National Pension System (NPS)

The National Pension System (NPS) is a voluntary, defined-contribution retirement savings scheme which has become a central pillar of India’s pension framework. It was initially introduced for government employees but later expanded to all citizens. NPS is structured, regulated, and administered by PFRDA, and it aims to provide a sustainable solution to old age income security across both public and private sectors.

Historical Background

The NPS (originally called New Pension Scheme) was launched on 1 January 2004 for new Central Government recruits (except armed forces) as a move away from the fiscally burdensome defined-benefit pensions (Old Pension Scheme). Under the NPS, government employees themselves contribute toward their pension (earlier, under OPS, they did not contribute at all).

The shift was driven by the need to ensure long-term sustainability – the old system’s costs were rising steeply. In 2009, the NPS was opened to all citizens of India on a voluntary basis, including private sector employees and the self-employed. Over time, almost all State Governments (barring a few exceptions) also adopted NPS for their new employees.

NPS thus became the default pension system for government services and an optional retirement investment vehicle for others. Notably, as of August 2021, the entry age for NPS has been extended up to 70 years (from an earlier 65), so any Indian citizen (resident or NRI/OCI) between 18 and 70 years can join NPS. They can continue contributing up to the age of 75 under current norms.

Structure of NPS (Tier I and Tier II Accounts)

NPS operates through two types of accounts: Tier-I and Tier-II.

Tier I Account

This is the primary pension account. Contributions to Tier-I are locked-in until the age of 60 (the default retirement age under NPS), with restricted withdrawal rules. Tier-I is mandatory for anyone who wants to avail NPS benefits.

For government employees, a percentage of salary is deducted and contributed here. For others, this is the account that qualifies for tax benefits. Tier-I has a low minimum contribution requirement (e.g. ₹500 to open, and minimum ₹1,000 per year). Importantly, Tier-I investments cannot be freely withdrawn; one can generally withdraw only upon retirement (age 60) or on leaving the scheme (with conditions).

However, partial withdrawals from Tier-I are allowed for specific reasons (like house purchase, medical treatment, children’s education, etc.) after a minimum of 3 years of subscription – up to 25% of one’s own contributions can be withdrawn, and this can be done a limited number of times. At age 60 (normal exit), the subscriber can withdraw up to 60% of the accumulated corpus as a lump sum (which is tax-free since 2019 reforms), and the remaining 40% must be used to purchase an annuity (to provide a monthly pension). (If the total corpus is small – currently ₹5 lakh or below – 100% withdrawal as lump sum is allowed as an exception.) If one exits NPS before age 60, at least 80% of the corpus must be annuitized (only 20% can be taken as lump sum).

These rules ensure that NPS indeed serves as a pension provision and not just a savings account.

Tier II Account

This is a voluntary savings account that NPS subscribers can open in addition to Tier-I. Tier-II offers flexible withdrawals – one can deposit or withdraw at any time, much like a bank account or mutual fund. No lock-in applies to Tier-II (except for certain taxpayers under specific conditions), and there are no separate tax benefits for contributions to Tier-II for non-government subscribers. (Central government employees were given a provision to claim tax deduction up to ₹1.5 lakh for Tier-II contributions, but only if they lock-in that contribution for 3 years – this facility is not available to general public).

Essentially, Tier-II is meant for extra savings with convenience, while Tier-I remains the core pension account. Notably, one can open Tier-II only if one has an active Tier-I NPS account.

Contributions and Investment Choices

NPS is a contributory scheme where both the individual and (for salaried persons) the employer contribute. For government employees, the NPS contribution rate is defined – employees contribute 10% of their basic salary plus dearness allowance, and the government (employer) contributes a matching amount.

In fact, since April 2019, the Central Government’s contribution for its employees was increased to 14% of basic pay + DA, to enhance retirement benefits under NPS. (Many State Governments have followed with a 14% employer contribution as well.)

For private sector subscribers, employers can also contribute to employees’ NPS (and get tax benefits under Section 80CCD(2)), typically up to 10% of salary. Self-employed or individual contributors pay their own contributions.

All NPS contributions from subscribers are pooled into pension funds and invested as per the subscriber’s choice. NPS offers a menu of investment options and Pension Fund Managers (PFMs):

• Multiple Pension Funds: Subscribers can choose from a list of Pension Fund Managers (there were 11 PFMs as of 2025) to manage their contributions. Examples include SBI Pension Funds (the largest), LIC Pension Fund, HDFC Pension, etc. Each PFM operates several schemes under NPS guidelines.
• Asset Classes and Allocation: NPS funds invest in a mix of asset classes denoted as Equity (E), Corporate Debt (C), Government Securities (G), and Alternate assets (A). The subscriber can allocate contributions across these asset classes within prescribed limits. For instance, for a typical “Active choice” investor, up to 75% can be put in equity (E) till age 50 (with a tapering cap beyond age 50), while the rest can go into corporate bonds, government bonds, etc. The idea is to allow higher growth potential (equity) while young, and shift to safer assets as retirement nears.
• Active vs Auto Choice: Active Choice means the investor decides the allocation percentages to E, C, G, A (subject to limits). Auto Choice is a lifecycle fund option – the allocation is automatically adjusted according to the age of the subscriber. In auto choice, there are preset lifecycle funds (conservative, moderate, aggressive) which define what percentage goes into equity vs debt at various ages. Younger investors get higher equity exposure, which gradually reduces as they age, without the subscriber needing to rebalance manually.

