions for investments in NPS Tier I. 
• Section 80CCD(1): A maximum deduction of 10% of salary (basic + DA) or ₹1.5 lakh (whichever is lower) is allowed under the old tax regime. 
• Section 80CCD(1B): Offers an additional deduction of ₹50,000 over and above the ₹1.5 lakh 
• Section 80CCD(2): Employer contributions to NPS are tax-free, up to 10% of salary (basic + DA) in the old tax regime and 14% in the new regime.
• NPS Withdrawal Rules: At the time of withdrawal, there is no tax implication in the hands of the investor. However, regular payments from annuities are taxed at slab rates. 

The post NPS Tax rules & benefits appeared first on Varsity by Zerodha.

NPS Tier I and Tier II work just like that. Tier I is the older sibling with stringent rules and regulations. Tier II, on the other hand, is the younger sibling—no minimum contribution, no withdrawal restrictions, and no mandatory annuity purchase. But there’s a catch. With anything in life — you can’t have your cake and eat it too — while you enjoy the flexibility, you lose out on the tax benefits that Tier-I accounts offer.

Tier II account works just like the NPS Tier I account and can be opened once you have a Tier-I account. Subscribers in NPS Tier 2 also have four fund options to choose from—Scheme E (primarily equities), Scheme G (government securities), Scheme C (corporate debentures), and Scheme A (alternative investment securities). You can opt for the ‘active choice’ option, where you set your own investment allocation. Alternatively, there’s the ‘auto choice’ option, where your exposure to equities and corporate debt is automatically reduced as you grow older, providing a more conservative approach as you near retirement.

Further, one can also choose different fund managers to manage different assets.

The flexibility here is that subscriber can select different Pension Fund and Investment Option for his/her NPS Tier I and Tier II accounts. For example, if you have selected 50% allocation to equity in Tier I to be managed by HDFC Pension, you can go for 60% in Tier II and select UPI as fund manager in Tier II.

In fact, in Tier I, a subscriber can have an equity allocation of only up to 75% of the overall investment value, but in Tier II, you can allocate up to 100%.

As mentioned earlier, the Tier-II account does not have any withdrawal restrictions and one can also transfer the funds from this account to the Tier-I account (only one-way). In case of closure of NPS Tier-I (pension account), the balance outstanding in NPS Tier-II account will also get transferred to the bank account.

Should you invest in the NPS Tier II account?

If the lock-in period of NPS Tier I isn’t appealing to you, but you appreciate its structure and performance as a retirement fund, Tier II could be a good alternative. Psychologically, you can still set aside your investments in Tier II for retirement and maintain financial discipline, even though there are no restrictions.

You might recall how I mentioned that the real strength of NPS as a retirement product comes from its strict withdrawal and contribution rules, which encourage long-term discipline. Since the Tier II account doesn’t come with these restrictions, it’s not technically a retirement savings scheme—it’s more like an open-ended savings account in the form of a mutual fund.

Whether for retirement or other financial goals, NPS Tier II is simply another investment option alongside mutual funds.

Let’s compare it in the usual ways—returns, liquidity, and safety.

In terms of safety, it depends on the underlying assets of the schemes. Scheme E, which invests in top-listed companies, carries the same risks as any equity product with a large-cap focus. 

Schemes C and G, which invest in corporate bonds and government securities, respectively, have historically taken on lower risk than similar mutual fund options like gilt or corporate bond funds in terms of credit risk as NPS funds primarily focussed on AAA-rated bonds, for which the probability of default is low. For debt funds, there’s another risk – interest rate risk – as the duration of the papers held by the funds goes up, the risk also increases. It is more nuanced based on the country’s economic conditions. The duration of NPS debt funds is typically higher than that of peers in the MF space – hence NPS funds can be slightly volatile. 

When it comes to liquidity, Tier II offers complete flexibility—you can withdraw your money anytime.

As for returns, Scheme E typically mirrors the performance of broad market indices, while Schemes C and G have often outperformed their mutual fund counterparts in similar asset classes.

