The National Pension System (NPS) is a retirement savings scheme that aims to provide individuals with financial security after retirement. It is mandatory for government employees, while for private-sector employees, it remains optional. In addition to its long-term savings benefits, the NPS offers significant tax advantages under the Income Tax Act of 1961. Investors can claim tax deductions of up to ₹2 lakh: ₹1.5 lakh under section 80CCD(1) for contributions to NPS Tier-1 and ₹50,000 under section 80CCD(1B) for additional donations.NPS is a powerful tool for retirement planning. Understand how this government-backed scheme with tax benefits can help you build wealth for the future.
Eligibility and Account Types:
To open an NPS account, an individual must be between 18 and 70 and either a resident or a non-resident Indian. The NPS has two primary types of accounts: Tier-1 and Tier-2.
Tier-I Account: The Core of NPS
The NPS Tier-1 account is the primary, mandatory account for retirement planning under NPS. This account allows investors to benefit from market-linked returns and is meant explicitly for long-term retirement savings. The main features of the NPS Tier-1 account are:
- Minimum Investment: To open an NPS Tier-1 account, you need a minimum investment of ₹500 and contribute at least ₹1,000 annually to keep the account active.
- Returns: NPS Tier-1 invests in equity, government bonds, corporate bonds, and alternative investment funds (AIFs). These investments’ returns can vary annually, and in the past year, DSP Pension Fund Managers achieved the highest return of 26.51%. On the other hand, the LIC Pension Fund posted the lowest return.
Tier-II Account: Add-On Flexibility
An NPS Tier-2 account functions as an add-on to the Tier-1 account, offering more flexibility in terms of withdrawals. The main features of this account include:
- Minimum Investment: The minimum amount required to open a Tier-2 account is ₹1,000. Unlike the Tier-1 account, there is no mandatory annual contribution, allowing investors to withdraw as needed.
- Contribution Limits: There is no upper limit on contributions to a Tier-2 account, making it more flexible for those who wish to save beyond the prescribed limits.
- PRAN: To open a Tier-2 account, an individual must already have a Permanent Retirement Account Number (PRAN), which is also required for Tier-1 accounts.
Though the Tier-2 account offers more flexibility, it does not have the same tax benefits as the Tier-1 account. For instance, contributions to Tier-2 are not eligible for the same tax deductions under sections 80CCD(1) and 80CCD(1B).
Regarding performance, DSP Pension Fund Managers posted the highest return for a Tier-2 account in the past year, 23.27%, while LIC Pension Fund posted the lowest return, 15.49%. It’s important to note that Tier-2 accounts generally have smaller asset sizes compared to Tier-1 accounts. This is primarily because the Tier-2 account is considered an add-on, and most investors open it to supplement their Tier-1 account.
Asset Sizes and Fund Managers:
There are currently five pension fund managers with assets under ₹100 crore in the Tier-2 accounts, with two of them having assets under ₹10 crore. These figures demonstrate the relatively smaller scale of investment in Tier-2 accounts compared to Tier-1 accounts.
Conclusion
The National Pension System is a highly effective tool for retirement planning. The two-tier system allows individuals to benefit from mandatory long-term savings for retirement and optional flexibility for short-term withdrawals through the Tier-2 account. By investing in a combination of equities, bonds, and AIFs, NPS offers diverse asset classes to cater to varying risk appetites. However, it is essential to be aware of the distinct features of both account types, including their minimum investment requirements, tax benefits, and flexibility, to ensure that the NPS aligns with your long-term financial planning goals.
Happy investing for your future!
.){kind=link}