Pension Planning: Choosing The Right Nps Fund

The National Pension System (NPS) is a defined contribution pension system introduced by the Central Government as part of a social security initiative for all Indian citizens. The NPS offers two types of accounts: Tier 1 and Tier 2. Tier 1 has a longer lock-in period as it is designed to provide income after retirement, while Tier 2 functions more like a savings account with the freedom to withdraw money at any time. Investments in Tier 1 also offer additional tax deductions of up to Rs. 1.5 lakh under Section 80C and Section 80CCD of the Income Tax Act, 1961.

There are currently 10-11 NPS pension fund managers in India, including HDFC, ICICI, Kotak, and SBI. When choosing a pension fund to invest in, it is important to evaluate the performance of each fund manager across different asset classes, such as equity, government bonds, and corporate bonds. Returns are not the only factor to consider, as volatility and risk should also be taken into account when making investment decisions. Additionally, investors have the flexibility to decide their NPS asset allocation and can now select multiple fund managers for different asset classes.

Tax benefits of NPS

The National Pension Scheme (NPS) offers a range of tax benefits for investors, which can make it a strategic choice for retirement planning. Here are the key tax advantages of investing in the NPS:

Tax Benefits for Employees on Self-Contribution

Employees who invest in the NPS can claim tax deductions on their contributions. Under Section 80CCD(1), they can avail of a deduction of up to 10% of their salary (Basic + DA) within the ceiling of ₹1.5 lakh under Section 80CCE. Additionally, under Section 80CCD(1B), they are eligible for a further deduction of up to ₹50,000, which is over and above the ₹1.5 lakh limit under Section 80CCE.

Tax Benefits for Self-Employed Individuals

Self-employed individuals who contribute to the NPS can also benefit from tax deductions. They can claim a deduction of up to 20% of their gross income under Section 80CCD(1), with an overall ceiling of ₹1.5 lakh under Section 80CCE. Similar to salaried employees, they can also avail of an additional deduction of up to ₹50,000 under Section 80CCD(1B), which is over and above the ₹1.5 lakh limit.

Tax Benefits on Employer Contributions

The NPS also offers tax benefits for employer contributions towards their employees' NPS accounts. Under Section 80CCD(2), employers can claim a deduction of up to 10% of the employee's salary (Basic + DA) contributed to the NPS. This deduction is over and above the ₹1.5 lakh limit under Section 80CCE. It is important to note that this benefit is only available to salaried employees.

Tax Benefits on Partial Withdrawal

The NPS allows for tax-exempt partial withdrawals of up to 25% of the self-contribution under specific circumstances prescribed by the Pension Fund Regulatory and Development Authority (PFRDA) under Section 10(12B). This provision offers flexibility for investors to meet unforeseen financial needs.

Tax Benefit on Annuity Purchase

The NPS provides a tax exemption on the purchase of an annuity upon attaining the age of 60 or superannuation under Section 80CCD(5). However, it is important to note that the subsequent income received from the annuity is subject to tax under Section 80CCD(3).

Tax Benefit on Lump Sum Withdrawal

Investors in the NPS are eligible for a tax exemption on lump sum withdrawals of up to 60% of their accumulated pension wealth upon attaining the age of 60 or superannuation under Section 10(12A). This benefit further enhances the attractiveness of the NPS as a retirement savings option.

Tax Benefits for Corporates/Employers

Corporates or employers can also avail of tax deductions on their contributions towards employees' NPS accounts. Under Section 36(1)(iv)(a), they can claim a deduction of up to 10% of the employee's salary (Basic + DA) contributed as 'Business Expense' from the Profit & Loss Account.

Tier 1 and Tier 2 accounts

Tier 1 Accounts

Tier 1 is the primary NPS account for retirement savings, with a lock-in period until retirement age, which is currently set at 60 years in India. This account offers tax benefits for contributions made under Section 80C of the Income Tax Act, with additional deductions available under Section 80CCD (1B). The minimum contribution for this account is Rs. 1,000 per financial year, with no maximum limit. At maturity, individuals receive 60% of the total corpus, while the remaining 40% must be used to purchase an annuity plan.

Tier 2 Accounts

Tier 2 accounts are voluntary accounts that can be opened by individuals who already have a Tier 1 account. These accounts have no lock-in period and contributions can be withdrawn at any time. However, withdrawals from Tier 2 accounts are added to the individual's taxable income and are taxed accordingly. There is no minimum contribution for Tier 2 accounts, but the minimum contribution amount is Rs. 250. This account type does not offer any tax benefits.