So, if you’re already considering gilt funds or corporate bond funds for your debt allocation—whether for retirement or another financial goal—Schemes C and G in NPS currently look quite competitive.

For equity exposure, Scheme E  of NPS can be one of the options when considering, but there are plenty of strong alternatives available in the mutual fund space as well.

Tax moves the needle!

NPS Tier II comes with no tax benefits, and everybody seems to have made peace with it. As per the NPS website, gains from NPS Tier II are taxed at a slab rate and not treated as capital gains. This is similar to how debt funds are treated as well. 

However, there is a significant difference between this and equity funds. Equity gains are treated as capital gains and taxed at a lower 12.5%, which is much more attractive compared to the slab rates of those in the higher brackets. 

NPS Tier II taxation is also in a grey area. Some say it can be taxed just like other capital gains – but there is no official clarification.Thus, the analysis also changes based on which tax interpretation you consider. 

But you know what? Tax rules keep changing—while taxation moves the needle, it can’t be the only metric used to decide which product to invest in. 

We also hear about so-called ‘tax planning’ with NPS Tier II funds. Since one can freely transfer funds from Tier II to Tier I, and since withdrawals from Tier I are tax-free, one could transfer the money to Tier II at the time of redemption. By being in the industry for quite some time, my hunch is that this loophole in the name of ‘ta planning’ will not be entertained for long. So, be cautious when considering that as a potential route to save taxes. 

Key takeaways

1. Tier II account works just like the NPS Tier I account and can be opened once you have a Tier-I account.
2. But Tier II has no minimum contribution or lock-in restrictions
3. No tax benefits are available for investing in Tier II
4. You can choose different fund managers and allocations for Tier II, independent of your Tier I selections.
5. NPS Tier II can be considered an additional investment option, alongside mutual funds, either for retirement or other financial goals.

The post NPS Tier II Account appeared first on Varsity by Zerodha.

This chapter covers the exit and withdrawal rules from the NPS Tier I account. These rules apply whether you reach the retirement age of 60 or want to withdraw prematurely from the fund. We will also discuss what happens to the fund upon the subscriber’s death.

I sincerely hope you will only withdraw from the fund at the retirement age. In NPS terms, this is referred to as normal superannuation.

4.1. Normal Exit (Superannuation) Rules

• Upon Retirement at Age 60: When a subscriber exits the NPS, at least 40% of the accumulated pension wealth must be used to purchase an annuity, providing a regular pension. The remaining balance will be paid as a lump sum.

• Total corpus less than or equal to ₹5 lakh: Subscribers can withdraw the entire corpus as a lump sum (100% withdrawal).

• Continuation of NPS Account: At 60 years, if you are still working and you feel that you don’t need funds immediately and are comfortable with NPS rules, you can continue contributing to the NPS account until the age of 75. All the benefits you would get otherwise will continue to be available, including the tax benefits. 
• Deferment of NPS Account: You can also stop contributing to NPS but postpone withdrawing the amount until you are 75 years old. You will have the following options-
• • Defer withdrawing your lump sum (60% of the corpus) amount until 75 years of age, but purchase the mandatory annuity with 40% cash.
  • You can postpone buying an annuity plan for a maximum of three years from the date you turn 60.
  • Or both

If the subscriber takes no action before turning 60, the account is automatically continued until 75 years of age. Also, if you are not comfortable receiving 60% of the deferred amount all at once, you can also withdraw it in a phased manner anytime. At 75, your account will be automatically closed.

4.2 Types of annuity plans

Whether you like it or not, you must use 40% of your retirement savings to buy an annuity plan. To refresh your memory, an annuity guarantees a regular pension for life. There are 15 annuity providers – who are insurance companies—empanelled with PFRDA to offer these products. You can check the list here. 

• Annuity for Life: You receive a consistent pension for life. Upon your death, the policy ends with no further payments.

• Life Annuity with 100% to Spouse: You receive the pension, and after your death, it continues to your spouse at the same rate. Once both pass, payments stop.

• Life Annuity with Return of Purchase Price: You receive a pension for life. Upon your death, the initial investment (purchase price) is returned to your nominee, and the policy ends.

