New Pension Scheme

The New Pension Scheme (NPS), officially known as the National Pension System, is a voluntary, long-term retirement savings scheme launched by the Government of India in January 2004. Initially introduced for new entrants to the Central Government service (except armed forces), it was later extended to all citizens of India on a voluntary basis from May 2009. The NPS aims to provide individuals with a structured and regulated retirement plan, combining market-linked returns with transparent fund management. It is administered and regulated by the Pension Fund Regulatory and Development Authority (PFRDA).

Background and Objectives

The NPS was introduced as part of a broader pension reform initiative to replace the traditional Defined Benefit (DB) pension system for government employees with a Defined Contribution (DC) framework. Under the earlier system, retirees were assured a fixed pension based on their last drawn salary, placing a long-term financial burden on the government.
The New Pension Scheme was designed to achieve the following objectives:

• To promote retirement savings among citizens through systematic and disciplined investments.
• To provide a sustainable and portable pension system in both public and private sectors.
• To reduce the fiscal pressure of pension liabilities on the government.
• To encourage individual financial planning and self-reliance in old age.

By introducing NPS, India joined the global trend of pension reforms that shifted from government-funded benefits to individual contribution-based schemes.

Structure and Administration

The New Pension Scheme operates under a multi-tiered institutional framework regulated by the PFRDA, which ensures transparency, accountability, and efficiency in its functioning.
Key entities involved include:

• PFRDA (Pension Fund Regulatory and Development Authority): The apex body responsible for regulating and developing the pension sector in India.
• Central Recordkeeping Agency (CRA): Maintains the database of NPS subscribers and processes transactions. The main CRA is Protean eGov Technologies Ltd (formerly NSDL e-Governance Infrastructure Ltd).
• Pension Fund Managers (PFMs): Professional institutions approved by PFRDA to manage subscribers’ investments across asset classes.
• Points of Presence (PoPs): Authorised intermediaries such as banks and financial institutions that serve as customer service points for NPS subscribers.
• Trustee Bank: Handles fund flow and settlement operations; currently, Axis Bank serves this role.

Coverage and Eligibility

The NPS covers the following categories of subscribers:

1. Central Government Employees: All employees who joined central government service on or after 1 January 2004, except those in the armed forces.
2. State Government Employees: Most state governments have adopted NPS for their employees joining after specified dates.
3. Corporate Sector Employees: Companies can register with NPS to offer it as part of their retirement benefits.
4. All Citizens Model: Any Indian citizen between 18 and 70 years of age can voluntarily join the scheme.
5. NPS–Lite / Atal Pension Yojana (APY): Designed for unorganised sector workers with low income levels, offering simplified processes and government co-contributions.

Types of Accounts

The NPS operates through two main types of accounts:

• Tier I Account (Mandatory Pension Account):
  • This is a retirement account with restrictions on withdrawals.
  • Minimum annual contribution: ₹1,000.
  • Withdrawals are permitted only under specific conditions, such as retirement, attaining 60 years of age, or defined contingencies.
  • Partial withdrawals (up to 25%) are allowed for specific purposes like higher education, medical treatment, or purchasing a house.
• Tier II Account (Voluntary Savings Account):
  • Functions like a voluntary investment account, offering greater liquidity.
  • Subscribers can withdraw funds at any time without restrictions.
  • Only those with an active Tier I account can open a Tier II account.

Contribution and Investment Mechanism

Under the NPS framework, both the employee and the employer contribute towards the pension corpus.

• For Government Employees:
  • Employee contribution: 10% of basic pay + dearness allowance (DA).
  • Employer (government) contribution: 14% of basic pay + DA (as per the 2019 revision).
• For Private and Individual Subscribers:
  • Minimum contribution per instalment: ₹500 for Tier I and ₹250 for Tier II.
  • Subscribers can decide their own contribution frequency and amount, offering flexibility.

The contributions are invested in diversified asset classes, including:

1. Equity (E): Investments in equity shares (higher return, higher risk).
2. Corporate Bonds (C): Investments in fixed-income instruments issued by corporations.
3. Government Securities (G): Investments in sovereign bonds (low risk, stable returns).
4. Alternative Investment Funds (A): Limited exposure to alternative assets like infrastructure or real estate funds.

Subscribers can choose between two investment options:

• Active Choice: Subscribers decide the asset allocation within permitted limits (up to 75% in equity).
• Auto Choice (Lifecycle Fund): Asset allocation automatically adjusts with age, shifting from higher equity exposure in youth to safer investments as retirement approaches.

Withdrawal and Exit Rules

The NPS aims to provide retirement income, and hence, withdrawals are subject to specific rules:

• At Retirement (Age 60):
  • Up to 60% of the accumulated corpus can be withdrawn as a lump sum (tax-free).
  • The remaining 40% must be used to purchase an annuity plan from a PFRDA-approved insurance company, providing a lifelong pension.
• Early Exit (Before 60 years):
  • Up to 20% can be withdrawn as a lump sum; at least 80% must be used to purchase an annuity.
• Upon Death of Subscriber:
  • The entire accumulated corpus is paid to the nominee or legal heir, exempt from tax.

Tax Benefits

The NPS offers multiple layers of tax incentives, making it one of the most tax-efficient retirement savings instruments:

• Under Section 80CCD(1): Employee’s contribution (up to 10% of salary) is eligible for deduction within the overall limit of ₹1.5 lakh under Section 80C.
• Under Section 80CCD(1B): An additional deduction of up to ₹50,000 is available for NPS contributions, over and above the 80C limit.
• Under Section 80CCD(2): Employer’s contribution (up to 10% or 14% for government employees) is deductible from taxable income without the ₹1.5 lakh ceiling.
• Lump-sum withdrawals (up to 60%) at retirement are exempt from tax.

These provisions make NPS one of the most attractive long-term tax-saving investment options available in India.

Advantages of the New Pension Scheme

• Portability: The NPS account is portable across jobs, locations, and sectors.
• Low Cost: It is one of the lowest-cost pension products in the world, with minimal administrative charges.
• Transparency: Subscribers can monitor their accounts online through the CRA system.
• Flexibility: Choice of fund managers, investment options, and contribution amounts.
• Market-Linked Returns: Offers potentially higher returns compared to traditional fixed pension schemes.

Limitations and Criticisms

Despite its strengths, the NPS has faced certain criticisms:

• Market Risk: Returns are subject to market volatility due to equity and bond exposure.
• Annuity Returns: Pension payouts from annuities are often modest compared to traditional pension schemes.
• Complexity: Multiple choices and procedures may deter less financially literate individuals.
• Limited Liquidity: Tier I restrictions reduce flexibility for early withdrawals.

NPS Variants and Expansions

Over the years, the NPS has evolved into multiple sub-schemes to serve diverse sections of society:

• Atal Pension Yojana (APY): Launched in 2015 for workers in the unorganised sector, guaranteeing fixed monthly pensions ranging from ₹1,000 to ₹5,000.
• NPS Corporate Model: Allows employers to offer NPS as part of employee benefit packages.
• NPS for Non-Resident Indians (NRIs): NRIs can also participate, contributing in Indian Rupees through NRE/NRO accounts.

Role in India’s Pension Landscape

The New Pension Scheme marks a significant step in India’s transition toward a sustainable, contributory, and inclusive pension system. It complements other retirement-oriented instruments such as the Employees’ Provident Fund (EPF) and Public Provident Fund (PPF), broadening social security coverage in both organised and unorganised sectors.