The National Pension System (NPS) is a defined contribution based pension system launched by Government of India with effect from 1 January 2004. Like most other developing countries, India does not have a universal social security system to protect the elderly against economic deprivation. As a first step towards instituting pension reforms, Government of India moved from a defined benefit pension to a defined contribution based pension system. Apart from offering wide gamut of investment options to employees, this scheme would help government of India to reduce its pension liabilities. Unlike existing pension fund of 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 from 1 May 2009
Tier-II account: The tier-II NPS account permits withdrawal.
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. 27 State/UT Governments have notified the NPS for their new employees. Of these, 6 states have already signed agreements with the intermediaries of the NPS architecture appointed by Pension Fund Regulatory and Development Authority (PFRDA) for carrying forward the implementation of the National Pension System. The other States are in the process of finalization of documentation.
Pension Fund Regulatory and Development Authority (PFRDA) is the prudential regulator for the NPS. 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. PFRDA has set up a Trust under the Indian Trusts Act, 1882 to oversee the functions of the PFMs. The NPS Trust is composed of members representing diverse fields and brings wide range of talent to the regulatory framework.
Coverage and eligibility
NPS was made available 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 Govt. servants joining Govt. service on or after 1.1.2004. In Tier I, Govt. servants will have to make a contribution of 10% of his Basic Pay, DP and DA which will be deducted from his salary bill every month. The Govt. will make an equal matching 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 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’s estimated that 8 crore citizens of India are eligible to join the NPS.
NPS is designed to leverage network of bank branches and post offices to collect contributions and ensure that there is 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. Dhirendra Swarup is one of the founders.
There will be one or more CRA, several PFMs to choose from which will offer different categories of schemes. The participating entities (PFMs, CRA etc.) would give out easily understood information about past performance & regular NAVs, so that the individual would able to make informed choices about which scheme to choose. PFMs would share this common CRA infrastructure. The PFMs would invest the savings people put into their PRAs, investing them in three asset classes, equity (E), government securities (G) and debt instruments that entail credit risk (C), including corporate bonds and fixed deposits.
The following contribution guidelines have been set by the PFRDA:
- 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 would be levied and the account would become dormant. In order to re-activate the account, subscriber will have to pay the minimum contributions, along with penalty due. A dormant account will be closed when the account value falls
Under the investment guidelines finalized for the NPS, pension fund managers will manage three separate schemes, each investing in different asset class. The three asset classes are equity, government securities and credit risk-bearing fixed income instruments. The subscriber will have the option to actively decide as to how the NPS pension wealth is to be invested in three asset classes:
E Class: Investment would primarily be in Equity market instruments. It would invest in Index funds that replicate the portfolio of either BSE Sensitive index or NSE Nifty 50 index.
G Class: Investment would be in Government securities like GOI bonds and State Govt. bonds
C Class: Investment would be in fixed income securities other than Government Securities
* 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 bodies Corporate including scheduled commercial banks and public financial institutions
Credit Rated Public Financial Institutions/PSU Bonds
Credit Rated Municipal Bonds/Infrastructure Bonds
In case the subscriber does not exercise any choice as regards asset allocation, the contribution will be invested in accordance with the ‘Auto choice’ option. In this option the investment will be determined by a predefined portfolio. At the lowest age of entry (18 years) the auto choice will entail investment of 50% of pension wealth in “E” Class, 30% in “C” Class and 20% in “G” Class. These ratios of investment will remain fixed for all contributions until the participant reaches the age of 36. From age 36 onwards, the weight in “E” and “C” asset class will decrease annually and the weight in “G” class will increase annually till it reaches 10% in “ E”, 10% in “C” and 80% in “ G” class at age 55. The following table will illustrates this auto choice more clearly-
NPS levies extremely low Investment management charge of 0.00010% on net AUM (Asset Under Management). This is extremely low as compared to charges levied by mutual funds or other investment products. Initial charge of opening the account would be Rs. 470. From second year onwards the minimum charge would be Rs. 350 a year. As per the offer document of NPS, annual and transaction charges would be reduced once the number of accounts in CRA reaches 10 lakh.
