What is the NPS?
The National Pension System is a government-backed retirement savings scheme that helps the individuals to build a pension fund through regular contributions. The scheme provides exposure to both equity and debt, allowing for growth while minimizing risk over the long term. This is managed by Pension Fund Regulatory and Development Authority of India (PFRDA). This helps individuals to accumulate a sizable corpus, which can be withdrawn at retirement, with a portion converted into an annuity to provide a steady post-retirement income.
The power of compounding
When it comes to investing, the earlier you start the longer your investment has to grow, benefiting from the power of compounding. In the case of NPS, a monthly investment or Systematic Investment Plan (SIP) of Rs 10,000 can grow to nearly Rs 4 crore over time.
A Rs 10,000 investment can grow over time with a 10% annual return. Over 35 years, this consistent contribution can generate a retirement corpus of approximately Rs 4 crore. Here’s a breakdown of the growth potential: (Source: NPS Trust)
- Monthly SIP: Rs 10,000
- Start age: 25 years
- Investment duration or total years of contribution: 35 years (from age 25 to 60)
- Estimated rate of return: 10% annually (based on historical returns from a mix of equity and debt exposure)
- Total investment over 35 years: Rs 42 lakh (Rs 10,000 x 12 months x 35 years)
- Purchase annuity for: 40%
- Expected annuity rate: 6%
- Total corpus: Rs 3.82 crore (Lumpsum value – Rs 2.29 crore + Annuity value – Rs 1.53 crore)
- Monthly pension – Rs 76,566
ETMarkets.comSource: NPS TrustThis is the power of compounding, where the returns generated by the investments are reinvested, leading to exponential growth over time. The longer one remains invested, the greater is the corpus.
How NPS is useful for retirement planning
NPS offers several key features that make it an excellent choice for building a retirement corpus:
- Equity and debt exposure: NPS provides exposure to both equity and debt. This balanced approach helps to manage risk while aiming for steady long-term growth. Young investors can opt for a higher equity allocation, which typically delivers higher returns over time.
- Lifecycle fund option: NPS also offers an auto-choice option where the equity exposure gradually decreases according to the age, shifting towards more stable debt instruments as one reaches near retirement. This reduces risk during the later years when securing wealth becomes important.
- Low cost: NPS is a cost-effective retirement savings option. With low fund management charges and minimal administrative fees, more of your investment remains invested, allowing for greater growth potential.
- Tax benefits: One of the key advantages of NPS is the tax benefits it offers. Contributions are eligible for a deduction of up to Rs 1.5 lakh under Section 80C of the Income Tax Act. Additionally, an extra Rs 50,000 deduction is available under Section 80CCD(1B), giving NPS a significant tax-saving edge over other investment options.
- Disciplined savings: The structure of NPS encourages disciplined and long-term savings. Since withdrawals are limited until retirement, investors are less likely to touch their retirement savings for short-term needs, allowing the corpus to grow.
Retirement withdrawal and annuity benefits
After attaining the retirement age of 60, NPS allows investors to withdraw up to 60% of the corpus as a lump sum, which is completely tax-free. The remaining 40% must be used to purchase an annuity, which will provide a regular pension income. This feature ensures that retirees have both a lumpsum for immediate needs and a regular income to live their lifestyle throughout their retirement.