Similarities Between Tier 1 and Tier 2 Accounts

Both account types have similar charges and offer the same choices of fund managers and fund schemes. The available asset classes for investment (equity, corporate bonds, and government securities) are also the same for both Tier 1 and Tier 2. Additionally, the fund management costs are similar for both account types.

Pension Fund Managers

It is important to note that the choice of a pension fund manager will impact the performance of your NPS investment. Currently, there are 10-11 NPS pension fund managers in India, including SBI Pension Funds, LIC Pension Fund, UTI Retirement Solutions, HDFC Pension Management, ICICI Prudential Pension Fund Management, and others. The performance of these fund managers varies across different asset classes, and individuals can choose different fund managers for different asset classes.

Choosing a pension fund manager

When choosing a pension fund manager, it is important to consider various factors to make an informed decision. Here are some key points to keep in mind:

Performance and Returns

One of the critical factors in choosing a pension fund manager is their performance and the returns they have generated over time. Look at the track record of different fund managers and compare their returns over the past few years. Consider both the point-to-point returns and the SIP (Systematic Investment Plan) returns, as they provide different perspectives on the fund's performance. SIP returns, calculated using the internal rate of return formula, are especially indicative if you plan to invest through monthly instalments.

Investment Options and Flexibility

Different pension fund managers offer various investment options and levels of flexibility. Some pension funds focus on low-risk investments, such as government securities and loans, while others may offer a mix of large-cap and mid-cap stocks or investments in real estate investment trusts (REITs) and Infrastructure Investment Trusts (InvITs). Consider your risk tolerance and investment goals when evaluating fund managers. Additionally, some pension schemes allow you to choose the allocation of your investments actively, while others will make allocations based on your age and risk profile.

Tax Benefits

The National Pension Scheme (NPS) offers significant tax benefits under Section 80C and Section 80CCD of the Income Tax Act, 1961. These benefits can provide substantial savings on your taxable income. However, it is essential to understand the specific rules and clauses related to tax implications, withdrawals, and lock-in periods before investing.

Reputation and Reliability

Consider the reputation and reliability of the pension fund manager. Look for fund managers with a long-standing presence in the market and a solid track record of managing pension funds. Review their credentials, regulatory compliance, and customer satisfaction levels.

Fees and Charges

Pension fund managers typically charge fees for their services, which can vary among different fund managers. Be sure to understand the fee structure, including any management fees, transaction fees, or other associated costs. Compare the fees across different fund managers to make an informed decision.

Investor Support and Services

Evaluate the level of investor support and services provided by the pension fund manager. Consider choosing a fund manager that offers easily accessible customer service, provides clear and transparent communication, and has a responsive team to address your queries and concerns.

Personal Circumstances and Goals

Finally, consider your personal circumstances, risk tolerance, and retirement goals when choosing a pension fund manager. Different fund managers may cater to specific investor profiles, such as government employees or high-income earners. Ensure that the fund manager you select aligns with your investment objectives and risk appetite.

Remember, it is always a good idea to diversify your investments across different fund managers and schemes to mitigate risk and maximise returns. Conduct thorough research, consult experts if needed, and carefully review the latest information before making your decision.

NPS asset allocation

The National Pension System (NPS) is a popular choice among Indians due to its tax-saving benefits and the flexibility it offers in terms of investment options and asset allocation. NPS subscribers can choose from four primary asset classes: Equities (E), Corporate Debt (C), Government Bonds (G), and Alternative Investment Funds (A). Each of these asset classes carries a different risk-return profile, allowing investors to customise their portfolio according to their risk tolerance and investment objectives.

Active Choice vs Auto Choice

NPS offers two options for asset allocation: Active Choice and Auto Choice. Active Choice gives investors the highest flexibility in selecting the proportion of each asset class in their portfolio, while Auto Choice automatically adjusts asset allocation based on the investor's age and risk profile.

Active Choice

Under Active Choice, investors can choose their asset allocation, with some restrictions:

• Maximum allocation to Alternative Investment Funds (AIFs) is capped at 5%.
• Maximum equity exposure is limited to 75%.
• Allocation to corporate or government bonds can be up to 100%.

