National Pension System (NPS) Benefits and Limitations

NPS has its own set of benefits and limitations, which you need to carefully analyse before investing in it. If choosing to invest in NPS is your decision, then remember to check the key benefits and limitations that tag along. In this blog, we will talk about the significant National Pension System benefits so that you can make an informed decision for your financial future.

What is NPS (National Pension System)?

The National Pension System (NPS) was introduced by the government in order to motivate people to invest and build long-term savings for the future. Investors can benefit by making regular contributions during their working years. Being a market-linked investment, one of the key benefits of NPS is the potential to earn decent returns over time.

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Benefits of NPS (National Pension System) Scheme

The National Pension System (NPS) scheme provides several benefits for those looking for options to have a secure retirement with a strategic planning

Investment Choices Flexibility

Two major options for investment management come with NPS: Auto Choice and Active Choice. Your investments are handled by fund managers who diversify them across equity, corporate bonds and government securities as per their competency under the Auto Choice option. Conversely, Active choice gives you power to do asset allocation on your own thus guidelines to allow 75% of the total amount invested in equities till the age of 50 years, among other investment decisions.

Partial Withdrawals

One of its interesting features is that NPS allows partial withdrawals from Tier I accounts. Partial withdrawals from Tier I accounts are allowed after three years of subscription, with up to 25% of contributions allowed for specific purposes such as higher education, marriage, or medical treatment. Maximum three such withdrawals can be made with a gap of at least five years between each withdrawal. The condition of withdrawal after 5 years gap is waived for medical treatment and for those who subscribe after 60 years of age.

Tax Benefits

Large tax reliefs are given by the NPS scheme. Section 80CCD(1) grants tax deduction till Rs. 1,50,000 for contribution made towards the scheme annually. Besides Section 80CCD(2) provides tax benefits for employer contributions up to 10% of the employee's salary (basic + DA). There is a further provision for voluntary contributions up to Rs. 50,000 exempted from tax purposes in this regard when he pays employees’ statutory retirement benefits like pension contributions etc.

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Low Cost: NPS is a cost-effective investment option, with low fund management charges. This way, you can be sure that more of your money is invested toward building a large retirement corpus.

Power of Compounding: With regular contributions, NPS calls for a long-term investment where you can watch your money grow exponentially through compounding.

Diversification and Market-Linked Returns

The combination of equity and debt investments by NPS offers a significant diversification. This balance helps to achieve favourable returns which are linked to the market, thereby helping in growing your retirement corpus over time.

Flexible Contributions and Fund Manager Options

Contributions can be made any number of times in a financial year subject to a minimum contribution of Rs. 1,000 per year for Tier I accounts. Subscribers can change fund managers once a year if they are not satisfied with their performance.

Limitations Under NPS (National Pension System)

Benefits and limitations of NPS should be understood before investing. Several benefits have been offered under the National Pension Scheme (NPS) but at the same time certain limitations also exist that any potential investors should consider.

• Limited Liquidity: A big limitation is that the withdrawals from NPS are limited until retirement. However, you can make partial withdrawals, which are allowed only under specific conditions after completing a few years.
• Mandatory Annuity Purchase: NPS asks you to make a compulsory 40% annuity purchase at maturity. This means you may be offered lower returns compared to market-linked investments.
• Tax on Annuity Income: The annuity income received post-retirement is taxable, which may reduce your net retirement income.
• Market-Linked Risks: Though returns are higher than traditional savings plans, they are not assured and depend on market performance.
• Limited Investment Flexibility: You can choose asset allocation within limits, but cannot freely switch between multiple investment products.
• Complex Exit Rules: Early exits and withdrawals involve complex rules, which may not suit everyone’s needs.

Is NPS Good or Bad?

Now that you know some of the most important advantages and drawbacks of NPS funds, you can decide whether or not it is the right option for you. Just like every other investment, NPS also has a few drawbacks. However, most of them have been intentionally put in place to meet the retirement objective of the scheme. If you are still finding it difficult to make a decision, get in touch with an investment advisor or PFRDA-authorised bank to know more.

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