What is the National Pension Scheme (NPS) & How it Works?

Employees in the private sector till 2009 faced distinct risks post-retirement as there was no source of fixed income for them with low risks. However, government employees enjoyed the pension scheme, which let them get a fixed amount after their retirement, as an initiative from the government since 2004.

If you are searching for what the NPS scheme is, this article is the right place to guide you through its nuances.

NPS full form is National Pension Scheme – it is a government-sponsored pension scheme. It is, in essence, a long-term voluntary investment plan. In 2009, it was opened up to all Indian citizens with certain eligibility criteria by the Pension Fund Regulatory and Development Authority (PFRDA). It allows subscribers to contribute regularly to a pension account while they are working. The individual can choose an amount as necessary or suitable.

If you are an NPS account holder, you can withdraw an amount from the corpus and will continue receiving the remaining amount through a monthly pension after retirement.

In an NPS account, subscriber contribution is invested into various debt and equity instruments, and its returns depend on the performance of these investments, and of course, market conditions.

The Budget 2024-25 proposed the introduction of the NPS Vatsalya Scheme, a National Pension Scheme for minors, which allows parents to open NPS accounts for their minor children and contribute some amount to the account on their behalf regularly, until the children turn 18. They can make a minimum contribution of ₹1,000 per year, while there is no limit on the maximum amount.

Once the children turn 18 years old, the NPS Vatsalya account can be converted to a normal NPS account, as then the children can manage the account independently.

Now, Budget 2025-26 proposed to offer the same tax benefits to NPS Vatsalya accounts that are available for NPS contributions under Section 80CCD(1B), along with an additional ₹50,000 deduction over the ₹1.5 lakh limit.

NPS was first introduced in 2004 with the objective of providing retirement income to all citizens. It is open to all Indian citizens (except armed forces) between 18 and 60 years of age.

Some core objectives of NPS are:

• This scheme ensures every person employed in the Public Service of the Federation, the private sector, or the Federal Capital Territory receives retirement benefits as and when applicable.
• It is to encourage the habit of saving among individuals to sustain their livelihood post-retirement. Therefore, it is also a key to averting old-age poverty risks.
• The scheme will also systemise an efficient pension distribution procedure and eliminate the hassles for subscribers to the pension.
• To help bring uniformity in rules, regulations, and standards for the administration and payment benefits of NPS subscribers.
• It also aims to prevent outstanding payment liabilities.
• Safety, sustainability, security of benefits, equity, practicality, uniformity, accountability, transparency, inclusivity, and practicability are the cornerstones of the NPS scheme.

• Tier I – Minimum opening amount ₹250, does not allow withdrawals
• Tier II – Minimum opening amount ₹500, allows withdrawals for up to 3 times in 5 years

Following are the noteworthy features of NPS:

• A part of the contribution in NPS goes into equities.
• Returns earned from NPS are higher than other traditional tax-saving investments. NPS usually offers 9% - 12% returns.
• Individuals can choose to change their fund managers if they are unsatisfied with the fund performance. This option is available to both Tier I and Tier II account holders.
• For Tier I accounts, subscribers need to make a yearly contribution of ₹6000 and ₹500 as a one-time contribution. In the case of tier 2 accounts, the minimum yearly contribution is ₹2500, and the one-time contribution is ₹250.
• One cannot withdraw the entire corpus at any point of time after retirement.
• After completing three consecutive years as an NPS subscriber, one can withdraw up to 25% of the corpus at one go for reasons like medical emergency, higher education, house purchase, etc.