• Life Annuity with 100% to Spouse and Return of Purchase Price: The pension continues as long as one annuitant (you or your spouse) is alive. After both passes away, the purchase price is refunded to the nominee.

• NPS Family Income Plan: The pension is paid to you and then to your spouse. After both, it goes to your parents. After their demise, the purchase price is returned to your nominee or child.

The annuity amount depends on the amount invested and the payment frequency (monthly, quarterly, etc.). Compare rates from providers before making a choice. As of October 2024, annuity rates range from 7.5% to 9%, but these higher rates typically don’t return the purchase price. A slight difference in rate can significantly impact your monthly income, so research carefully. You can check the annuity calculators online here. 

For your reference, I give a sample of how this calculator works and the annuity returns offered by HDFC Life Insurance for a 60-year-old under various plans –

4.3 – Partial or pre-mature withdrawal

If you need funds before retirement age, there are two options – partial withdrawal or pre-mature withdrawal. The difference is that partial withdrawals are when a subscriber wants to use the NPS amount for certain conditions like health or buying a house, while the pre-mature withdrawals are when the investor wants to close the account and exit,

In both cases, you wouldn’t get more than 25% of your corpus in your hand. This highlights how hard it is to get your money from the retirement kitty once it is locked. If you are wondering if one can take a loan from NPS, the answer is no, at least until 2024.

Partial Withdrawal

If you need funds before reaching retirement age, partial withdrawal is an option:

• Eligibility: After completing 3 years in the NPS.
• Withdrawal Limit: You can withdraw up to 25% of your contributions.
• Specific Reasons: Funds can be withdrawn for specific purposes:

• Frequency: You can make partial withdrawals up to three times during your tenure in NPS.

Pre-mature exit

If you want to exit NPS before the retirement age of 60 and not for any of the conditions above, you need to choose pre-mature exit. 

• Eligibility: After completing five years of mandatory contribution in NPS.
• Withdrawal Limit: If the corpus is more than 2.5 lakh, at least 80% of the accumulated pension wealth of the Subscriber has to be utilized to purchase an annuity. That is, only 20% can be taken as a lump sum payment from the NPS, while the rest of the amount generates a regular annuity throughout your life. 
• Exception: If the corpus is equal to or less than 2.5 lakh, the entire amount can be withdrawn without any annuity purchase requirement. 

4.4 – Unfortunate death

If the Subscriber dies before or after attaining 60 years, the entire accumulated pension wealth of the Subscriber is payable to the nominee or legal heirs. The nominee/family members of the deceased subscriber can also purchase an annuity if they want to, but it’s not mandatory. 

you need to mention a nominee at the time of opening of a NPS account. You can appoint up to 3 nominees for your NPS Tier I and NPS Tier II account. And tell the percentage of your savings you wish to allocate to each nominee.

4.5 – Final words

The withdrawal rules are different for those who onboarded NPS between the ages of 60-70. Check the NPS website for the details. Those mentioned above are the exit or withdrawal rules that apply to those who joined NPS before 60. 

Even in cases of incapacitation or disability greater than 75%, no more than 25% of the corpus can be accessed. This highlights the importance of having separate investments and an emergency fund outside of NPS for access in case of emergencies.

Key takeaways

1. Options at age 60: NPS subscribers have three choices—withdraw 60% as a lump sum and use the remaining 40% to purchase an annuity, continue contributing to NPS, or stop contributing but defer the withdrawal.
2. Account closure at 75: The NPS account will automatically close at age 75 if no action is taken.
3. Partial withdrawals: Allowed for specific purposes such as education, marriage, illness, or starting a business, with a limit of up to 25% of the corpus.
4. Pre-mature withdrawal: If withdrawing before age 60, 80% of the funds must be used to purchase an annuity.
5. In case of death: The total NPS corpus is transferred to the nominee.

The post Exit & Withdrawals appeared first on Varsity by Zerodha.

Once you have decided to invest in NPS, it is time to understand the details of the product. 

Before that, a quick note on the two routes you can choose to invest in NPS –

1. You can directly invest through the All Citizens Model.
2. Or, if your company is registered under the Corporate NPS Model, you can contribute to NPS as a deduction from your salary.

