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National Pension Scheme: Is NPS Still A Good Investment Option?

Thinking of investing in the National Pension Scheme (NPS)? Read this blog to understand how NPS investments work and if NPS benefits can set you up for retirement. You will also learn about alternatives to NPS investments that can help you retire with financial security.
May 7, 2021

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Retirement is an uphill battle for most people. Even government jobs no longer offer a pension and almost no private jobs offer retirement solutions for working professionals. 

This means you alone have to plan your finances for retirement. In fact, nearly 50% of urban Indians don’t have a plan for retirement. However, when you think of retirement, the National Pension Scheme comes to mind.

This story will help you understand what NPS is, how it works and delve into the benefits that it offers. We will also compare NPS to other popular investments that can be alternatives to an NPS investment.  

What Is The National Pension Scheme (NPS)?

The National Pension Scheme (NPS) is a government-backed investment option. Saving for retirement in India is difficult and that’s the problem the NPS aims to solve

NPS allows subscribers to voluntarily invest money in the scheme using an NPS account. This contribution can accumulate and earn interest over the course of time. 

NPS contributions follow a two-tier system:

1. Tier-I

A Tier-I NPS account will be opened by default whenever you invest in the NPS. The money you’ll invest will be locked in till you turn 60 but there are exceptions to this rule. 

For example, you can withdraw half the NPS investment in case you complete 25 years of service. The mandatory lock-in in NPS is enforced to ensure that you have money when you retire.  

Furthermore, you can claim a tax deduction on the contributions you make to your NPS account under Sections like 80C and 80CCD. You can read more about this in our blog: All You Need To Know To Save Tax In 2021

The Minimum Contribution To NPS Tier-I Account

  • ₹500 when you open the NPS account 
  • ₹1000 per year (excludes tax and fees)
  • At least 1 contribution per year

There are penalties in case the minimum contributions mentioned above are not met. Your NPS account may be frozen with restricted access to facilities in case you contribute less than ₹1000 a year.

The contribution boils down to a regular Systematic Investment Plan (SIP) that’s at the least yearly in the case of NPS. The inflexible nature of NPS may be a turn off for modern investors. 

2. Tier-II

You can voluntarily open a Tier-II NPS account if you have a Tier-I account. It doesn’t have a lock-in period and you’ll be free to withdraw your investment at any time. 

Furthermore, you can’t claim any tax deduction for the contributions made to a Tier-II NPS account. However, these flexible caveats don’t apply to government employees who want to claim tax benefits. 

Government employees will have to endure a 3-year lock-in period in case they want to claim tax deductions for the contributions they make to their Tier-II NPS account. 

The Minimum Contribution To NPS Tier-II Account

  • ₹1000 when you open the NPS Tier-II account 
  • ₹250 per year (excludes tax and fees)
  • No mandatory minimum transactions necessary

 

Parameter

Tier-I

Tier-II

Mandatory

Yes

No

Account Opening Contribution

₹500

₹1000

Minimum Yearly Contribution

₹1000

₹250

Minimum Yearly Transactions

1

-

How To Open An NPS Account?

You can open an NPS account online or offline. Here's how:

A. Offline NPS Account Opening

  • Visit a registered Point of Presence (POP)
  • Get the registration form
  • Fill the form
  • Attach KYC documents (photo ID, PAN, address proof, and others)
  • Submit the form

B. Online NPS Account Opening

  • Go to the NSDL website
  • Select "New Registration"
  • Choose desired options
  • Register with Aadhar (or Virtual ID)
  • Add relevant information (personal, bank a/c, etc)
  • Start investing

Who Can Open An NPS Account?

The NPS investment option is open to Indian citizens with valid KYC documents between the age of 18 to 65. NRIs can invest in the NPS as well. You must visit a Point of Presence - Service Providers to open the NPS account.

Benefits Of NPS Investment

1. Reasonable Returns

An NPS investment will give you exposure to pension funds, fixed income instruments, government securities, and others, that have generated reasonable historical returns between 8 to 10%. 

This may be better than other traditional assets like Fixed Deposits, Recurring Deposits, and PPF but it isn’t as lucrative as equity funds, international funds, and alternative investments.

 

Investment

Average Long Term Returns

NPS

8 to 10%

Equity Funds

9 to 12%

International Funds

12 to 15%

Alternative Investments

8.5 to 12%

2. Relatively Low Risk

The NPS investment is structured in a way that reduces your exposure to risk. Your NPS portfolio cannot have more than 75% exposure to equity. Equity exposure is capped at 50% for government employees.

