The National Pension System (NPS) is a great scheme to save tax and build massive wealth for retirement.
Millennials don’t save money the traditional way, which is with fixed deposits and recurring deposits. They tend to look at the investments that provide multiple benefits, such as tax saving funds.
Think of NPS as a forced-saving account. Once you deposit your money, it is locked until you hit 60 years of age, well kind of.
This is why it isn’t as cool as stocks or mutual funds, but it is way better for average investors.
Here are 6 benefits of having an NPS account.
Guaranteed Returns When You Play Safe
An NPS will yield you guaranteed returns if you choose not to invest aggressively in the high-risk funds.
The NPS allows you to put your money into equity. Your corpus money is shared between four categories of assets which are Government Bonds, Equity stocks, Corporate debt, and Alternative Investment Funds.
To make it easier for beginners, NPS contribution allocation has two choices:
When you start an Auto-choice NPS account, you have the following investment options to choose from:
Choosing Moderate investment will divide 50% of your contribution to high-risk equity funds. As your age gets older, the percentage of your contributions allocating to equity markets lower down.
Choosing the Conservative investment approach is what I call playing safe. As a conservative mindest would do, only 25% of your contributions are allocated to equity funds. This too gets lowered down as you grow older.
The aggressive investment approach comes with the highest risk as well as higher returns. This approach is for people who have accomplished their certain goals look forward to living like king even when retired. Going Aggresive will allocate 75% fo your contributions to the equity market.
The Active-choice allows you to specify how much you would like to invest in each asset category. You can choose to go up to 30% in equity, 100% on Government Bonds, and 100% on Corporate Debt.
By not choosing to invest more in equity and allocating your funds in Debt assets and Government Bonds, you can ensure decent returns in the long term. In any case, that would be better than FDs and Liquid Mutual Funds.
There are two tiers of NPS:
- Tier – I
- Tier – II
Any contributions in the Tier – I account is locked for a minimum of 3 years of continuous contribution. This a true retirement account, similar to the Roth IRA in the US.
Once you put any money in the Tier – I NPS account, it stays there until you attain 60 years of age. There’s no way you can withdraw more than 25% of the money from your retirement corpus.
This kind of forced savings is highly effective especially when you are someone who has a bad habit of spending money from a savings account.
Your money, if you choose to invest with a Conservative approach is invested in Government Bonds and Corporate Debt. Both of these two assets are more secured and safe from getting negative returns in the long term.
Now The Tier – II account is liquid. You can deposit and withdraw as much as you want, without restrictions.
Since Tier – II is a voluntary investment option, the Tax rebate isn’t appliable to the money you deposit in it.
You are free to choose and change your fund manager or the asset allocation percentage twice a year. In both tiers.
Remember to deposit any money that’s leftover after all your required expenses in the Tier – I NPS account. You don’t want any emergency money in it because you won’t be able to access them when you need them the most.
With the Tier – I NPS account, you can save up to 2,00,000 INR on your income tax every fiscal year.
You can claim up to 1,50,000 under section 80 CCD (1)and addittional 50,000 for subscribers under 80CCD (1B).
When you turn 60 you are allowed to withdraw up to 60% of your entire corpus. The rest 40% is withheld for you to receive regular pensions every month.
When you withdraw the funds, your retirement corpus (your total investment amount) will not be taxed as a whole. The 40% of the total amount os taxed as by the government under regular income tax tables of the fiscal year.
The rest 60% that you can withdraw will be tax-free.
And that’s a huge benefit of investing in NPS. Not only you save 2,00,000 every year tax, you’ll have plenty of tax to spend in your sixties. Without worrying about any tax management.
Let’s take another look at both, Tier – I and Tier – II of an NPS account.
Tier – I help you build a retirement fund by not letting you withdraw any funds for the first 10 years. It doesn’t allow you to withdraw any funds until you hit 60 years unless:
- You plan to buy your first home
- Have critical illness
- Need money for causes like higher education, marriage of children
Your corpus should be equal or more than 1,00,000 to make a withdrawal from Tier – I account. And you have to make at least 6,000 INR every year to keep your NPS account active.
There is very little liquidity in the Tier – I but still, you can withdraw funds when you need them for a special cause. The withdrawal process takes time so, you’ll need to do a little bit of planning beforehand.
This should also remind you to not invest any money you plan to use in the near future, like in the next 5 years.
Now take a look at Tier – II, the voluntary NPS account.
Tier – II allows you to contribute as much money you want. And also withdraw as much you want, whenever you want.
There are no restrictions on Tier – II accounts. It’s pretty much liquid money invested in the same asset categories as Tier – I.
It’s just that you won’t receive any monthly pension from Tier – II. So, if your plan is to build a corpus to receive monthly pensions in your old days, choose Tier – I.
For short term goals, Tier – II is the one to choose.
High Returns & Compounding Effect
With an Aggressive investment approach, you are looking at an above-average and possibly very high returns depending on the market.
By investing more than 75% of your contributions in Equity funds, the returns could be well above 10%.
Surely higher than liquid Mutual funds and Debt funds.
Another benefit of investing regularly in NPS is compounding your return on investments.
Considering you are starting an NPS account at the age of 25, In a span of 35 years, your contributions of 1,000 per month will become 38,28,277 if we take an average interest of 10%.
And your actual investment for the span of 35 years equals to 4,20,000. That’s nearly 10X of your actual investment.
In my case, I’ve been contributing to my NPS since I was 18 years old. That means my contribution of 1,000 (I contribute more) every month will become 70,57,183 on the same 10% interest.
So, you’ve got a valid reason now to start early.
No Cap On Investment in Tier 2
There is no cap on how much you can invest in the tier 2 NPS account.
Tier – II doesn’t have any threshold where you can’t deposit any more funds.
Whatever money you’ve left after building your emergency funds, stock purchases, security pay-offs and expenses can be deposited in NPS Tier – II.
You can easily withdraw this money at any time. Switch investment scheme or transfer to NPS Tier – I account. You can set up weekly standing instructions and watch your investment grow on autopilot.
Keep in mind, money deposited and interest earned from Tier – II NPS account is taxable.
There are certainly many benefits of an NPS account that make you consider having one.
It’s a nice way to save extra money and plan for your retirement and future where you know you’ll need money to live a happy old life.
Any questions? Let us know in the comments.