What is NPS? Advantages, Tax Benefits & How to Open NPS Account

Shekhar and Samrat sit on a park bench chatting after their daily morning walk. Both are in their 30s, married with children. Both men have their senior parents residing with them.

‘I feel so bad for my father. In spite of working for a lifetime, he is financially dependent on me. He feels bad asking me for money. To avoid embarrassing him, I have made a fixed deposit in his name where the interest is credited to his savings account to help him with his daily expenses,’ Shekhar confides in Samrat.

He continues, ‘I would never want to be in this situation. My financial advisor has suggested that I invest in the NPS to avoid being dependent on anyone during my retirement.’

Samrat’s interest is piqued. He asks, ‘What is the NPS?’

‘NPS stands for national pension system,’ replies Shekhar.

Samrat listens intently as Shekhar explains the NPS.

NPS is an investment plan which provides financial security and stability to individuals during their later stages of life. It is a voluntary plan; in other words, it’s not mandatory for every citizen to invest in it. Under this plan, you invest during your working life and receive a pension once you retire.

What is the eligibility criterion?

If you are a citizen of India and between 18 and 65 years of age, you are eligible to invest in the NPS. It doesn’t matter whether you are a resident or a non-resident Indian (NRI), but you need to comply with the know-your-customer (KYC) guidelines.

What are the advantages?

NPS offers the following benefits:

  1. Available at the lowest fund management cost of just 0.01% p.a.
  2. Flexibility to shift between investment options and fund managers.
  3. Online access to your account via website as well as mobile app
  4. NPS account is portable across jobs and locations across the country.
  5. Partial withdrawal of funds permitted for certain emergency purposes
  6. Regulated by the Pension Fund Regulatory and Development Authority (PFRDA).

What are the disadvantages?

While NPS has a number of positive aspects, the following are aspects to watch out for:

  1. It is mandatory to buy an annuity with a minimum 40% of the total corpus at maturity.
  2. Only 40% of the corpus is tax-free at maturity. You can delay tax on the remaining 60% by buying an annuity.
  3. The monthly income from the annuity is fully taxable. The corpus used to buy the annuity is composed of both the capital contribution and returns. Hence, part of the capital contribution is also taxed.

Are there any tax benefits?

The NPS offers you multiple tax benefits under sections 80CCD (1), 80CCD (1B), and 80CCD (2).

Section 80CCD (1) offers a tax deduction of up to Rs 1.5 lakh on investment in the NPS. This is part of the tax deduction available under section 80C (tax benefits for investments made in provident funds (PFs), public provident funds (PPFs), life insurance, and national savings certificates (NSCs), among other instruments, and tuition fees and home loan principal).

Note: There is a maximum limit for investments in NPS. This is fixed at 10% of your basic salary, including dearness allowance, or 10% of your total gross income if you are a non-salaried individual. For example, if your basic salary and dearness allowance is, say, Rs 10 lakh, then the maximum amount you can invest in the NPS cannot exceed Rs 1 lakh.

Section 80CCD (1b) offers an additional tax deduction of up to Rs 50,000 on investment in the NPS. In other words, the investor can claim a tax deduction of up to Rs 2 lakh on investment in the NPS using both these sections. This is over and above the section 80C limit, which means you can claim up to Rs 1.5 lakh for your section 80C investments (including the NPS) and an additional amount up to Rs 50,000 for NPS contributions made in the financial year.

Section 80CCD (2) offers a tax deduction if your employer contributes to your NPS account. This deduction is over and above the two aforementioned deductions under sections 80C and 80CCD (1B).

Note: There is a maximum limit to the employer’s contribution eligible for a deduction, which is restricted to 10% of your salary (basic + dearness allowance). This deduction is over and above the deduction of Rs 2 lakh available under the above two sections.

What is the tax levied if one withdraws or exits from the plan?
While 40% of the lump sum amount is tax-free in your hands, the monthly pension received from the annuity is taxable as per the income tax slab that applies to your total income. To avoid paying tax on the lump sum amount, you can purchase an annuity for 60% of the retirement corpus and take only 40% in a lump sum. For example, assume you have Rs 10 lakh in your NPS account at the time of maturity. You can withdraw 40% of the corpus tax-free (i.e. Rs 4 lakh). With the remaining Rs 6 lakh, you are required to buy an annuity and will receive a pension payment every month.

How to open an NPS account?

You can open an NPS account online. Visit, click on ‘Registration,’ fill in the online form, and provide your Aadhar number. You will receive a one-time password (OTP) after your registration via your Aadhar-registered mobile number. Using this password, you will fill in the rest of your application, make your investment, provide your nomination, and finalize other details. Eventually, you will receive your investment acknowledgment, which will include your permanent retirement account number (PRAN).

When Shekhar finishes explaining the NPS, Samrat says, ‘I am going to call my financial advisor to help me invest in the NPS today.’

The NPS is an attractive retirement investment plan. However, make your investment after consulting your financial advisor to ensure that this plan is suitable to your retirement needs.

Note: The tax structure given above is as per current Income Tax laws and may change in the future.

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Key Takeaways

  1. The NPS is an investment plan that helps you save for your retirement.
  2. Any citizen of India between 18 and 65 years of age can invest in the NPS online.
  3. At retirement, you get a lump sum and the balance is used to purchase an annuity, which will help you in securing your retirement funds.
  4. Investment in the NPS also gives you tax benefits.
  5. While the NPS has a number of benefits, you must also be aware of its pitfalls