Under Corporate NPS, employers contribute to NPS on top of the Employee Provident Fund (EPF) contribution. The employer may either keep it a mandatory or a voluntary retirement benefit plan. If NPS is offered on a voluntary basis, you will have a choice whether or not to join NPS. 

Moving on, under NPS, there are two types of accounts—Tier I and Tier II. Tier I is your primary retirement account, with restricted withdrawals and minimum construction rules until you turn 70 or retire.  So, all the minimum contribution requirements and withdrawal restrictions we mentioned earlier apply specifically to this Tier I account.

To keep your Tier I account active, you need to invest at least ₹1,000 per year (₹500 minimum per contribution). Tier II, on the other hand, is more of a savings account. You can only open it after getting a Tier I account, and there are no minimum contributions and withdrawal restrictions with Tier II. There’s no limit on how much you can invest in either account. In this chapter, let us focus on the Tier I option.

There are two important decisions you need to make at this stage – asset allocation and the fund manager.

3.2 – How it works

If you’ve ever been to a fancy five-star hotel, you’ve probably seen a variety of restaurants—Asian, Italian, Indian, Mediterranean, French, and more—all under one roof. Each restaurant offers you a starter, main course, and dessert.

Now, imagine you can pick and choose: maybe you have an appetizer in one, a main course in another, and dessert somewhere else, or if you’re feeling lazy (like me), you settle for everything in just one spot.

Think of the NPS (National Pension System) like this hotel. The restaurants are your fund managers, and the dishes are your assets. Each fund manager can offer you a mix of equity, debt, corporate bonds, and alternatives. You get to choose whether one fund manager manages all your assets or different managers handle each type, giving you full control over how you build your retirement portfolio.

3.3 – Investment options

You’ve got four fund options—Scheme E (equities), Scheme G (government securities), Scheme C (corporate debentures), and Scheme A (alternative investments) under the All Citizen Model.

• Scheme E primarily invests in listed shares and has higher risk than others. However, this is the only component that contributes significantly to returns. NPS fund managers typically focus on large-cap stocks and keep the exposure to mid and small-cap stocks lower to reduce the risk.
• Scheme G focuses on central government securities and state development loans. While there is virtually no default risk here, the portfolio is still exposed to interest rate movements.
• Scheme C is riskier than Scheme G. It invests in corporate securities and infrastructure-related debt instruments.
• Scheme A is a relatively newer option (introduced in 2016) and invests in unconventional assets through Alternative Investment Funds (AIF Category I and II), Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), Basel III Tier 1 bonds, and securitized papers. These investments carry higher risk compared to other schemes. 

Now, you can invest up to 75% in Scheme E, and up to 100% in Schemes C and G. But for Scheme A, you’re limited to just 5%. The NPS regulator announced in October 2022 that equity exposure under active choice can continue at 75% unless changed by the investor. This is under what’s called the “active choice” model. 

If you don’t want to pick and choose, there’s also an auto choice- lifecycle fund option. In this, your investments are automatically balanced based on your age. The older you get, the less risky your investments become, meaning your exposure to equity and corporate debt decreases over time. Here too, depending on your risk appetite, you can choose from three different options available – LC75 – Aggressive Life Cycle Fund, b) LC50 – Moderate Life Cycle Fund and c) LC25 – Conservative Life Cycle Fund.

For those upto 35 years, the maximum equity allocation under the aggressive plan is the highest at 75%, while for the moderate and the conservative funds, the equity allocation is capped at 50% and 25%, respectively.

Recently, in October 2024, a new investment option called ‘Balanced Life Cycle Fund’ has been introduced in which the maximum equity allocation of 50% tapers down after the age of 45 years as compared to 35 years under existing life cycle funds. 

If you don’t choose any of the options in the auto-choice too,the  Moderate Life Cycle Fund (LC50) will continue to be the default choice

If you’re just starting out in your career, don’t be put off by the relatively lower returns from Scheme E in the short term. Equity has the potential to give inflation-beating returns over the long haul.