If subscriber exits before 60 years of age, he/she has to invest 80% of accumulated saving to purchase a life annuity from IRDA regulate life insurer. The remaining 20% may be withdrawn as lump sum. On exit after age 60 years from the pension system, the subscriber would be required to invest at least 40% of pension wealth to purchase an annuity. In case of Government employees, the annuity should provide for pension for the lifetime of the employee and his dependent parents and his spouse at the time of retirement. If subscriber does not exit the system at or before 70 years, account would be closed with the benefits transferred to subscriber in lump sum. If a subscriber dies, the nominee has the option to receive the entire pension wealth as a lump sum. Recent changes permit subscriber to continue to remain invested after 60 and up to 70 but subscriber can no longer add further investments. Subscriber to intimate the period of deferment and can not withdraw during the deferment period. If the subscriber does not exit by 70, the lumpsum will be monetised and transferred to subscriber’s bank account.
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 current provisions, 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 would be taxed as normal income (EET). ncessions for contributions made in National Pension System in the budget 2011.
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:
So far, the contribution made by a National Pension System subscriber in Tier I scheme is deductible from the total income under Section 80CCD of the Income Tax Act. Like wise, the contribution made by the employer for the employee in Tier I of National Pension System is also deductible under Section 80CCD. However, the aggregate deduction under Section 80C, 80CCC and 80CCD is fixed at Rs.1 lakh.
So, if the NPS subscriber is already having other eligible deductions such as LIC premium, PPF, bank or NSC deposits, ELSS etc., under Section 80C, 80CCC and Section 80CCD., deduction allowed under Section 80CCD in respect of National Pension System may not be of much useful as the overall limit of savings eligible for deduction is pegged at Rs. 1 lakh.
Further, contribution made by the National Pension System should also be included in the Total income of NPS subscriber as far as calculation of income tax is concerned, while full deduction of the same from income under Section 80CCD may not be possible as other savings made by the subscriber covers the overall limit of Rs.1 lakh under Section 80CCD. Hence, for a NPS subscriber contribution for NPS by the Government is taxable in most of the cases.
For example, if an employee receives a salary of Rs.40,000 (pay+da), 10% of the same (Rs.4000) is paid by him as contribution towards NPS. The Government will also be paying Rs.4000 in this case in NPS fund of the said employee. Until now, an amount of Rs.96,000 (Rs.48,000+Rs.48000) could be deductible from the total income as far as this employee is concerned under Section 80CCD.
However, if the said employee has been paying LIC premium of Rs.20,000 per year, he will be allowed to deduct only Rs.4000 in respect of the same under Section 80CC as total ceiling of Rs.1,00,000 under Section 80CCE will apply in this case. So, an eligible deduction of Rs.16,000 could not be availed under Section 80CCD. In other words, employer contribution to NPS to an extent of Rs.16,000, which is already included in the income is taxable in this case.
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 one lakh rupees provided under section 80CCE. This proposal is effective from the assessment year 2012-13 (financial year 2011-12) and would totally exempt employer’s contribution in NPS from levying 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 will be effective from 1 April 2012 and will be 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 money since April 2008. Rs.2100 crore is invested as corpus of Central Government employees. In 2008-09, as per unaudited results of the Pension Funds, the average weighted return on the corpus have been over 14.5% with the individual returns of three Pension Funds varying from 12% to 16% on the NPS corpus during the year 2008-09, weighted average return being over 14.5 per cent. According to the latest data released by the government in Parliament on Aug 23, 2011, return on investment is as low as 1.8% in case of those private sector employees, who opted for investments in government securities, the safest of the categories. The performance of the three pension fund managers for the central government employees indicate that the returns on subscribers’ contributions under NPS ranged between 8% and 16% during 2008-09 and 2010-11.
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 three years, that is, 2011-12, 2012-13 and 2013-14. 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 given below: Permanent Retirement Account should be opened in the year 2009-10 or 2010-11 and Minimum contribution should be Rs. 1,000 per annum (Financial year) in Tier I account and maximum contribution should be Rs. 12,000 per annum (Financial year) in both Tier I as well as Tier II account together.