Less than 5,000 voluntary investors joined the National Pension System (NPS) when it was made available to the public fifteen years ago in 2009. The structure was complex, the investing regulations were not clear, and it was ambiguous how the income would be treated tax-wise.
However, the NPS has changed significantly over time and is now more investor-friendly. The Pension Fund Regulatory and Development Authority (PFRDA) have added additional features and have also increased the scheme’s flexibility. Additionally, it has simplified the process of creating an NPS account. You may open the account online in a matter of minutes if you have the required paperwork. The introduction of tax incentives on NPS contributions, such as NPS-only tax deductions and the exemption of 60% of the maturity corpus from taxes, is another way this NPS scheme is attractive.
These actions have caused NPS to pick up speed, and in 2023–2024 alone, 8.73 lakh voluntary investors entered the scheme (compared to 5000 voluntary investors in 2009). Almost 100 investors join every hour, with an average of 2,391 investors entering each day. However, the NPS is still not being considered by the investors as the best option for retirement investments. The NPS plan has barely reached 10% of the nation’s overall investing population, with only 55 lakh voluntary investors participating.
There are a number of reasons why NPS has not yet been embraced for retirement, including as a lack of knowledge about the scheme, an aversion for long-term financial commitments, and the requirement that 40% of the maturity corpus be paid out as an annuity. Many people are unaware; nevertheless, that NPS has every feature that one might want in a retirement savings plan. It is a low-risk, long-term investment with extremely cheap costs.
In this blog-post, we will try to see the top 5 reasons why you should consider investing in the NPS scheme.
1. Very Low charges:
Higher returns from NPS are the result of extremely cheap charges. When compared to standard mutual fund and insurance company fees, the NPS’s fund management fees are quite low. The NPS is the most affordable financial product in the Indian market. In a year, the investor only pays between Rs. 30 to Rs. 90 per lakh. That is equivalent to the fees charged by mutual fund providers, but it is a small fraction of the almost 2% to 2.5% fee that you incur for actively managed equity funds.
Even while a 2% annual fund management fee seems little, compound interest causes it to add up to a significant amount over time. Here’s the perspective: You will pay around Rs. 19 lakh in fund management costs over a 25-year period if you invest monthly SIP of Rs. 5,000 in a mutual fund that charges 2% annually. Investing the same money in the NPS will only cost you Rs. 1 lakh over 25 years, presuming the NPS’ maximum fund administration charge of 0.09%. The investor receives larger returns as a result of the relatively cheap fees. For this reason, over the last ten years, NPS equities funds have consistently outperformed the large-cap mutual fund category.
Also, if you do not wish to keep your money in the NPS until you reach the age of 60, you can choose the NPS Tier II option, which provides no tax benefits on contributions but no limits on withdrawals as well. You can make an investment today and take the money out the next day. Furthermore, there is no exit fee for NPS.
However, one might argue that since debt mutual funds could be less expensive than equity mutual funds, we should choose them over NPS. Even while debt funds have lower fund management fees (0.5–1.25%) than equity funds, they are still unable to meet the ultra-low costs of NPS debt funds.
For this reason, NPS debt funds have outperformed debt mutual fund schemes.
Only those with a standard Tier I account are eligible to invest in the NPS Tier II. Investors should be aware that funding an NPS Tier II account has no tax advantages.
2. Exclusive tax benefits:
While there is no tax advantage for investments made in the NPS Tier II, there are several tax benefits available in the Tier I option. With NPS, tax savings may be achieved in three ways. First of all, under Section 80C, contributions to the NPS scheme can be tax deducted up to the whole 1.5 lakh maximum limit. Then, an extra Rs. 50,000 is deducted for contributions made under Section 80CCD (1b). This is unique to the NPS and goes beyond the Section 80C deduction. By investing Rs. 50,000 in NPS, taxpayers in the 30% tax band can save up to Rs. 15,600 in tax. Hence, the net cash outflow for the investor will only be Rs. 34,400 if the tax savings are taken into account.
