A Comprehensive Guide to the Benefits of the National Pension System (NPS)

The Dual Structure: Tier I and Tier II Accounts

To understand the best NPS scheme, one must understand the structure first. The NPS scheme benefits offers two different types of accounts under the single Permanent Retirement Account Number(PRAN). It becomes very important to understand the difference to avoid pitfalls of "half information".

• Tier I Account: Tier I is mandatory for NPS subscribers once they choose to join NPS. It comes with restricted withdrawals to ensure disciplined savings for your sunset years. The substantial tax benefits discussed below are available principally to this account.
• Tier II Account: The Investment Account. This account is voluntarily added on. In general, it is a high-liquidity mutual fund wherein you can withdraw money anytime. It generally does not enjoy any tax benefits on investment for the private sector subscriber.

Quick Comparison - NPS Tier I vs. Tier II

(Source: PFRDA FAQs)

Note*: Assessees who are Central Government employees can claim 80C deduction on Tier II contributions if they lock in funds for 3 years.

Powerful Tax Savings Through NPS Contributions

The main attraction of NPS for many investors is its unparalleled tax efficiency, especially under the Old Tax Regime. It offers a "triple bonanza" of deductions that few other instruments are able to match.

1. The Standard Deduction (Section 80CCD(1) within 80CCE)

   Investments in NPS Tier I are eligible for the standard ₹ 1.5 lakhs deduction.

2. The Exclusive "Extra" Deduction - Section 80CCD(1B)

   This is the game-changer. NPS scheme benefits allow for an additional deduction of up to ₹50,000 over and above ₹1.5 Lakh as mentioned above. The advantage of this is only with NPS and available for all subscribers under the Old Tax Regime.

   Pro Tip: By using both the provisions together, a taxpayer following the Old Tax Regime can reduce his/her taxable income by a total amount of ₹2 Lakhs using only NPS. This is applicable under the Old Tax Regime and subject to income and salary structure.

3. The Corporate Booster Section 80CCD(2)

   This is one of the key benefits for salaried employees under both the Old and New Tax Regimes. If your employer is contributing to your NPS Tier I account, then such contribution is deductible up to:

   •  For private sector employees:
   • 10% of Basic Salary + DA in old regime
   • 14% of Basic Salary + DA in new regime
   • 14% of Basic Salary + DA for Central Government and stipulated State Government employees.

   This, therefore, is not included in your taxable salary, which means substantial tax relief without touching your personal 80C or 80CCD(1B) limits.

EEE Tax Advantage in NPS Explained

NPS follows the Exempt Exempt Exempt pattern for most stages of investment and thus is quite tax-efficient across its lifecycle, with one important exception.

• Contribution stage: Deductions are available for investments made into NPS under Sections 80CCD(1), 80CCD(1B), and 80CCD(2) within the overall limit
• Accrual stage: Returns from the investment in NPS are absolutely tax-free while the corpus is invested
• Withdrawal stage: You can withdraw upto 80% lump sum at retirement out of which 60% is tax-free

Partial withdrawal made for specified purposes under Section 10(12B) is also tax-free. However, the monthly pension received from the annuity portion is taxable and treated as income from other sources, taxed according to the individual’s.

Ultra-Low-Cost Structure

How to invest in NPS scheme? Costs eat into returns. A 1% difference in fees over, say, 20 or 30 years can shave significant amounts off your final corpus. The NPS is arguably the world's cheapest pension scheme.

While mutual funds may charge expense ratios ranging from a minimum of 0.5% to over 3%, in the case of NPS scheme benefits, the regulator essentially caps the investment management fee charged by Pension Fund Managers.

The investment management fees are approximately 0.09 % or lower, subject to Pension Fund Manager and regulatory revisions. This minuscule fee structure ensures that almost your entire contribution works for you, maximizing the power of compounding over decades.

Flexibility and Investment Control

NPS is not a "one-size-fits-all" government scheme. It offers sophisticated investment choices that enable subscribers to tailor their portfolio based on their risk appetite.

Asset Classes

Your money is invested in a mix of funds managed by professional Pension Fund Managers (like LIC, HDFC, ICICI,SBI NPS scheme etc.).

• Asset Class E (Equity): Investments in stocks. Offers high growth potential but carries market risk.
• Asset Class C (Corporate Debt): Investments in fixed-income instruments issued by private companies. Moderate risk and return.
• Asset Class G (Government Securities): Investments in Central and State Government bonds. Low risk, stable returns.
• Asset Class A (Alternative Assets): Investment in AIFs, REITs, InvITs, etc. (Capped at 5%).

Investment Choices: Active vs. Auto

• Active Choice: You decide the exact percentage split between E, C, and G asset classes (subject to caps).
• Auto Choice (Lifecycle Fund): Ideal for passive investors. The system automatically adjusts your asset allocation based on your age. As you get older, exposure to Equity (riskier) decreases, and exposure to Debt/Govt Securities (safer) increases to protect your accumulated corpus.

Regulation, Transparency, and Portability

• Regulated Safety: NPS is regulated by PFRDA. Calculators are illustrative tools and not regulated entities. It is a statutory body set up by the Parliament of India, for ensuring transparent norms and regular monitoring of Pension Fund Managers.
• Portability: In the current gig economy, nobody sticks to a particular job forever. NPS is fully portable. Your PRAN (Permanent Retirement Account Number) remains the same, whether you change employment, shift to another city, or move from the private sector to self-employment.

Conclusion

The National Pension System is far more than a last-minute tax-saving device at the end of every financial year. In fact, it is a low-cost, efficiently regulated, and flexible vehicle designed to impose the discipline required by any serious effort at long-term retirement planning. For those impatient to liquidate their funds, the lock-in period may sound very restrictive. In reality, it is necessary to ensure long term retirement income while allowing limited, regulated withdrawals. By availing of the exclusive tax benefits today and the power of market-linked compounding over time, NPS forms a basic building block of a financially secure retirement in India.