• Returns/interest: A portion of the total scheme contribution is invested in equities to generate higher returns than other traditional tax-saving instruments like PPF. It generally offers 9% - 12% interest, making it suitable for long-term secure investment for individuals with a low-risk appetite.
• Premature withdrawals and exit norms: As per government norms, it is mandatory to contribute to the NPS until retirement, or 60 years of age, whichever is earlier. Subscribers can make partial withdrawals up to 25% of the corpus after three years from the date of opening the account. Premature withdrawal is only available for Tier I account holders. They can make a maximum of three withdrawals in 5 years.
• NPS tax benefits for self-contribution: Employees who contribute to NPS get a tax deduction of up to 10% of pay (Basic + DA). Subscribers of Section 80CCD(1B) also get a higher tax deduction of ₹50,000, which is over and above the ₹1.5 lakh exemption limit available under Sec 80CCD (1) of the Income Tax Act.
• NPS tax benefits for employer contributions: On NPS of an employee for employer contribution, one can avail a tax deduction of up to 14% of salary under Section 80CCD(2). This is beyond the ₹1.5 lakhs limit under Section 80CCE.
• NPS tax benefits for self-employed: Self-employed individuals contributing to NPS can claim tax deduction of up to 20% of gross income under Section 80CCD(1) and tax deduction of ₹50,000, which is over and above the ₹1.5 lakhs exemption limit available under Sec 80CCD (1) of the Income Tax Act.
• After retirement withdrawal rules: After retirement, individuals can withdraw a maximum of 60% of their total contribution, which is also tax-free. The remaining 40% is paid off to the individual as a regular annuity from the PFRDA-registered insurance firm.
• Equity allocation rules: One of several other NPS benefits allows individuals to choose the allocation of their contributions as per their choices. Subscribers can choose an active choice or an auto choice. The former allows investors to choose funds and split the investment as per suitability, while the latter considers the age and risk profile of an individual before investing. However, as per the equity allocation rule, investors can allocate a maximum of 50% of the corpus to equity.
• Risk assessment: The equity cap, marked at 50%-75 %, will reduce by 2.5% every year after the investor turns 50. This is to ensure the safety of the corpus from market volatility.
• Voluntary: It allows the subscribers to contribute their desired amount at any time of the year and can also change his/her contribution amount every year.
• Flexibility: Individuals can choose their investment mode and fund as per their requirements.
• Simplicity: Subscribing to NPS is as simple as visiting the NPS website or any point of presence (POP).
• Regulated: Since it is under the regulations of PFRDA, there is regular monitoring along with transparency in norms, and it provides reliability to its subscribers.

NPS eligibility can be broadly categorised into 2 models.

1. All Citizen Model

In this case, the eligibility criteria are:

One needs to be a citizen of India; resident and non-resident residents are both included.

The age of the applicant at the time of submission of application documents needs to be between 18 and 60 years.

All applicants need to comply with Know Your Customer (KYC) regulations as mentioned in the Subscriber Registration Form.

Submission of all required documents for KYC verification is mandatory.

2. Corporate Model

This model is available to entities under:

• Entities registered under the Co-operative Acts.
• Trust/society
• Proprietorship concern
• Entities registered under the Companies Act.
• Central Public Enterprises
• State Public Enterprises
• Registered Limited Liability Partnerships (LLPs)
• Registered partnership firm
• All bodies incorporated under an act of Parliament or State Legislature, or by State/Central Government order

NPS is a market-linked scheme and is one of the best retirement-planning schemes since its introduction in 2004.

Individuals in the following categories can find maximum benefits from NPS:

• All salaried individuals who are not eligible for a pension from their existing employer can secure their post-retirement regular income source.
• It is also ideal for people who do not have a high-risk appetite but are looking for more interest than other traditional tax-saving investments.
• NPS is also beneficial for individuals looking to make a low-risk investment that can provide a regular annuity.

With options to save up to ₹2 lakhs in taxes as per Section 80CCD (1) (₹1.5 lakhs) and Section 80CCD (₹50,000) of the Income Tax Act, it is an excellent tax-saving investment.

Are you thinking, ‘Can an NRI invest in NPS?’ If so, you should know that any individual can subscribe to NPS and open a pension account through eNPS with either his/her Aadhaar card or PAN card and a bank account. Moreover, NRIs cannot subscribe to NPS in the Tier II category.

Eligibility requirements for NRIs to open an NPS account include:

• The individual has an age between 18 and 60 years.
• Any NRI who has a valid Aadhaar card with his/her mobile number linked to the same.
• An internet-enabled bank account
• They must have a PAN card.

NPS is an ideal investment option for people with a low-risk appetite and looking for fixed income reliability post-retirement. Further, since it is a regulated investment option, it is a secured income instrument for the long term for salaried individuals.