National Pension System

NPS is a defined contribution scheme, and that single phrase settles most of what candidates get wrong about it.

What is fixed is what goes in. What comes out depends entirely on what the markets did in between and on the annuity rate available on the day of exit. The workbook says so bluntly: there is no guaranteed return or principal protection in the NPS.

It is open to public and private sector employees except the armed forces, and to any Indian citizen voluntarily. It is portable across jobs and locations, and at retirement the corpus is used partly as a lump sum and partly to buy an annuity that pays a pension for life.

Three models. The Government Sector model (mandatory for Central — except armed forces — and State employees and autonomous bodies), the All Citizens model (voluntary, ages 18 to 70), and the Corporate model.

Two accounts. Tier I is the default, mandatory retirement account with conditional and restricted withdrawals. Tier II is a voluntary savings add-on with unrestricted withdrawal and, for anyone other than a government employee, no tax deduction at all.

Four asset classes. Equity (E), Corporate Debt (C), Government Securities (G) and Alternative Investments (A). Under Active Choice the subscriber sets the mix, but equity is capped at 75% and alternatives at 5%; C and G may go to 100%. Under Auto Choice a life-cycle fund does it automatically — LC 25 (Low), LC 50 (Moderate), LC 75 (High) and LC Aggressive — each starting equity-heavy and taper­ing as the subscriber ages. LC 75, for instance, holds 75% equity up to age 35 and 15% at 55 and above.

Switching. The scheme or fund manager may be changed once in a financial year; All Citizen and Corporate subscribers may change the investment choice or allocation four times in a financial year.

Partial withdrawal. After three years of investing, up to 25% of the subscriber's own contributions, for specified purposes such as children's education or marriage, a house, or medical treatment — a maximum of four times before 60, with at least four years between two withdrawals. Tier II has no such restriction.

Tax deduction, own contribution
  Sec 80CCD(1)  = lower of contribution, or
                  10% of salary (salaried) / 20% of gross income (non-salaried),
                  inside the Rs 1,50,000 ceiling shared with 80C and 80CCC
  Sec 80CCD(1B) = a further Rs 50,000, exclusive to NPS
                                          -----------------------
  Maximum, own contribution               = Rs 2,00,000

Tax deduction, employer contribution
  Sec 80CCD(2)  = lowest of (a) actual employer contribution,
                            (b) 14% of Basic + DA for a Central/State Government
                                employee; for any other employee 10% (old regime)
                                or 14% (new regime),
                            (c) gross total income

Mr Menon is a Central Government employee, Basic + DA of Rs 12,00,000 a year, and is on the old tax regime in the 30% slab. (Because he is a government employee, the employer deduction runs to 14%. A private-sector employee on the old regime would be capped at 10%, i.e. Rs 1,20,000.)

The 80CCD(1B) Rs 50,000 and the 80CCD(2) employer contribution sit outside the Rs 1.5 lakh Section 80C ceiling — together worth Rs 65,400 of tax in the year, on top of whatever 80C already absorbed.

At exit, age 60, corpus Rs 1,00,00,000:

Lump sum, 60%                 = Rs 60,00,000   exempt u/s 10(12A)
Annuitised, 40%               = Rs 40,00,000
Pension at an assumed 6% rate = Rs 2,40,000 a year
                              = Rs 20,000 a month, taxable at slab

The Rs 60 lakh arrives tax-free; the Rs 20,000 a month is added to income every year it is due. An adviser who quotes only the corpus has told the client half the story.

NPS is taught twice and examined from both ends. Chapter 5 (Retirement Products), section 5.1.6 covers the models, account types, asset classes, Active versus Auto Choice, and the withdrawal and exit rules. Chapter 12 (Taxation of Other Products), section 12.3 covers 80CCD(1), 80CCD(1B), 80CCD(2) and the taxability of the lump sum and the annuity. Chapter 19 compares NPS Tier 1 against ELSS and fixed-income tax-saving instruments. The Module 9 questions include the maximum NPS deduction for a self-employed person under the old regime.

• 80CCD(1B) is Rs 50,000 over and above Rs 1.5 lakh; 80CCD(2) is outside both. The classic wrong answer treats the whole NPS deduction as part of Section 80C.
• Employer contribution is first a perquisite, then a deduction. It is added to the employee's income and then deducted under 80CCD(2) — it is not simply invisible.
• Watch the Rs 7.5 lakh aggregate. Employer contributions to EPF, NPS and superannuation together above Rs 7.5 lakh in a year, and the return on the excess, are taxed as a perquisite.
• The exit chapter and the tax chapter use different percentages. The PFRDA exit rules require a minimum of 20% annuitisation for non-government subscribers and 40% for government subscribers, while the tax provision exempts a lump sum of up to 60% under section 10(12A). Read which chapter the question is set in.
• Partial withdrawal is 25% of own contributions, not 25% of the corpus, and not of the employer's share.
• Tier II gets a deduction only for Central Government employees, and even then within the Section 80C limit. For everyone else Tier II is an ordinary open-ended investment, taxed as capital gains.