How does National Pension Scheme work?

Posted by neha sharma on May 26th, 2019

The National Pension Scheme (NPS) is a scheme to help the contributors build a corpus for their retirement. Under this scheme, regular contributions made have to be invested in different funds. The funds will mature when the subscriber reaches 60 years of age. At that time, the corpus can be used to buy an annuity plan that will provide a monthly pension.

Who can open an NPS account?


Anyone between the age of 18 years to 65 years can invest in the NPS. A special NPS account has to be opened in either the post office or a bank branch. The account can be opened online through the National Pension Scheme website or offline through a Point of Presence Service Provider (POP-SP)

Types of NPS accounts:


There are two types of NPS accounts: Tier I and Tier II accounts.

Tier I account:

A Tier I account is the basic mandatory account that has to be opened for the purpose of the National Pension Scheme. Investments made into this account qualify for a tax benefit under Section 80CCD. The investments made in this account are locked in till the time the subscriber reaches retirement. This account is charged the account opening and account maintenance fees. The minimum contribution under this account is Rs. 500.

Tier II account:


This account is an optional account that can be opened under this scheme. The minimum investment in this account is Rs.1,000. The funds in this account can be withdrawn at any time. However, since this is an optional account, no tax benefit is available on this.

Tax benefits on NPS:


Any investments made in the NPS get a tax benefit under Section 80CCD of the Income Tax Act up to Rs. 50,000. This is available only on the Tier I account. Furthermore, on maturity, 60% of the corpus can be withdrawn while 40% has to be used to purchase an annuity plan. The 60% of corpus that is withdrawn is completely tax free.

Where to invest?


The subscriber to the scheme gets different choices to invest funds in. Either the subscriber can be active, which means he handles all the investments, or be passive, where the National Pension Scheme switches investments between funds depending on the age of the subscriber.

The different asset classes available are:

  • Equity or E
  • Corporate Bonds or C
  • Government Securities or G
  • Alternative Investment Funds or A

The investment in these funds can be made based on the risk tolerance of the investor. Switching between these funds is also possible.

NPS withdrawals:


Withdrawals from the NPS can be made pre retirement, on retirement and defer the withdrawal till the time the subscriber reaches 70 years of age.

Premature withdrawals can be made only after the NPS account is 3 years old. This withdrawal is restricted to 25% of the subscriber’s contributions. No tax is charged on these withdrawals. These partial withdrawals are only allowed 3 times during the scheme’s operation. The minimum gap between such withdrawals must be 5 years old.

On maturity, 40% of the proceeds have to be used to purchase a plan that will give the subscriber a monthly pension. 60% of the corpus can be withdrawn tax free.

On the other hand, the subscriber can defer withdrawal and stay invested till the time he reaches 70 years of age. On reaching 70 years of age, 60% corpus can be withdrawn and 40% has to be used to purchase an annuity plan.

What to do in case of death of the subscriber?


In case of death of the subscriber, 100% of the proceeds accumulated in the National Pension Scheme account are allowed to be withdrawn without any conditions.

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neha sharma

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neha sharma
Joined: April 18th, 2019
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