FRIDAY, MAY 03, 2024
Planning for retirement is an important part in every individual’s financial planning. There are very few financial instruments that are completely focused on retirement savings. Even though EPF and PPF are oriented towards saving, there is no compulsion to stay invested in them till you actually retire. However in the case of NPS, you are expected to stay invested till you retire. In order to provide an architecture to ensure systematic planning for retirement needs, the Government of India launched the ‘National Pension Scheme’ in 2004. This scheme was initially available exclusively for government employees. However in 2009, the scheme was made open to all including those working in the private sector. It is interesting to note that even the self-employed can take advantage of this scheme.It brings an attractive long term saving avenue to effectively plan your retirement through a safe and regulated market-based return.
Liquidity: NPS allows individuals to make systematic investments during their working life, via two accounts: Tier-I and Tier-II. The big difference between the two accounts is the withdrawal of money invested in them. The former functions as a pension account and withdrawal from it are subject to specific restrictions. There are conditions under which partial withdrawal is allowed earlier, in cases when the subscriber has a critical illness, or in need of money for children’s education, buying or constructing a house.
Tier-II account is voluntary providing liquidity for funds via investment and withdrawals. It can act as a savings account.
Since NPS is a pension product, you are expected to stay invested until your retirement. Investments done in NPS mature when the investor attains 60 years of age. On maturity, 60% of the accumulated wealth in the scheme is transferred to your bank account. This amount withdrawn on maturity is completely exempt from income tax on receipt. The remaining 40% is mandatorily used to purchase an annuity product. An annuity is a type of financial instrument that pays out a fixed and regular dividend. This amount invested will be used to pay the regular monthly pension to the investor. There is however an option to invest even more than 40% of the corpus in an annuity product. To take an example, at the age of 60, if the total accumulated wealth in NPS is Rs 20 lakh, a lump sum withdrawal of 60%, ie Rs 12 lakh is completely tax free. Further the amount used to purchase the annuity, ie 40% of the corpus will be tax free. Only the income generated from annuity that is received as pension every year will be taxable at slab rates in the hands of the pensioner.
If you are opting out of the scheme before the age of 60, withdrawal is allowed only up to 20% of the accumulated wealth. In this case, a minimum of 80% of the corpus must be used to buy an annuity. If the account holder dies before the age of 60, the entire accumulated wealth would be paid to the nominee.
Tax benefits of NPS:
As it is rightly said, few of us ever test our powers of deduction, except when filling out our income tax form. There is no escaping from paying taxes, but thankfully there are provisions to reduce the tax outflow that can soften the pinch.
During the investing stage, tax benefit under NPS can be claimed under 3 sections: 80CCD(1), 80CCD(1B) and 80CCD (2).
Tax benefit under 80CCD(1) is available on an individual’s own contribution to the NPS Tier-I account. The amount that can be claimed as a deduction under this section is limited to 10% of the salary including dearness allowance, (in case of salaried individuals) and 20% of the total income (in case of self-employed individuals). This deduction is however subject to an overall ceiling of Rs 1.5 lakh under section 80CCE.
NPS gained much attention as a retirement product after the government provided an additional benefit of Rs 50,000 under section 80CCD(1B) in Budget 2015. This deduction is available over and above the Rs 1.5 lakh. Thus when an individual exhausts the limitunder section 80CCE of Rs 1.5 lakh by making other eligible investments(other than NPS contribution), a further deduction can be claimed up to Rs 50,000 under section 80CCD(1B), thus taking the total deduction to Rs 2 lakh.
There is yet another benefit available only to salaried employees. 80CCD(2) pertains to contributions made by the employer into employee’s account to notified pension plan. Government employees can claim upto 14% of their salary including dearness allowance, while for private sector employees, it is capped at 10% of the salary including dearness allowance.
In the absence of suitable alternatives, an annuity is beneficial for people looking for fixed and regular income after retirement. Monthly cash flows serves this purpose, and they can use other investment options to counter inflation and other factors impacting their cost of living. If fixed income is your priority on retirement, an annuity could work for you.
Just like the hardworking ant, who stores food for the winter, we too need to put aside money now so we can enjoy the benefits of our hard work later. Waiting until you’re 60 to start saving isn’t the best option. Start early.
