Understanding employer’s NPS scheme!

New Pension Scheme (NPS) is a pension scheme launched by Government of India (in effect from 1st April, 2009) and is a defined contribution based pension scheme. NPS differs from the existing pension scheme in the sense that existing pension fund of Government of India offers assured benefits while NPS has defined contribution structure where an individual can decide where his contributed money will be invested.

NPS is intended to resemble a 401k plan offered for US employees but not in totality. NPS will follow EET (Exempt Exempt Taxable) structure similar to its global peer but the withdrawal amount after the age of 60 cannot remain invested nor can be withdrawn fully. Another important difference being premature withdrawal is subject to few life changing situations. Let’s explore other aspects of this scheme.

Product Structure

The scheme is available in two forms:

1. Tier-I account –  Premature withdrawal not allowed
2. Tier-II account – Premature withdrawal allowed

Features

Until now the pension schemes were available to Government employees and employees of big firms who have provident fund facility. With NPS common man gets an entry to the system. The other important features of the schemes are:

1. Low Cost – Annual Fees of .00009% (90 paisa for Rs 10,000) for fund management
2. You can choose from six different funds for investment
3. Withdrawing from one fund and investing in another will not have any tax implication
4. No upper limit on Investment
5. Minimum limit of investment is 6,000 per year
6. Tax benefit over and above the current limit of 1L under sec 80C
7. All citizens between 18 and 55 years can invest in NPS

Taxation

Under the newly introduced Section 80CCD (2), up to 10% of an employee’s basic salary put in the New Pension Scheme is tax deductible. If you fall in the 30% tax bracket, the NPS investment under Section 80CCD (2) will reduce your tax liability by almost 15000. Now onwards, NPS will be more beneficial from the tax angle. From the next financial year, contributions by employers to the NPS accounts of their employees can be deducted as a business expense which was not allowed till now. As such contributions will not be part of the Rs. 1 lakh tax deduction limit under Section 80C, your employer’s contribution on your behalf will be a tax free benefit for you.

Fund withdrawal

Premature exits before 60 years

• You will have to invest 80% of accumulated wealth to purchase a life annuity from registered life insurer
• The remaining 20% is liable for withdrawal as lump sum

Exits after 60 years

• You will have to invest at least 40% of pension wealth to purchase an annuity

No exits till 70 years

• Beneficiary account will be closed and the accumulated amount will be transferred in lump sum

In case of death of the scheme holder nominee will receive the whole amount as lump sum.

NPS scheme on its own vs. the one offered by the employer

If the employer is offering NPS he will be making an equal contribution in the scheme from his side. The structure will be of Tier-1 type where premature withdrawal will not be allowed. You will be liable for additional tax benefit on the employer’s contribution.

Additional to above structure individual can also choose a voluntary tier-II account having premature withdrawal facility. Government and employers will make no contribution into this account. The accumulated wealth in this account can be withdrawn anytime without stating any reason.

Benefits to investors

1. Additional tax saving – Both employers and employees will get tax exemption on their contribution
2. Low cost of fund management – The fund management cost is very low, which will enhance the returns
3. Higher return potential as compared to old plans – As it’s a defined contribution plan, investors can choose from the 6 funds available for investment for better returns.  Rebalancing of accumulated amount is free of cost so you can always invest in the best fund.

The Drawbacks

1. Tier 1 option doesn’t give much flexibility – It’s a rigid structure. A little flexibility with respect to premature withdrawal would have made it more lucrative.
2. Annuity rates post maturity is not fixed – There is no floor rate decided so you cannot be sure of the returns until maturity.
3. Fund management costs might increase in future – Depending on the pension liability and costs involved this rate might shift northward.
4. Only six fund managers makes it a risky proposition – If we take into account the working population of India this number seems to be pretty risky. As the number of subscribers increase hopefully government will increase this number.

How does employee and employer benefit?

The scheme will benefit both employees and employers a like when they participate. Employees get tax deduction on their contribution and from next financial year employers will be in a position to show their contribution as business expense generating additional tax benefits for the firm.