National Pension Scheme
The National Pension System (NPS) is a defined-contribution-based pension system launched by the Government of India with effect from 1 January 2004. Like most other developing countries, India did not have a universal social-security system to protect the elderly against economic deprivation. As a first step towards instituting pension reforms, the Government of India moved from a defined-benefit pension to a defined-contribution-based pension system. Apart from offering a wide gamut of investment options to employees, this scheme helps the Government of India to reduce its pension liabilities. Unlike existing pension fund of the Government of India that offered assured benefits, NPS has defined contribution and individuals can decide where to invest their money. The scheme is structured into two tiers:
- Tier-I account: This NPS account does not allow premature withdrawal and is available to all citizens from 1 May 2009.
- Tier-II account: This NPS account permits withdrawal for exceptional reasons only, prior to the retirement age.
Since 1 April 2008, the pension contributions of Central Government employees covered by the National Pension System (NPS) are being invested by professional Pension Fund Managers in line with investment guidelines of government applicable to non-Government Provident Funds. A majority of state governments have also shifted to the defined contribution based National Pension System from varying dates. Twenty-nine state/UT governments have notified the NPS for their new employees. Of these, five states have already signed agreements with the intermediaries of the NPS architecture appointed by Pension Fund Regulatory and Development Authority (PFRDA) for the implementation of the National Pension System. The other states are in the process of finalization of documentation.
The Pension Fund Regulatory and Development Authority (PFRDA) was established by the Government of India on 23 August 2003 to promote old age income security by establishing, developing and regulating pension funds and is the prudential regulator for the NPS for the past 11 years, covering 95 Lakh subscribers from Central Government and State Governments.
Coverage and eligibility
NPS is open to all citizens of India on voluntary basis and is mandatory for employees of central government (except armed forces) appointed on or after 1 January 2004. All Indian citizens between the age of 18 and 55 can join the NPS.
Tier-I is mandatory for all government servants joining government service on or after 1 January 2004. In Tier I, government servants will have to make a contribution of 10% of his Basic Pay, GP and DA which will be deducted from his salary bill every month. The government will make an equal contribution. Since 1 April 2008, the pension contributions of Central Government employees covered by the NPS are being invested by professional Pension Fund Managers in line with investment guidelines of the Government. However, there will be no contribution from the Government in respect of individuals who are not government employees. The contributions and returns thereon would be deposited in a non-withdrawable pension account.
In addition to the above pension account, each individual can have a voluntary tier-II withdrawable account at his option. Government will make no contribution into this account. These assets would be managed in the same manner as the pension. The accumulations in this account can be withdrawn anytime without assigning any reason. It is estimated that 8 crore Indian citizens are eligible to join the NPS.
NPS utilizes the network of bank branches and post offices to collect contributions and ensure that there is a seamless transfer of accumulations in case of change of employment and/or location of the subscriber. It offers a basket of investment choices and Fund managers. The Government appointed PFRDA Board of Trustees meet every three months to review the functioning of NPS architecture.
The subscribers have the choice of one or more Central Recordkeeping Agency (CRA), several Pension Fund Managers (PFMs) and different categories of schemes. PFMs share a common CRA infrastructure and invest the money in three asset classes such as equity (E), government securities (G) and debt instruments that entail credit risk (C), including corporate bonds and fixed deposits.
PFRDA has set the following guidelines with regard to subscriber contribution:
- Minimum amount per contribution: Rs. 500 per month
- Minimum number of contributions: 1 in a year
- Minimum annual contribution: Rs 6,000 in each subscriber account.
If the subscriber is unable to contribute the minimum annual contribution, a default penalty of Rs.100 per year of default is levied and the account becomes dormant. In order to re-activate the account, subscriber has to pay the minimum contribution, along with penalty due. A dormant account is closed when the account value becomes nil subject to deductions in the from of penalties.
