New pension scheme, National pension scheme, National pension system or whatever name you call it with is all the same. New pension scheme is a defined contribution scheme started by Government of India for the central government employees excepting the Armed forces with effect from 01 January ’2004; gradually state governments also adopted this system. Defined contribution means that unlike the old pension system, here the employee and employer (government) will make a defined contribution/deposit in the scheme (which is 10% of basic+DA) and at the time of retirement the pension/annuity can be purchased with the accumulated corpus in this account.
With Effect from 1st may’2009, NPS is available to all citizens of India who can contribute on voluntary basis.
NPS is a good but not so popular product. As it is a government’s initiative, the snail pace of its popularity is quite obvious.
Basic Features of New Pension scheme
- NPS is regulated by PFRDA. As SEBI is for Stock markets and Corporates, RBI is for banking, IRDA is for Insurance companies…the same way PFRDA (Pension Funds Regulatory and Development Authority) is for NPS. So don’t confuse this with another insurance company’s product.
- It is Open to All citizens of India in the age bracket of 18 – 60 years.
- Minimum contribution required is Rs 6000/- annually, with no limit on number of transactions (there are charges per Transaction).
- Minimum Transactions amount required is Rs 500/- .
- As this is strictly a pension product, so subscriber compulsorily has to Purchase life annuity with some specified restrictions/flexibility.
- It is very lost cost product. With a fund management charge of just 0.0009%, this product is perhaps world’s lowest cost pension scheme.
- Investment can be made in different Asset classes through 6 fund managers.
Working mechanism of new pension Scheme
It is very simple. It requires regular yearly/monthly/quarterly contribution from the subscriber and on maturity subscriber has to transfer the specified minimum corpus to any IRDA regulated Life insurance company to Purchase Life Annuity and balance can be withdrawn in Lump sum.
Types of Accounts in New pension Scheme
TIER 1 – This is the First account that subscriber has to opt for. Withdrawal in this account is permitted as per the above chart.
TIER 2 – This account can be opened only after TIER 2 account. Anytime withdrawal is permitted through this account. You may also transfer the funds from TIER 2 a/c to TIER 1 but not the other way round.
Investment style and Asset allocation in New pension scheme
Pension Portfolio Fund Managers
Right now there are 6 fund managers appointed under “All Citizens account” category. Subscriber can chose any of these for his investments. He’s also free to switch the funds from one fund manager to other without any extra charge.
- ICICI Prudential Pension Fund Management Company Limited
- IDFC Pension Fund Management Company Limited
- Kotak Mahindra Pension Fund Limited
- Reliance Capital Pension Fund Limited
- SBI Pension Funds Limited
- UTI Retirement Solutions Limited
Please note that the term of these fund managers are going to be over in October’12 and then they will be Re appointed by PFRDA as per the new criteria laid.
Every portfolio fund manager has to manage the money in 3 separate accounts having separate asset profile. Here E stands for Equity, C stands for Corporate Bonds and G stands for Government securities.
There are 2 choices available for subscribers.
Active choice – Investors are free to allocate there money the way they want among ECG, but not more than 50% in E Asset class.
Auto choice – Here the money will be transferred in a Lifecycle fund which has a predefined portfolio composition as per the age.
Taxation aspects in New Pension scheme
Taxation aspect is very interesting to understand and if used properly it will help in decent reduction in tax payment.
This is covered under Section 80CCD of income tax act, which says
Deduction in respect of contribution made by individual in the previous year to his account under a notified pension scheme, is allowed in computation of his total income –
a) In the case of employee 10% of his salary in the previous year.
b) In any other case 10% of his Gross Total Income in the Previous Year.
It is further clarified that the aggregate limit of deduction under this section along with Section 80C, 80CCC shall not in any case exceed Rs 1 lakh.
Where the central government or any other employer makes any contribution to the account of employee for the pension scheme, the assesse shall also be allowed a deduction in the computation of his total income of the whole of the amount contributed by the central government or any other employer, provided it does not increase 10% of his salary (basic +DA)
Any contribution made by subscriber in NPS a/c in a financial year will be eligible for tax benefits up to Rs 1 lakh u/s 80CCD, subject to overall Limit of Section 80C.
Further as per Section 80CCD (2) of income tax act says W.E.F 1st Apr, 2012 up to 10% of the salary (basic and dearness allowance) of employers Contribution can be deducted as ‘Business Expense’ from their Profit & Loss Account.
Thus from now onwards if you can negotiate with your employer on salary break up or increment at the time of appraisal, you may include NPS contribution by employer in your total CTC. This will help you in significant reduction in tax payment. You can make use of this change from your Retirement planning purpose.
Pros and Cons of New Pension scheme
- Low cost structure has definitely made it a product to consider.
- Additional Tax saving u/s 80CCD (2) on employer’s contribution is another attractive option.
- Flexibility on part of investors on asset selection and choice of 6 fund managers with good track record.
- This account is completely portable. Unlike other products like PPF/EPF where you have to get the account transferred the time you change your job to some other place, this account is accessible everywhere in country with the same account number.
- Taxation on withdrawal at maturity is the biggest disadvantage in choosing this product.
- Data on performance of fund managers and respective schemes is not readily available.
- Restriction on equity Investment to 50% may be unacceptable to some.
- Not so flexible in pre closure or prematurity withdrawal.
Should you invest in New pension Scheme?
The low cost structure and now the tax exemption on employer’s contribution have made this product a very attractive one. Otherwise all other features can be brought in the portfolio through other products with proper investment planning.
Tax at maturity a big drawback in this. But still, I feel that if one is a disciplined investor and has done proper Retirement planning then he may include some portion of his investments into this. Yes, if government makes the withdrawal at maturity tax free, New pension scheme will become a must buy option.