National Pension Scheme is a government initiated pension scheme, which is regulated by the Pension Fund Regulatory and Development Authority of India (PFRDA). The NPS scheme was specifically introduced to ensure the financial security of the individuals after retirement. The individual can make a regular contribution towards the NPS scheme during their working life and avail the benefit of regular income in form of annuity after retirement.
Along with the benefit of financial protection after retirement, the NPS scheme also offers the advantage of tax savings. With a current interest rate of 9%-12% this is one of the most lucrative option of investment for individuals who wants to create a financial cushion in the long-term and secure their retirement phase. Let’s read further to know in detail about the interest rate on NPS scheme.
NPS is a voluntary pension fund, which is regulated by the Pension Fund Regulatory and Development Authority of India. The individual can start contributing towards the NPS scheme with a minimum contribution of Rs. 6000 in a financial year, which can be paid as lump-sum or as monthly installment of Rs. 500. The contributed amount is invested in market-linked securities with an objective to create long-term investment return and is compounded annually.
Currently the NPS interest rate ranges between 9%- 12%. Any Indian citizen between the age group of minimum 18 years to a maximum of 60 years can subscriber for the scheme. The maturity age of the scheme can be further extended up to 70 years. In case of specific situation such as buying home, treatment of any critical illness, or for sponsoring child’s higher education, the subscribers can make a partial withdrawal up to 25% of the fund after completion of 3 years of scheme from the date of opening the scheme.
The returns or interest from the national pension scheme depends on the contribution made towards the scheme and the asset classes chosen. The returns generate on NPS investment are market-linked, as the money is invested in equities and debt. Based on the asset class chosen by the subscriber and the amount of contribution made by the them, the interest is applicable. As compared to other investment options available in the market, NPS offers a profitable return and provides a opportunity to accumulate wealth in the long-term.
The higher contribution an individual make towards the scheme, the higher retirement corpus they can create over a specific tenure. Moreover, the advantage of power of compounding makes NPS a lucrative option of retirement planning.
The interest rate on NPS is computed based on monthly compounding. Let’s see an example to understand it in a much better way. Ms. Richa is 25 years old and want to invest Rs. 5,000 per month in the NPS scheme. The expected rate of return is 10%, she desires to retire at the age 60 years. As per the NPS rules, she uses 40% of the corpus to purchase annuity at the age of 60 years.
The accumulated corpus for Ms. Richa at the age 60 can be computed using the Future Value of Annuity(FVA)
P= INR 5000
r= 10% per year or 0.83% per month
n= 420 months ( 35 years until retirement)
FVA= INR 1, 89, 83,190.26
The contribution made s INR 21 lakh and the interest earned is INR 1. 68cr.
Out of INR 1.89Cr, 40% is used to purchase an annuity that is INR 75.93 lakhs. The accumulated sum Ms. Richa will receive after attaining the age of 60 is INR 1.13 Cr. This sum will be 60% of the retirement corpus, which is entirely tax exempted. The rest 40% of the accumulated sum used to purchase annuity will be given to Ms Richa as monthly pension for the tenure chosen by her.
The subscriber can use the NPS calculator to evaluate the retirement corpus, interest earned on it, the amount used to purchase annuity and expected monthly pension from an annuity.
The contribution made towards the NPS scheme is qualified for tax exemption under Section 80C of the Income Tax Act. Thus, the subscriber can claim a tax exemption up to a maximum of Rs.1 .5 lakh is a financial year. Moreover, the subscribers can also claim a tax exemption on investment up to Rs. 50,000 over and above the limit of Rs. 1.5 lakh in a financial year U/S 80CCD (1b). Also, U/S 80CCD (2) the subscriber can claim an additional limit on the contribution up to 10% of the basic salary of the employee made by the employer. However, the add-on deduction is applicable only for employees and there is no upper limit on that.
For financial year 2020-2021, the taxation of NPS scheme has been revised by the government. The entire 60% of the withdrawal amount on maturity is entirely tax-exempted. Earlier out of 60%, only 40% was tax exempted. The rest 20% was taxed as per the IT slab rate of the subscriber.