Under the investment guidelines finalized for the NPS, pension fund managers manage three separate schemes, each investing in a different asset class. The three asset classes are equity, government securities and credit risk-bearing fixed income instruments. The subscriber has the option to decide as to how the NPS pension wealth is to be invested in three asset classes:
- E Class: Investment primarily in Equity market instruments. It invests in Index funds that replicate the portfolio of either BSE Sensitive index or NSE Nifty 50 index.
- G Class: Investment in government securities like GOI bonds and state government bonds.
- C Class: Investment in fixed-income securities other than government securities such as:
- Liquid Funds of AMCs regulated by SEBI with filters suggested by the Expert Group.
- Fixed deposits of scheduled commercial banks with filters.
- Debt securities with maturity of not less than three years tenure issued by corporate bodies, including scheduled commercial banks and public financial institutions.
- Credit-rated public financial institutions/PSU bonds.
- Credit-rated municipal bonds/infrastructure bonds.
The Minimum Guarantee Clause of PFRDA Act of 2013:- As per the Chapter VI of National Pension System, Rule 20, Clause 2(4)(a), the subscriber has an option of investing up to 100 percent of his funds in government securities only and also as per clause 2(4)(b),the subscriber seeking minimum assured returns, has an option to invest his funds in such schemes providing minimum assured returns as may be notified by the authority; as mentioned above in G Class and C Class minimum guaranteed bonds, securities and time deposits of definite nature.
In case the subscriber does not exercise any choice with regard to asset allocation, the contribution is invested in accordance with the ‘Auto choice’ option. In this option, the investment is determined by a predefined portfolio. At the lowest age of entry (18 years), the auto choice entails investment of 50% of pension wealth in "E" Class, 30% in "C" Class and 20% in "G" Class. These ratios of investment remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in "E" and "C" asset classes decreases and the weight in "G" class increases annually till it reaches 10% in " E", 10% in "C" and 80% in " G" class at age 55.
|Class||Till the of age 35 years||At age of 45 years||At age 55 Years|
NPS levies a nominal investment management charge of 0.00010% on net AUM (asset under management). This is significantly lower as compared to charges levied by mutual funds or other investment products. Initial charge of opening an account is Rs. 470 and from the second year onwards, the minimum charge is Rs. 350 a year, as per the offer document of NPS.
If subscriber exit before 60 years of age, subject to Voluntary Retirement Scheme (VRS), they have to invest 80% of accumulated saving to purchase a life annuity from an Insurance Regulatory and Development Authority (IRDA) regulated life insurer. The remaining 20% is eligible for withdrawal as a lump sum. On exit, after age 60 years from the pension system, the subscriber is required to invest at least 40% of pension wealth to purchase an annuity and remaining 60% will be repaid as a lump sum. In the case of government employees, the annuity provides for pension for the lifetime of the employee and his dependent parents and spouse at the time of retirement.
If subscriber does not exit the system at or before 70 years, account is closed and the benefits are transferred to subscriber in a single pay out. If a subscriber dies, the nominee has the option to receive the entire pension wealth as a lump sum.
Recent changes permit the subscriber to continue to remain invested after 60 and up to 70 but subscriber is not allowed to add further investments. If the subscriber does not exit by 70, the entire lump sum will be monetised and transferred to the subscriber's bank account as a full and final settlement.
The offer document of NPS does not specify the tax benefits in elaborate manner. It specifies "Tax benefits would be applicable as per Income Tax Act, 1961 as amended from time to time." As per the current provisions, the withdrawals under the NPS attract tax under the EET (exempt-exempt-taxable) system, which means that while contributions and returns to the NPS are exempt up to a limit, withdrawals are taxable as normal income (EET).
While the NPS subscribers are directly benefited from one of these Income tax concessions, the second one is beneficial to the employers who contribute for NPS each month equivalent to employees contribution in Tier I.