NPS being a market-linked product means the final corpus depends on investment performance. There is no fixed guaranteed return; however, historically NPS funds have delivered reasonable returns in line with markets. An important feature of NPS is its low cost structure – the fund management and administrative charges are very low compared to other investment products, making compounding more efficient for the subscriber in the long run.

Tax Benefits

NPS is an attractive tool for retirement saving also due to its tax incentives. Contributions to NPS Tier-I are eligible for tax deduction under Section 80CCD of the Income Tax Act. As a subset of Section 80C, one can invest up to ₹1.5 lakh per year in NPS (combined with other 80C investments) and claim a deduction.

Additionally, NPS offers an exclusive extra deduction of ₹50,000 per year under Section 80CCD(1B) for contributions to Tier-I, over and above the ₹1.5 lakh 80C limit. This effectively means an individual can get tax benefits on ₹2 lakh of NPS contributions annually.

Employers’ contributions to NPS (for salaried subscribers) are deductible under Section 80CCD(2) – up to 10% of salary (or 14% in case of central government employers) – this is over and above the employee’s own limit and is not subject to the 80C cap.

At withdrawal, following the 2018-19 reforms, NPS enjoys an Exempt-Exempt-Exempt (EEE) like status in effect: the lump sum withdrawal (60% of corpus) at age 60 is tax-free, and the 40% used for annuity is also tax-exempt at the time of purchase (though subsequent pension annuity payments are taxable as per income slab).

Subscriber Categories and Coverage

NPS caters to multiple segments:

Government Sector NPS

Central and State Government employees (who joined service in 2004 or later) form a large chunk of NPS subscribers. For them, NPS is mandatory as their pension system, with automatic paycheck deductions and matching government contributions. Nearly all states implemented NPS for their employees (although a few states in recent times have debated reverting to the old scheme).

The NPS architecture for government employees has some default settings – for example, contributions are usually invested in a government-prescribed mix of assets if the employee doesn’t choose a fund manager or allocation (often a conservative mix heavy on government bonds).

As of 2019, the Central Government’s enhanced 14% contribution has improved projected benefits for government NPS subscribers. In late 2022 and 2023, to address concerns of government employees about adequate pension, the government introduced the Unified Pension Scheme (UPS) under NPS for central government employees. Effective from April 1, 2025, UPS offers central government NPS subscribers an option for an assured pension after 25 years of service, equal to 50% of their last drawn salary (with certain conditions).

This is essentially a reform within NPS to provide a minimum pension guarantee to government employees, blending defined-benefit elements into the NPS framework. The UPS is optional and had a deadline for existing employees to opt in (by late 2025). This development reflects the dynamic nature of pension reforms to balance fiscal prudence with employee welfare.

Corporate Sector & Others

NPS was opened to the private sector in 2009. Employers in the private sector can register under NPS to offer it to their employees (often termed NPS Corporate Model). Many companies have adopted NPS as part of their employee benefit offerings, since contributions to NPS can be a tax-efficient way to provide retirement benefits (employer contributions are deductible and not counted in the employee’s taxable income up to the limit).

Individuals who are self-employed or whose employers don’t offer NPS can also join NPS directly through points-of-presence (banks, etc.) or online. They have full flexibility in choosing fund managers and contribution amounts/frequency. As of March 2024, the subscriber base in the private sector NPS (including corporate and individual) had crossed 55 lakh (5.5 million) and is growing steadily.

Unorganized Sector

While NPS is open to unorganized sector workers as well, the uptake there had been modest until the introduction of simpler schemes like APY.

However, there are aggregation models under NPS (through NGOs, microfinance, etc.) to enroll self-employed, informal workers (this was earlier called NPS-Lite or Swavalamban Yojana, now mostly subsumed by APY). A recent initiative is the NPS for Gig workers (Platform Workers) introduced in 2025 to extend pension coverage to gig economy workers.

NPS Performance and Outlook

Over the years, NPS has grown into a significant corpus. The combined Assets Under Management of NPS (including APY) crossed ₹16 lakh crore in 2025. NPS funds have generally delivered annual returns in the range of ~8-10% (varying by asset mix and markets), which, coupled with low fees, makes it an effective long-term wealth generator. PFRDA continues to refine NPS – for example, in 2025 a Multiple Scheme Framework was introduced to give subscribers more choice in investment styles, and consultations are on for more flexible payout options (like systematic withdrawals instead of a one-time annuity purchase).

Such changes aim to make NPS more attractive and suitable for a variety of retirement needs. With increasing awareness, NPS is expected to play a vital role in providing retirement income to India’s vast young workforce in the coming decades.