NPS Lock-in Period: Benefits, Taxation, & Withdrawal Rules
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Pension Fund Regulatory and Development Authority (PFRDA) set up the National Pension System (NPS) under the PFRDA Act, 2013. It is a market-linked contribution product you can use to earn considerable returns after retirement. Its primary purpose is to let employed individuals invest in a pension plan and create a corpus for their post-retirement years. Any Indian resident or non-resident citizen between 18 - 70 years can invest in the scheme. Here is an overview of the NPS lock-in period and other related details.

What is the NPS Lock-in Period?

The NPS lock-in period is the period before which you cannot withdraw the accumulated corpus in your NPS account. Officially, you can exit an NPS at 60. However, there are exceptions and conditions which you must follow. For instance, you can withdraw 25% of your individual contribution after three years of constant participation. The maximum frequency is three times capped at 25% each time. The withdrawal can be for the purpose of illness, house construction, self-development, and education only.

Significant corpus building is one of the major benefits of a longer NPS locking period. While avoiding unnecessary withdrawals, you build wealth for your retirement when other income sources will diminish.

Benefits and Implications of the NPS Lock-in Period

The National Pension Scheme lock-in period has multiple benefits, including the following:

  • Returns: Higher returns than other traditional investment options
  • Risk Assessment: Stabilised risk-return equation ensuring safety for the corpus against market volatility
  • Regulation: NPS has transparent norms under the purview of PFRDA
  • Flexibility: Anytime NPS contribution without any upper limits
  • Tax Benefits: Substantial tax benefits with tax-free withdrawals at 60

Taxation Benefits of NPS

Here are the tax benefits of the National Pension System (NPS):

1. Section 80CCD (1)

  • Tax deductions are available on the employee's contributions to NPS.
  • The limit for this deduction is up to 10% of the employee's salary, which includes Basic and Dearness Allowance (DA).
  • This falls within the overall ceiling of Rs. 1.50 lakh specified under section 80CCE. It's important to note that the combined limit under section 80CCE covers various eligible investments, including NPS.

2. Section 80CCD (2)

  • Employers can contribute up to 10% of the employee's Basic and DA to the employee's NPS account.
  • There is no monetary limit on the employer's contribution.
  • Employers can claim deductions on these contributions under section 80CCD (2).
  • This benefit is in addition to the Rs. 1.50 lakh limit under section 80CCE, meaning that it provides an extra tax advantage.

3. Section 80CCD 1(B)

  • Employees have the option to make voluntary contributions to their NPS Tier I account.
  • They can claim tax deductions on these voluntary contributions under section 80CCD 1(B).
  • The maximum deduction allowed under this section is Rs. 50,000.
  • This deduction is in addition to the deductions available under section 80CCD (1) and section 80CCD (2).

These tax benefits make NPS an attractive investment option for individuals looking to save for their retirement while reducing their tax liability.

NPS Annuity: What is it and How Does it Work?

When your NPS account reaches maturity, you can withdraw 60% of the accumulated amount without tax liabilities. You can use the remainder amount for purchasing an asset under a PFRDA-listed company providing an annuity. It is an asset that generates income in the stipend form by investing in real estate or various schemes. You can use this asset for annuity only and not withdraw it as money or sell it off.

Conditions for Exceptions and Withdrawals

Here are a few conditions for exceptions and withdrawals before the National Pension Scheme locking period:

  • Premature Retirement: You can withdraw 20% lump sum and 80% pension corpus after at least five years of constant participation.
  • Post-Retirement: You can withdraw 60% of the lump sum and 40% of the pension corpus at 60 years.

Important Terms in NPS

Are you planning to invest in the NPS scheme? These are a few terms you must be aware of:

  • PRAN: PRAN stands for Permanent Retirement Account Number, a 12-digit sequence the POP issues upon registration and NPS subscription.
  • Tier 1 Account (Retirement Account): Tier 1 is a restrictive account with a strict NPS lock-in period and restrictions.
  • Tier 2 Account (Investment Account): Tier 2 is a free account where you can withdraw more freely from your account.

After opening an NPS account, you must contribute at least Rs 1,000 per year to keep your account active. The minimum amount per contribution is Rs 500, and there is no limit to the frequency of contributions. For a Tier 2 account, you must pay Rs 1,000 at the time of account opening, with Rs 250 as the minimum amount per contribution. There are no restrictions related to minimum annual investments and number of contributions.

NPS offers two types of investments:

  • Active Choice: In this NPS investment type, you can choose which assets and percentage you want to invest.
  • Auto Choice: Also known as lifecycle fund, wherein the investment between asset classes is made basis the age of the Subscriber and risk taking capacity of the Subscriber. There is a predefined matrix shared by the regulator.

If you make a wrong choice, there is no need to panic as you have the flexibility to change your Pension Fund Manager (PFM) ONCE and investment type FOUR times in a Financial year.

Frequently Asked Questions

1. How long is the lock-in period for NPS?

The NPS lock-in period is till the subscriber turns 60. Premature withdrawal is also possible but with certain restrictions.

2. Can I access my NPS funds during the lock-in period?

Certain conditions, like illness, house construction, self-development, etc., make NPS funds accessible.

3. What are the tax implications of withdrawals during the lock-in period?

Gains up to Rs 1 Lakh are tax-free, while those above are taxable.

4. Are there penalties for withdrawing funds before the lock-in period ends?

The penalties depend on your bank. However, loss of tax benefits is the major drawback of premature withdrawal before the NPS locking period.

5. Can I switch between Tier I and Tier II accounts during the lock-in period?

Yes, you can switch funds from a Tier II account to Tier 1. This is known as one-way switch.

6. How can I maximise the benefits of the NPS lock-in period?

Refraining from withdrawing the funds before the NPS lock-in period is the best way to maximise the benefits.

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Disclaimer: This Article is for information purposes only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. The Bank makes no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Article. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from the Bank. The Bank, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein. Tax laws are subject to amendment from time to time. The above information is for general understanding and reference. This is not legal advice or tax advice, and users are advised to consult their tax advisors before making any decision or taking any action.