Scheme A, however, carries more risk and doesn’t have much of a track record yet, so you might want to avoid it for now. You can switch between active and auto choices up to four times a year. You can also change your asset allocation between Schemes E, C, G, and A four times a year. If you want a set-it-and-forget-it strategy where the risk automatically lowers as you age, auto choice could be your best bet.

3.4 – Selecting fund managers

Ten pension funds are currently available for the All Citizens Model: Axis, Aditya Birla Sun Life, HDFC, ICICI, Kotak, LIC, Max Life, SBI, TATA, and UTI. You can check their performance online to compare their performance across different schemes and time frames.

You are also allowed to select multiple Pension Fund Managers (PFMs) under the Active Choice option.

This means that you can choose up to three different PFMs to manage your investments across different asset classes. For instance, you can have one manager handling your equity investments (Scheme E), another managing corporate debt (Scheme C), and a third for government securities (Scheme G). However, to invest in the Alternate Investment Fund (Scheme A), you must pick one of the PFMs you’ve already selected for your other schemes.

You should review your fund manager’s performance regularly and consider factors like long-term consistency. If you’re not happy, you have the option to switch fund managers once a year.

You can check the returns of the schemes here and portfolio details here.

The good part is that switching from one asset class to another or changing your pension fund manager will not have any tax implications on you. This is unlike mutual funds, where switching from one fund to another is treated as a sale, and profits are taxed as capital gains. 

Key takeaways:

1. There are two important decisions you need to make in NPS — asset allocation and the fund manager.
2. You have four fund options: Scheme E (equities), Scheme G (government securities), Scheme C (corporate debentures), and Scheme A (alternative investments).
3. You can decide the allocation under an active choice, or the auto choice will decide the allocation based on your age.
4. You can change asset allocation four times a year and the fund manager once a year.
5. Unlike mutual funds, changing the fund manager will not have any tax implications for you.

The post Investment Options in NPS appeared first on Varsity by Zerodha.

 – John Wooden, the famous American Basketball Coach

2.1 – Retirement-focused investments

Should you invest in NPS? Well, that’s a decision only you can make after weighing it against other retirement options and seeing how it fits your goals. So, let’s take some time to compare it with other investment avenues in India and figure out if it’s right for you.

In India, we have EPF (Employee Provident Fund), the post office savings scheme—PPF (Public Provident Fund), and solution-oriented mutual funds specifically for retirement. EPF and PPF are both long-term savings accounts that require a minimum contribution and restrict withdrawals, similar to NPS. However, the big differentiator is that NPS can be equity-heavy, while others are mostly debt-focused (with 7%-8% returns per annum, going by the past).

In a country like India, where inflation can eat away the returns, having equity exposure is crucial to beat inflation over the long run. 

So far, NPS returns have stayed close to the broader market performance without significantly outperforming it. Over ten years, only one out of six NPS equity funds outperformed the Nifty 100 TRI benchmark of 14.4%, with the others trailing by up to 1%. For those who don’t know, the Nifty 100 index represents the top 100 companies in India and their stock prices. 

Now, let’s look at a shorter time frame of five years. As of October 1, 2024, Nifty 100 TRI delivered around 19%, with NPS equity funds giving 19%—21% CAGR. Now, let’s see how it stacks against diversified equity mutual funds in India—the average return by flexi-cap funds stood at 21% CAGR. This means MFs delivered varied performances, with some significantly outperforming or underperforming the index. On the other hand, NPS has been close to the benchmark return. 

Please remember that your overall return from NPS would be lower than the standalone equity component return in the long run. This is because our money in NPS is spread across different asset classes, such as equity and debt, and the returns depend on the allocation we choose. The debt component of NPS provides a cushion to the portfolio but lowers the overall return. 

Next, solution-oriented mutual funds that target specific financial goals like retirement or education. Mutual funds focussing on retirement also invest in different asset classes and come in various options—conservative, hybrid, and aggressive. Each option comes with varying levels of equity and debt. You can choose any option based on your risk appetite. These schemes also come with a few tax benefits and a lock-in period of 5 years or more.