This percentage reduces by 2.5% every year starting from when you turn 50. Furthermore, investors above the age of 60 can’t have more than 50% exposure to equity instruments. 

Overall, the NPS is known to carry relatively lower risk compared to stock and international investments but is comparatively riskier than traditional investment options. 

Either way, the trade-off reveals itself in the returns which are reasonably higher than traditional investment options but lower than equity and stock investment options.  

3. Tax Benefit

The NPS was introduced to help investors save for a life post-retirement. But there are other benefits to an NPS investment like tax exemptions. 

You can claim a tax deduction of up to ₹1,50,000 under Section 80C for your contributions towards your NPS account per financial year. Thus, NPS is a viable tax-saving option, but it is not particularly efficient. 

However, the devil lies in the details. The tax saving incentive is a by-product of the primary benefit of an NPS investment which is to help you save for retirement. 

The two can often be conflated and may lead to bad investment decisions.

4. You’re (Partially) In Control

You have the option to change your fund manager in case you’re unhappy with your NPS investment’s performance. This option is available for Tier-I and Tier-II accounts. 

NPS Investment V/s Mutual Funds, Stocks & P2P

 

Investment

Risk

Average Long Term Returns

Liquidity

NPS

Medium

8-10%

Low

Debt Funds

Low

7-9%

Medium

Equity Funds

Medium-High

9-12%

Medium

ELSS Funds

Medium

13-15%

Low

International Funds 

High

12-15%

Medium

US Stocks

High

9-15%

Low

P2P Lending 

Medium

12%

Medium-High

Consumer Loans via Merchants

Medium

8.15-9.5%

Medium-High

Asset Leasing

Medium

12% (post-tax)

Medium


Essentially you can plan for your retirement without investing in the NPS as well. A combination of the assets mentioned above (excluding NPS) can allow you to create a diverse portfolio of investments with better returns than an NPS investment. 

NPS Tax Benefits V/s ELSS Funds, Tax Saving FDs, PPF, EPF

 

Investment

Lock-In Period

Average Long Term Returns

Tax Savings Under Section 80C

Tax Savings Under Section 80CCD

NPS

Retirement 

8-10%

ELSS Funds

3 years

13-15%

Tax Saving FDs

5 years

5.5-7.5%

PPF

15 years

7.1%

EPF

Varies

8.5%

The table above shows that ELSS funds are comparatively more effective at saving tax and generating lucrative returns with a low lock-in period compared to other Section 80C investments. 

Read more about the tax-saving mistakes to avoid in 2021

Should You Invest In NPS?

The NPS offers reasonable returns and tax benefits. However, you must narrow down your reasons for making an NPS investment. Conflating tax saving and retirement planning can be detrimental to your financial goals and the potential of your investments.

Investors are known to explore alternatives to NPS like building the perfect portfolio. Either way, it would help to consult a trained financial professional so that you can understand what would help you save for retirement.

Frequently Asked Questions Around National Pension Scheme (NPS)

Q. What is the NPS scheme and benefits?

Ans. The National Pension Scheme (NPS) is an investment option that is designed to help you build wealth for life after retirement. NPS is backed by the government.

NPS has been known to offer benefits like reasonable returns (8-10%) and tax deductions of up to ₹1,50,000 at relatively low-risk compared to other traditional investments like FDs. 

Q. Is NPS better than PPF?

Ans. NPS has been known to generate better returns on average than PPF. Furthermore, it may give investors tax benefits across two categories, Section 80C and Section 80CCD. 

Q. Can I invest more than ₹50,000 in NPS?

Ans. Yes, you can invest more than ₹50,000 in NPS. There’s no upper limit or maximum investment ceiling on an NPS investment for salaried employees. 

However, self-employed individuals can only invest up to 20% of their gross income. Overall, you can claim a deduction of up to ₹1,50,000 for contributions made to NPS under Section 80C. 

Furthermore, you can claim a maximum deduction of ₹50,000 for contributions made to NPS under Section 80CCD. 

Watch this video to find out more about building the perfect portfolio


Shriram Shekhar
Shriram is a Consultant at CubeWealth. He has developed cutting edge IT products for over 2 years before turning to his passion for the written word. His love for philosophy, developing products, and empowering people through quality content is what got him to CubeWealth.

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