The Active Choice option is suitable for investors who want more control over their investments and are comfortable with actively managing their portfolio. It allows investors to tailor their asset allocation to their specific investment goals. As investors approach retirement, Active Choice automatically reduces equity exposure and increases debt investments to help minimise volatility in the portfolio.

Auto Choice

Auto Choice is a passive investment approach that uses a life-cycle-based strategy. It starts with an equity-heavy portfolio during an investor's younger years and gradually reduces equity exposure as they get closer to retirement. Auto Choice offers three life-cycle funds with different equity exposure caps:

• Aggressive Life Cycle Fund (LC75): Allows up to 75% equity exposure until the age of 35, then reduces it by 4% every year.
• Moderate Life Cycle Fund (LC50): Caps equity exposure at 50% until age 35, then decreases it by 2% annually.
• Conservative Life Cycle Fund (LC25): Limits equity allocation to 25% until age 35, then lowers it by 1% each year.

Auto Choice is ideal for investors who prefer a more hands-off approach and want their portfolio to automatically adjust as they age. It helps optimise returns while reducing market volatility as investors approach retirement.

Tips for NPS Asset Allocation

When deciding on NPS asset allocation, investors should consider their risk tolerance, investment goals, and time horizon. Here are some tips to help choose the right asset allocation:

• For investors in their 30s, the Aggressive Life Cycle Fund (LC75) under Auto Choice is a good option as it provides high equity exposure, allowing for aggressive growth of retirement savings.
• As investors get closer to retirement, it is generally advisable to reduce equity exposure and increase the allocation to debt investments to preserve wealth and minimise volatility.
• Investors can use the NPS Calculator to estimate their returns based on different asset allocations and investment strategies.
• NPS subscribers can now change their asset allocation up to four times a year, providing flexibility to adjust their portfolio as needed.

Withdrawing from NPS

Withdrawing from the National Pension System (NPS) is a straightforward process, but there are some important rules to be aware of. Firstly, NPS withdrawal rules vary depending on the category of citizen making the withdrawal. For instance, the rules for government and corporate employees on retirement are different from those for government employees taking voluntary retirement, and corporate employees and citizens on voluntary exit.

Rules for government and corporate employees on retirement:

• Individuals need to invest a minimum of 40% of their accumulated corpus in an annuity while having the option to withdraw the rest as a lump sum.
• Individuals can defer withdrawing the lump sum until they reach 70 years of age.
• If the accumulated pension is less than Rs 2 lakh, the individual can withdraw the entire amount.

NPS withdrawal rules for government employees taking voluntary retirement:

• Individuals must invest a minimum of 80% of the amount in an annuity.
• If the pension accumulated is less than Rs 1 lakh, the individual can withdraw the entire amount.

NPS withdrawal rules in the case of the death of a government or corporate employee:

In the event of the death of a government employee before retirement age, the entire amount is handed over to the nominee or legal heir.

NPS withdrawal rules for corporate employees and citizens on voluntary exit:

• The individual must have remained invested in their account for 10 years.
• Up to 80% of the amount must be used to purchase an annuity.
• If the accumulated amount is less than Rs 1 lakh, the withdrawal of the entire amount is permitted.

Rules for partial withdrawal from NPS:

• Subscribers can make withdrawals from their NPS account up to three times during their tenure.
• There must be a gap of five years between two withdrawals, unless it is a medical emergency.
• Subscribers can withdraw up to 25% of their contributions to date.
• Subscribers should have been members for at least three years to qualify for partial withdrawal.
• Partial withdrawals are permitted for specific purposes, including children's education, marriage expenses, house construction, or medical emergencies.

NPS rules for premature withdrawal – Tier 1 & Tier II accounts:

NPS Tier I Account:

• Before 2011, there was a lock-in period until the age of 60 years. After a review, it was concluded that subscribers should be allowed to make premature withdrawals after completing 15 years of service in the form of repayable advances.
• If subscribers have completed 25 years of service, they can withdraw up to 50% of their contribution to NPS.
• Premature withdrawals are allowed in emergencies, medical illnesses, and other events requiring financial assistance.

NPS Tier II Account:

• Withdrawals from an NPS Tier II account are unlimited, similar to a savings bank account.
• However, withdrawing from an NPS account can be cumbersome due to the limited points of presence for withdrawal requests and the absence of an online portal.

Frequently asked questions