These products are relatively new in India, and we don’t have enough long-term history to evaluate how these funds have performed in different time frames.

Here’s a comparison chart –

2.2 Annuity Products

There are also annuity products in India designed for retirement. Simply put, annuity plans guarantee a set amount of money every month (or any other set interval) in return for a lump sum amount given to the insurer.

For example, if you give Rs 1 crore to the insurer at a 7% annuity rate, they promise to give you Rs 7 lakh every year as long as you live. Once you die, the plan will be terminated without giving back the capital.  You can also save periodically for a few years before you start the annuity payouts.

There are many variations in annuity plans in the Indian market—annuity with the return of purchase price (where the capital is repaid), annuity without the return of purchase price (where the capital is not given back), inflation-adjusted annuity plans (where the amount increases every year by a certain percentage), deferred annuity (where payouts start after a few years), and so on.

Annuity plans also have features similar to NPS, but they’re slightly more relaxed. Since there are so many variants of annuity plans, a direct comparison with NPS becomes a bit tricky.

Even with NPS, you are required to purchase an annuity product, but only with 40% of your NPS balance at maturity. You are free to invest 60% however you wish.

You need to understand that annuity plans pay a guaranteed amount periodically and the word ‘guaranteed’ often means lower returns. These plans prioritize stability in the payouts to customers, so insurers play a safe game when investing their money to generate returns.

The IRR (internal rate of return), which is usually the metric used to calculate returns when there are regular cashflows, shows that the return from such annuity plans is not very impressive. Currently, it stands at around 7% (assuming to receive monthly payments till 85-90 years old from the age 60), which comes down further after considering the taxes. If the person chooses to get the capital back, this interest rate falls further. 

Hence, we did not consider them as part of the comparison. Rightly so, these annuity products are also not so popular for building wealth for retirement in India. 

To conclude, NPS is a relatively better retirement product in India, especially considering its lower costs and significant equity exposure.

Now, the question arises: How does NPS compare to other general investment avenues that are not categorized as retirement products? These could include stock investments, mutual funds, PMS, and more…

2.3 Should you invest in NPS for retirement?

I’m afraid the answer to this isn’t straightforward. There are both pros and cons to this product. Let me first cover the pros:

NPS is a forced retirement savings product. From the first chapter, you understood that this product is primarily about instilling discipline in investors for their retirement journey, especially with withholding 40% of the corpus at the retirement age.

Think about it—say you diligently saved and accumulated enough money by the time of your retirement. Receiving such a large sum all at once can create a false sense of financial abundance. This illusion of having ‘more than enough’ can lead to impulsive or unnecessary purchases. The worst part is people using retirement funds to repay debts. You might have seen cases where people withdraw money from their EPF accounts to repay debts. 

Even if you’re disciplined, sometimes, family members or friends who know you received a large sum may have unreasonable expectations, and you might end up making emotional decisions to help them.

These are not just hypothetical situations. I’m sure you would agree that these things happen all the time around us.

So, when at least 40% is used to purchase an annuity, you have some security as you would have regular income throughout your life. That can be a huge psychological relief.

Now, coming to the cons, some view the very features of NPS that make the product stand out as an impediment to its growth. 

Some people simply don’t like the lock-in. They may have all the financial discipline, but the psychological burden of not having access to their own funds can be bothersome.

Because of the lock-in, it becomes challenging if you ever decide to retire early (before 60).

Another point is for salaried individuals. There’s already 24% of your salary going towards EPF/EPS, which are purely debt products. So, if you wish to invest the balance retirement savings entirely in equity to maximize long-term gains, that’s not possible with NPS, as you can only invest up to 75% in equity. 

Now, the biggest con: while the mandatory purchase of an annuity plan with 40% of the corpus at the time of retirement is good for security, that comes at the cost of sub-optimal returns from annuity plans. Currently, the IRR (internal rate of return calculates the return from an investment with a series of cash flows) of these plans stands at around 7.4%, which, after taxation, could fall to 5.18%. This is for a plan without the return of principal; if you opt for one that returns your principal, the rate would drop even further. Many argue that there are better financial products that would give higher IRR than the annuity plans. 

