An investment plan where a small part of the current income is invested and accumulated for old age needs is a helpful source of income. The National Pension Scheme (NPS) is one such investment plan. In addition to encouraging a disciplined approach to saving, NPS returns help create a corpus that will allow financial security in old age. Before we explore how NPS returns function in greater detail, let’s briefly understand its meaning.Read more
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The National Pension Scheme is a voluntary retirement scheme managed and controlled by the PFRDA under the Finance Ministry. This pension scheme aims to ensure retirement security for all citizens in the country. An individual invests a certain amount as per their will into funds or assets of their choice and then earns NPS returns on those investments.
With the combination of comfort, convenience, flexibility, portability, and taxation benefits in one scheme, it is one of the ideal financial tools for post-retirement security in the market.
Those who invest in the National Pension Scheme not only create savings but also earn returns for a better future. But how do individuals earn NPS returns on such investments?
To invest in a National Pension Scheme, you must open a Tier I NPS account and comply with KYC (Know Your Customer) requirements.
NPS has four asset classes:
Individuals have the option of splitting their money between these assets according to their wishes. However, a person may leave the decision to the pension fund managers if they do not wish to exercise this option themselves.
The pension fund managers, selected for their expertise and credibility, will allocate investments according to investors’ risk profiles. It is important to remember that these investments cannot be made in small-cap or foreign companies.
Currently, eight pension fund managers are approved by the government. While the government selects the fund managers for government employees (state or central), all individuals can choose their preferred pension fund manager.
The NPS returns depend entirely on the selected asset classes and pension fund managers. No interest rate is attached to the NPS returns. The growth of the respective assets along with the pension fund management over time dictates the overall returns on the scheme. Therefore, we can also say that NPS returns are market-linked returns.
Like all investments, taxation rules need to be considered before investing in the National Pension Scheme. The NPS returns are taxed according to the withdrawal rules of Tier I and Tier II NPS accounts.
Following are the withdrawal rules of both of the accounts:
Tier I NPS account rules stipulate that an individual cannot withdraw money from the retirement account until they turn 60. Funds accumulated in the account are not taxable.
However, if a person withdraws 25% of the corpus for purchasing a home, treating critical medical issues, or investing in children’s education, then he/she is permitted to withdraw the funds even before he/she is 60 years of age and they will not be taxed. The remaining balance will be used for purchasing annuities and will be subject to tax.
A person can only withdraw 60% of the total corpus of an NPS retirement account if they want to receive tax-free returns after 60 years of age. The remaining 40% is invested in annuities to earn NPS returns to provide regular monthly pensions for the individual’s lifetime. The income earned from NPS returns from this annuity will be taxable.
If individuals need to withdraw money for a different purpose not mentioned above, there are two conditions:
NPS schemes should be active for a minimum of three years.
A maximum of 20% of the corpus amount may be withdrawn, and this amount will be taxed at the individual tax slab rate. The remaining 80% of the annuity will also be taxed at the slab rate.
Although Tier II NPS accounts allow flexible withdrawals without age restrictions, except government employees, they don’t offer any tax benefits. The government employees can’t withdraw funds before a period of three years.
A person must fall between the age of 18 to 60 years to enroll and receive benefits of the scheme. An NPS calculator gives an overview of the amount the investor will accumulate at maturity, interest earned, and the monthly pension. Additionally, the calculator displays the amount withdrawn and the amount to be reinvested.
The investor must enter the following information into the calculator:
Age - current and expected retirement date
Desired NPS returns on investment
Rate of interest on the principal amount
Percentage of investment in annuity plan (minimum 40%)
Today, you can use online NPS returns calculators to estimate how much you may earn from a given NPS scheme. If you have any doubts, you can also speak to a financial advisor and understand the suitable NPS scheme for you. You must always do your research before making any investment.
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