Budget 2020: What is the National Pension System and how do you open an NPS account?

• The Pension Fund Regulatory and Development Authority (PFRDA) has recommended increasing the tax benefits under the National Pension System from ₹50,000 to ₹1 lakh.
  
  
• Any Indian resident between the age of 18 to 60 years can apply for an NPS account at their nearly PSU bank, select private banks or post offices.
  
  
• Opening a Tier I NPS account is compulsory for all subscribers, however, they will have the option to choose between auto, active and default accounts.
  
  
• NPS account holders can also choose between seven different fund managers.
  

The Union Budget is around the corner and expectations are high from Finance Minister Nirmala Sitharam. Analysts forecast that she will introduce a number of measures to boost the economy — including doubling the tax benefit on the National Pension System (NPS) contributions.


This will take the tax benefit from ₹50,000 to ₹1 lakh, as recommended by the Pension Fund Regulatory and Development Authority (PFRDA).


Currently, any Indian resident between the age of 18 to 60 years can open an NPS account and save up ₹1.5 lakh per annum under section 80C of the Income Tax Act. This includes investments in insurance plans and other select instruments — including buying a pension plan.


Additional tax benefits are available for up to ₹50,000 of self contribution under section 80CCD (1B), which is the NPS tax benefit. This is the amount that the PFRDA has recommended that the government should double.


NPS has an EET status — exemption on investment, exemption on returns, but taxation on redemption. 40% of the corpus that you will get on retirement will be tax-free.


Getting a Tier I NPS account — you don’t have a choice

Any Indian resident between the age of 18 to 60 years old can apply for NPS, including government employees that joined prior to January 2004 — although the measure is not compulsory for them.


Tier I accounts are mandatory for anyone who subscribes to NPS. Government employees have to pitch in a contribution of 10% from their basic salary and dearness allowance. The government matches that contribution.


For non-government employees to open an NPS account, they have to make an initial minimum contribution of ₹500. Every year, the cumulative contribution has to add up to at least ₹6,000.


For private-sector salaried employees, the company will provide two options — NPS and Employees Provident Fund. In choosing NPS, they will be subject to the same requirements as government employees. The only difference will be that the matching contribution would be provided by the employer, rather than the government.


The employer’s contribution to NPS is non-taxable. Taxpayers can find it under 80CCD2 in Form 16.


Tier II NPS accounts — Take it or leave it

A Tier II NPS account is not mandatory. It’s a type of saving account from which subscribers can make withdrawals at any time. It’s not subject to tax exemptions and there’s no equivalent contribution by the employer or the government.


In order to open a Tier II account, subscribers need to deposit a minimum of ₹1,000. Each contribution has to be a minimum of ₹250 and, at the end of the year, the account must have a minimum balance of ₹2,000.


Any returns from Tier II accounts are treated the same as returns from mutual funds.


How do you open an NPS account?

You can open an NPS account by approaching your nearest PSU Bank, select private banks— like ICICI, Kotak, and HDFC among others — and post offices.


At the bank, you will need to fill out the required NPS form and submit the relevant KYC documents. After your request is processed, the Central Record Keeping Agency will send you a Permanent Retirement Account Number (PRAN).


This account number will be unique to you and can be moved from employer to employer.


The minimum account opening fee is ₹500 and the fund management fee is 0.1%.


Picking an account and fund managers

NPS accounts are run through fund managers. These fund managers invest contributions into equity, corporate debt and government securities. Proportions vary according to market conditions and the type of NPS account you have.


The equity portion is invested in index stocks — these stocks make up NIFTY and Sensex.


Choice of fund managers:

1. HDFC Pension Management Company
   
2. ICICI Prudential Life Insurance Company
   
3. Kotak Mahindra Asset Management Company
   
4. LIC Pension Fund
   
5. Reliance Capital Asset Management Company
   
6. SBI Pension Fund
   
7. UTI Retirement Solutions
   

There are still three types of NPS accounts that you can choose from — active, auto and default. In choosing active, you will have control over how your money gets divided between different financial instruments. However, only a maximum of 50% can be allocated towards equities.


In choosing an auto account, the money will be invested according to the subscriber’s age. Till the time you are 35 years old, 50% of the investment will go towards equity and 30% will be divided allocated to corporate debt. Thereafter, investment in equity will be reduced by 2% each year and investment in corporate debt will be reduced by 1%.


By the time you will be 55 years old, 10% will be invested in equity, 10% in corporate debt and the other 80% will be allocated to government securities — a low-risk financial instrument.


The default account comes with the least amount of risk. As much as 55% of your contribution is invested in government securities, 40% goes towards corporate debt, 15% is allocated to equities and only 5% is put into money market instruments.


Government employees have no choice, but to opt for the default account.


When can you finally withdraw your money?

Withdrawals of up to 25% can be made after you’ve subscribed to the scheme for at least 10 years for reasons like children’s education or buying a house.


You can make three such withdrawals from NPS at a gap of at least 5 years between each withdrawal. However, an exception can be made in the case of critical illness, accidents or life-threatening diseases.


If you choose to retire before the age of 60 years, 80% of your corpus has to go towards annuity and up to 20% can be withdrawn. However, that amount will be taxed according to your tax slab.


If you retire at 60 years of age, you can withdraw up to 60% of the corpus and will only have to pay tax on 20% of the amount. As much as 40% of the corpus still has to go towards buying annuity. Any returns on the annuity are taxed as per tax slabs.


In the event of the death of the NPS account holder, the entire corpus amount is allocated to the nominee.