Now that I’ve mentioned both the pros and cons, depending on your risk appetite, it’s up to you to decide. 

You can consider this, too—it’s good to have exposure to NPS, but it may not be with 100% of funds. NPS offers good tax benefits at the time of purchase, and the multiple-stage lock-ins ensure you have a cushion to fall back on if everything else goes wrong.

The balance amount can be diversified and invested elsewhere, which gives you more control over access to and use of your funds at retirement.

This is assuming you are capable of making sound financial decisions. If you want the system to insist some financial discipline and you don’t mind sacrificing a few bucks for the security/relief  the product provides, NPS is an excellent choice for you.

If you are an NRI, you should understand how investments in Indian retirement funds are taxed and other compliance requirements in your country of residence, in addition to the above.

For instance, there’s a gray area regarding how the U.S. treats NPS investments in India; they may be considered passive investments outside the US, which means that unrealized gains at the end of each year would be taxed.

Make sure to consult with your tax advisor before making any investments.

Key Takeaways:

• The NPS product comes with its own set of pros and cons.
• Features that attract some investors may be viewed as drawbacks by others.
• Some investors may not feel comfortable with the lock-in of funds until retirement. Also the mandatory purchase of an annuity with at least 40% of the corpus that gives subpar returns.
• On the other hand, some investors prefer the lock-in for instilling discipline and are okay with sacrificing a bit of return for the psychological ease it provides.
• Ultimately, you, as an investor, must decide based on your risk appetite and financial goals.

The post NPS vs. other retirement plans appeared first on Varsity by Zerodha.

For those in the financial education space, writing and talking about retirement planning is never enough. Most people sweep ‘retirement talk’ under the rug until it’s almost too late. By the time they realize its importance, they might find themselves scrambling to catch up.

So, we’re always looking for ways to make retirement planning simple to understand. Because, even if we can move a single needle in this haystack, we’d call that a win.

In this module, I, Satya Sontanam, try to simplify the key features of NPS, an important investment avenue for retirement. NPS is an investment product that answers the ‘where to invest’ retirement planning question. But ‘how much’ to save is something you’ll need to figure out separately. If you haven’t run your calculations already, try one of those retirement calculators online, or check out our blog and videos here and here to get started.

1.1 – NPS: A product to overcome our biases

NPS is a savings plan in which individuals contribute money to their own pension account during the earning phase of their life. The goal is to build up a pension fund that will provide regular income after they retire.

The National Pension Scheme (NPS) was initially limited to government employees but later expanded in 2009 to include all individuals under the ‘All Citizen’ model. Our focus in this module is on ‘All Citizen’ NPS plan, in which any citizen of India, whether resident or non-resident, aged 18-70 years, can invest. 

These pension funds in India are regulated by the Pension Fund Regulatory and Development Authority (PFRDA), a government entity that develops and regulates pension funds in India.

Just because PFRDA is a government entity, it doesn’t mean you’ll receive a guaranteed pension as government employees do. NPS is a market-linked product – that is, your retirement fund entirely depends on how much you invest and how well those investments perform over time.

There are plenty of other market-linked investment options, such as mutual funds, investing in stocks directly, etc. So, you don’t necessarily have to choose NPS to build your retirement corpus.

But what makes NPS stand out as a retirement product is its features. It’s designed so that you can’t just dip into your retirement savings on a whim. The rules force you to stay disciplined with your investing journey for a long time.

Let’s talk about the key ones- 

• Minimum Contribution

Most government schemes want to encourage the discipline of saving, and they come with a mandate of a minimum contribution amount every year to the scheme. Retirement is a crucial financial goal that demands regular investing.

NPS freezes your account if you don’t contribute at least ₹1,000 annually. To unfreeze the account, you’ll need to make the missed contributions along with a penalty. While there is a minimum amount that has to be contributed to NPS, there is no cap on the maximum amount that can be invested.