Income tax concession to Employees under NPS:
Just as the contribution made by a National Pension System subscriber in Tier I scheme of the NPS is deductible from the total income under Section 80CCD of the Income Tax Act, the contribution made by the employer for the employee is also deductible under Section 80CCD. However, the aggregate deduction under Section 80C, 80CCC and 80CCD is fixed at Rs. 1.5 lakh. The total eligible deduction under Section 80C, 80CCC and Section 80CCD, such as LIC premium, PPF, bank or NSC deposits, ELSS and NPS for the subscriber is also pegged at Rs.1.5 lakh.
However, the Finance Act, 2011 amended section 80CCE so as to provide that the contribution made by the central government or any other employer to the pension scheme under section 80CCD shall be excluded from the limit of 1.5 lakh rupees provided under section 80CCE. This proposal is effective from the assessment year 2012–13 (financial year 2011–12) and totally exempts employer's contribution in NPS from the income tax on the employee.
Income tax concession to Employers under NPS:
The Finance Act, 2011 amended section 36 so as to provide that any sum paid by the assessee as an employer by way of contribution towards a pension National Pension System(NPS) to the extent it does not exceed ten per cent of the salary of the employee, shall be allowed as deduction in computing the income under the head "Profits and gains of business or profession". This amendment is effective from 1 April 2012 and is applicable to the assessment year 2012–13 (for the income earned in the financial year 2011–12) and subsequent years.
Past investment returns
The NPS architecture has been managing the NPS fund since Jan 2004.Over Rs. 2 Lakh Crores is invested as corpus of All Sector Employees [Public&Private]. In 2013–14, as per audited results of the Pension Funds, the average weighted return on the corpus was over 12.5% on the NPS corpus. According to the latest data released by the PFRDA on 15 May 2014, return on investment is as low as 8.38% in case of those private sector employees, who opted for investments in Equities, the most aggressive of all categories. The performance of the eight pension fund managers for the central government employees indicate that the returns on subscribers' contributions under NPS ranged between 8% and 14% during 2013–14. The Six Fund Categories are: 1. Central Government, 2. State Governments, 3. Swavalamban, 4. Private equity, 5. Private corporate debt and 6. Private government debt; and the eight PFMs are: 1. SBI Pension Fund, 2. UTI Retirement Solutions, 3. LIC Pension Fund, 4. Kotak Mahindra Pension Fund, 5. Reliance Capital Pension Fund, 6. ICICI Prudential Pension Fund, 7. HDFC Pension Management Company and 8. DSP BlackRock Pension Fund.
Swavalamban Yojana – As mentioned in the operating guidelines issued by MoF, "Government will contribute Rs. 1000 per year to each NPS account opened in the year 2010–11 and for the next four years, that is, 2011–12, 2012–13, 2013–14 and 2014–15. As a special case and in recognition of their faith in the NPS, all NPS accounts opened in 2009–10 will be entitled to the benefit of government contribution under this scheme as if they were opened as new accounts in 2010–11 subject to the condition that they fulfill all the eligibility criteria prescribed under these guidelines."
Accordingly, the basic eligibility criteria for joining the Swavalamban Yojana for a subscriber is:
- Permanent Retirement Account to be opened in the year 2009–10 or 2010–11.
- Minimum contribution to be Rs. 1,000 per annum (Financial year) in Tier I account and maximum contribution to be Rs. 12,000 per annum (Financial year) in both Tier I and Tier II accounts together.
- FAQ for Pensioners
- India's pension reforms: A case study in complex institutional change by Surendra Dave, page 149–170 in `Documenting reforms: Case studies from India', edited by S. Narayan, Macmillan India, 2006.
- Indian pension reform: A sustainable and scalable approach by Ajay Shah, Chapter 7 in `Managing globalisation: Lessons from China and India', edited by David A. Kelly, Ramkishen S. Rajan and Gillian H. L. Goh, World Scientific, 2006.
- NPS vs MFs
- The Gazzette of India