How does NPS work?

National Pension System (NPS) is a pension scheme that was commenced by the government of India in January 2004. Earlier, it was for new government recruits, but today, it’s open to all types of investors. For the central government employees, NPS is mandatory, which is also the case for certain state government employees who joined on or after January 2004. May 2009 onwards, the government of India opened NPS to all investors. The main objective behind this was to help build investment discipline and culture among Indians to ensure that they have a secure retired life. An NPS account can be opened by any Indian resident who falls in the age group of 18-60 years. The best part is that investors can open an account for the National Pension Scheme online.

Under the NPS, you can claim up to a maximum of Rs.1.5 lakhs of the amounts invested for tax deductions under your overall permissible yearly limit under section 80C. That said, the biggest difference NPS brings is the additional tax deduction of Rs.50,000, which you can claim under section 80CCD1B. Moreover, NPS enjoys EET status, which stands for EXEMPTION on investment, EXEMPTION on returns earned, but TAXATION on redemption. Thus, 40% of the corpus that you would withdraw at the time of retirement would be tax-free, which is a huge benefit.

As an NPS investor, you can open a tier 1 and/or tier 2 account. Please note that opening a Tier 1 account is mandatory for all NPS subscribers. If you are a government employee, you need to contribute 10% of your basic salary + DA to your NPS tier 1 account, while the government will make an equal contribution. Other NPS subscribers will need to open their tier 1 account with a minimum contribution of Rs.500. You will need to contribute at least Rs.6000 a year.

As a private sector employee, if you opt for NPS, you will be required to contribute 10% of your basic salary + DA into the tier 1 account, while your employer will be making an equal contribution. The best part is that your employer’s contribution is not taxable. You will be able to see this in your Form 16 under the head 80CCD2.

The second type of NPS account that you can open is a tier 2 account, which is not a mandatory account for NPS subscribers. This is a savings account, which allows you to deposit and withdraw money just like any other bank account. You will not be getting any tax exemptions for the contributions made into your tier 2 account. For opening a tier 2 account, you will require at least Rs.1000. You will need to make a minimum contribution into your tier 2 account of Rs.250. The minimum year-end balance that you will have to maintain in your tier 2 account balance is Rs.2000. The returns from your tier 2 account will be treated in the same manner as those from mutual funds.

The funds that you invest in NPS are managed effectively by experienced fund managers who invest your corpus into the equity markets, corporate debt, and other government securities in different proportions based on your investment objective and risk profile. NPS provides you with three options – Active Choice, Auto Choice, and Default Choice. Active Choice allows you to decide the proportion in which you want the NPS fund manager to allocate your money into equity markets, corporate debt, and other government securities.

Auto Choice options decide the investment proportion based on your age. Up to the age of 35, 50% of your funds will be allocated to equity while 30% will be invested in corporate debt. Contributions made into equity will be reduced from this point by 2% each year. Contributions made into corporate debt will be reduced each year by 1%. Therefore, by the time you touch 55, your equity and corporate debt allocation will become 10%.


Default Choice ensures that up to 55% of your funds are allocated towards government securities, up to 40% towards corporate debt, up to 15% towards equities, and up to 5% towards money market instruments. 

Comments

Post a Comment

Popular posts from this blog

5 Checks Before Choosing Your Mutual Fund Scheme

One of the first dilemmas you face as a start-up investor is where should you place your money. However, with so many options barging the market, it could become difficult to choose the option that perfectly fits your bill. Mutual funds often come to your rescue in such situations. They offer you the best of both worlds where you stay well-invested in the markets without having to track your investments on a regu lar basis. Online investment in mutual funds investment plans has become a basic norm of the day. Today, more investors are always on the look-out for how to start SIP investment to grow their savings. That said, how do you pick the perfect mutual funds scheme? There is no correct way to answer this question. However, you can often draw out criteria based on your needs and investment objective. There are certain checks you should maintain as an investor before investing your hard-earned money in mutual funds. Entry, exit, overhead loads, expense ratio, turnover ratio...
Read more

How A Mutual Fund SIP Compounds Over Time?

You would have likely read thousands of articles on how  investment in stocks  helps you in maximizing your money in the long run. The big question you must ask yourself here is whether you know the stocks to buy, especially if you are an inexperienced first-time investor in the stock markets. This is where mutual funds investment has made it easier, especially for first-time investors with no knowledge of the stock markets. What’s made them popular is the fact that you can  start SIP online  without much effort. All you need is a Demat and a trading account along with a bank account and you can buy/sell mutual fund units with ease. Let’s now look at how a mutual fund SIP compounds over time. When your returns start earning returns in turn, it is called compounding. It is very simple to visualize in case of fixed income securities such as FDs where the interest that you are getting is fixed. The investment is fixed. Let’s say you have a recurring de...
Read more

The Difference Between Saving, Investing, And Speculating

Every successful investor must begin by understanding the difference between saving, investing, and speculating. If you get those concepts confused, you run the risk of losing a lot of money. Let's start with saving. You can define saving as the process of setting money aside in order to make a purchase a short time in the future, which is typically under three years. The most important element when it comes to saving is the safety of your money. You don't want the value of your savings to fluctuate because you will need all of it to make your purchase. There are several options available to help you save money. These include savings accounts, money market accounts, and certificates of deposit . For example, unfortunately as a trade-off for protecting your money, saving typically pays interest at a rate that is just a bit higher than inflation. If you want to earn more than that, you will have to look at investing. Unlike saving, investing is a long-term process it oft...
Read more