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The National Pension System or NPS is a voluntary retirement planning scheme available for the citizens of India. This scheme was launched by the Government of India in January 2004 to help Government employees create a corpus for their retirement. However, in 2009, the NPS scheme was opened to all sections.
You can invest in the NPS to create a corpus and ensure a regular stream of income after your retirement. You can also receive certain tax benefits under Section 80C of the Income Tax Act of 1961 by investing in NPS. But many people are sceptical about the tax exemptions available on the NPS investments and returns.
In this article, we will discuss in detail the NPS, the expected rate of return on NPS investments, and whether NPS returns on maturity are taxable or not. Let’s get started with what NPS is first.
What is NPS?
As mentioned, NPS is a government-backed retirement planning tool in which you can invest your money to create a corpus for your retirement. It is a market-linked investment instrument, and that is why your money invested in NPS gets invested in a combination of debt and equity. A professional pension fund manager manages the money invested in the NPS.
As an investor, you can choose between the Auto Mode and Active Mode. When you choose the Active Mode, you have the freedom to manage your investments on your own by switching between debt and equity. However, if you choose the Auto mode, your pension fund manager automatically switches between securities to ensure maximum returns on your investments.
As per the current NPS rules, you can start investing in NPS by contributing at least ₹6000 every financial year (minimum ₹500 per contribution) till its maturity, i.e., your retirement age. At the time of maturity, you can withdraw up to 60% of the accumulated corpus, and the remaining amount will be used to provide you with a regular monthly income after your retirement.
When you invest in NPS, you have the flexibility to choose between seven pension fund managers and a Tier I or Tier II scheme. Depending upon the type of scheme and fund manager chosen by you, your NPS return rate may vary between 9 to 12 percent. You can use our online NPS return calculator to determine approximate long-term returns on your NPS investments.
Types of NPS Accounts
There are two types of NPS accounts – Tier I NPS account and Tier II NPS account. While a Tier I account is mandatory if you want to invest in NPS, Tier II is a voluntary savings account where you can park your money just like a savings bank account. Unlike a Tier I account,a Tier II account offers you more flexibility in terms of withdrawal.
While a Tier I account comes with a minimum lock-in period of three years, a Tier II account has no such provisions. You can invest and withdraw your money from a Tier II account anytime without any restrictions. NPS Tier II return calculator works in the same way as it does for NPS Tier I account.
Tax Provisions on NPS Returns
By investing in an NPS Tier I account, you can claim tax deductions of up to ₹2 lakh every financial year under various sub-sections of Section 80C of the Income Tax Act. However, no tax benefits are available forNPS Tier II accounts since they act as only a savings scheme and don’t necessarily help in retirement planning.
Now, let’s talk about whether NPS returns on maturity are taxable or not. Since NPS qualifies under the Exempt-Exempt-Exempt (EEE) category investment plan, its returns are tax-free for investors. To qualify for the EEE category, an investment instrument must fulfil these conditions:
- The amount of the investment should be available for tax deductions
- The income earned from the investment should be exempted from income tax
- No tax should be applicable on maturity proceeds
However, there is a little catch. As per existing NPS rules, up to 60% of the accumulated corpus can be withdrawn at maturity. The remaining amount is used to invest in annuities to provide you with a regular stream of income after your retirement. While no tax is applicable on the withdrawal of money upon maturity, money received as an annuity after your retirement is added to your taxable income.
For example, if the total accumulated corpus at maturity is ₹10 lakhs, you can withdraw up to 60%, i.e., ₹6 lakhs as non-taxable income. The remaining 40%, i.e., ₹4 lakhs, would be used to provide you annuity income, which could attract income tax.
To Conclude
NPS is a useful retirement planning tool. You can invest in it to get healthy returns. NPS rate of return is usually higher than most fixed-income instruments, such as Fixed Deposit and Public Provident Fund (PPF). Since NPS qualifies as an EEE-category investment instrument, the investments made in it, along with the maturity benefits, are non-taxable.
To know how NPS can help you build your retirement, click here.