• Withdrawal Restrictions

Withdrawing money from NPS before retirement isn’t a walk in the park. You’ve probably heard the saying, “Out of sight, out of mind,” referring to a breakup or junk food. Now, apply the same principle here, too. Once your money is invested in NPS, it’s locked until retirement, except for specific emergencies. Even in case of emergencies, only a partial amount will be available to be withdrawn. This keeps you from dipping into your savings for short-term needs when you make hasty or emotional financial decisions.

• Mandatory annuity plan at maturity

Until you are 60, you keep contributing to your NPS account while your investments generate returns. At maturity, you don’t receive all your savings in one go. Instead, you receive up to 60% as a lump sum, while a minimum of 40% has to be mandatorily used to purchase an annuity plan (an annuity plan is a financial product that gives a certain amount of money regularly for life, similar to pension). 

The intention of mandatorily purchasing an annuity is to prevent us from spending our retirement savings all at once or for unwanted reasons. Let’s be honest – when we receive a large sum of money all at once, the temptation to indulge in lifestyle upgrades or splurge on non-essential items temporarily seems justified in our heads. So, the mandatory purchase of an annuity in NPS with a minimum of 40% makes us financially covered, at least to some extent. 

•  Ease of Managing the Account:

Unlike other retirement products like EPF or PPF, NPS allows you to invest across multiple asset classes—equity, government securities, corporate bonds, and other alternative assets.  You have the option to tell the NPS manager how your investment, say Rs 100, must be divided and invested across assets; for instance, Rs 70 in equity markets, Rs 20 in government securities and Rs 10 in corporate bonds. If you are not sure how to allocate, there’s an auto choice that decides the asset allocation based on your age.

This feature makes NPS a well-rounded product, as it covers one of the most important aspects of managing a portfolio—diversification. So, it also ticks the box for ease of operation.

• Low cost and tax advantages

The key selling points that drove people to invest in NPS have been its lower cost and tax advantages. The cost of the NPS is a fraction of what active mutual funds charge. The investment fee for NPS ranges between 0.03% and 0.09%, which is the lowest compared to any fund management fee in India. Even passively managed mutual funds currently charge a slightly higher fee than that.

As for tax advantages, NPS falls under the EEE (Exempt-Exempt-Exempt) category. This means you get tax benefits at the time of investing (upto Rs 2 lakh per annum allowed as a deduction from income in the old tax regime), the gains or interest accrued are not taxed, and at maturity, the lump sum is also tax-free. However, 40% of the corpus, which must be invested in an annuity, pays you a monthly income that is taxable at regular tax rates. (More about taxation will be discussed in the next chapters.)

1.2 – Long-term commitment

These features make NPS distinctive. There’s nothing particularly unique about how the funds are managed, where they are invested, or the risk/return profile. Most of the NPS features are aimed at encouraging investment or discouraging early withdrawals.

It is in the government’s interest to promote retirement savings so people depend less on public welfare, which will eventually reduce the strain on government resources as populations age. This explains the low cost structure and tax benefits of NPS.  

On the other hand, the minimum contribution, withdrawal restrictions, and mandatory annuity purchases are in place to keep you committed for the long term so you don’t neglect your retirement needs.

That’s why I say, NPS is a product to overcome our behavioural biases of investing. I guess it’s collective wisdom that humans tend to be impulsive and irrational sometimes, which is why all long-term commitments come with some rules. Now, if you’ll excuse my analogy, think about marriage. While there are many ways for two people to commit to each other, ‘marriage’ is performed to keep it steady. The rituals, societal expectations, and legalities make it harder for individuals to walk away in the heat of the moment. Similarly,  NPS is structured with rules and safeguards to prevent impulsive decisions, ensuring that your retirement savings stay intact for when you really need them.

Key Takeaways:

1. NPS, initially introduced for government employees, has been extended to all citizens of India since 2009 under the NPS All Citizen Model.
2. Contributing to NPS doesn’t mean a regular pension from the government in old age.
3. Any citizen of India, whether resident or non-resident, aged 18-70 years, can invest.
4. The option to invest in equity sets NPS apart from other government-backed retirement products such as EPF and PPF.
5. NPS is designed to instill financial discipline in the subscriber for long-term savings.

The post Introduction to NPS  appeared first on Varsity by Zerodha.