An individual’s tax outflow may be more significantly benefited by the third method of tax savings through the NPS. That is, upto 10% of the basic salary contributed to NPS is tax-free under Section 80CCD(2). For instance, if an individual receives a basic salary of Rs. 30,000 per month, his employer may deduct Rs. 3,000 from taxable emolument and submit that sum to the NPS scheme on his behalf each month. The employee’s yearly tax would be lowered by Rs. 11,232, thanks to the Rs. 36,000 that was contributed to the NPS. However, this NPS payment may only be made through the employee’s organization and need to be included in the individual’s emoluments. By the way, the new tax regime also allows for this deduction under Section 80CCD(2).
Having said that, tax savings should not be the only consideration when it comes to retirement planning. We must view NPS as a comprehensive retirement package rather than merely a way to save taxes.
3. Increased options for NPS investors to invest-in:
There are now 11 pension fund managers available to NPS investors. In addition, they have the option to switch their pension fund manager once a year. As we see in mutual funds, investors in NPS have the option to switch fund managers from the top performers because pension fund managers’ performance varies among categories. This was not the case for NPS investors before, but the PFRDA modified the regulations in November 2023, allowing investors to make investments in the best-performing pension funds across several asset classes.
4. Flexibility has increased in NPS scheme:
Furthermore, the NPS is now more flexible. Up to four asset mix changes are permitted for investors each year in NPS. The greatest benefit is that there won’t be any tax repercussions if you change your pension fund manager or asset class. This is in contrast to mutual funds, as moving between mutual funds is regarded as a sale, and any profit is subject to taxes.
Aside from that, NPS equity funds used to only invest in index-based equities. However, since 2021, the PFRDA permitted investing in the top 200 (market cap) stocks of the Indian stock market. As a result, pension funds may invest in stocks with long-term potential and have access to a wider market.
Also, you have more options when choosing your asset mix. Many investors were upset with the 50% cap on stock participation in NPS, but it has eventually been expanded to 75%. Both younger investors and those with a greater tolerance for risk will benefit from this. Any of the three Lifecycle funds in the NPS scheme, which alter the asset mix over time as the subscriber ages, are suitable for those who are not particularly knowledgeable about investing. The only meaningful asset allocation product that adjusts the allocation automatically as the investor ages is these lifecycle funds. NPS’s lifecycle funds are ideal for investors who lack the time or expertise to choose how to allocate the money they have.
Furthermore, until they are 70, investors are permitted to keep making contributions to the NPS. Moreover, they can postpone taking out the 60% tax-free amount until they are 75 years old. This implies that even if an investor keeps taking money out of the corpus, he will still be able to take advantage of the NPS’s low cost structure far beyond his retirement.
5. NPS has become more liquid with the changes in rules:
It’s not always the case that investing in the NPS locks up funds until retirement. Similar to the Provident Fund, withdrawals are permitted for certain purposes, such as emergency, marriage or child education, and house construction or house purchase. However, withdrawals are only permitted three times over the duration of the NPS account and only if you have been a member of NPS for at least three years. I have tried to jot down the withdrawal rules of NPS here below for your ease of reference:
- Partial Withdrawal – After three years, the subscriber may withdraw 25% of his or her own payments for defined reasons such as illness, disability, child schooling or marriage, property purchase, or the launch of a new company. A subscriber can make partial withdrawals up to three times throughout his or her NPS tenure.
- Premature Withdrawal – After 5 years or before the completion of 3 years (if the subscriber joined NPS after reaching 60 years of age), the subscriber can take up to 20% of the corpus as a lumpsum payment, and the remaining 80% must be used to purchase an annuity plan to get the pension. If the cumulative corpus is less than Rs. 2.5 lakh, the full amount is paid in a lump sum to the subscriber.
- Normal Withdrawal – On reaching 60 years of age (if the subscriber had joined NPS before 60 years of age) or after three years (if the subscriber joined NPS after 60 years of age), the subscriber can withdraw up to 60% of the corpus as a lump sum, and the remaining 40% of the corpus is used to purchase an annuity plan to receive the pension. If the overall corpus is less than ₹5 lakhs, the full amount is given in a lump sum to the subscriber. In the event of a NPS subscriber’s death, the nominee/legal successor can withdraw the full accumulated amount. If the nominee or family members of the dead subscriber so wish, they can purchase an annuity as well.
