What is the New Pension Scheme?
The NPS was introduced by the government last year to give people a way to get a pension during their old age. Employees of the government sector already get a pension, so this scheme was introduced as a social security measure that enables people from the unorganized sector to draw a pension as well.
The working mechanism is quite simple – you contribute a certain sum every month during your working years, which is then invested according to your preference. You can then withdraw the money when you retire, which is currently set at 60 years old.
When I say you invest according to your preference, I mean that there are a couple of different options that you need to select from. These options pertain to your preference on withdrawal, and asset allocation.
What are Tier I and Tier II accounts in the NPS?
The NPS is meant to be a pension scheme, so it is geared towards giving you a steady stream of income on your retirement.
That means that NPS makes it difficult to withdraw your money during your working years or till the age of 60 in this case.
Tier I and Tier II are two options under the scheme where you can invest your money, the primary difference between them is how they differ in allowing you to withdraw your money before retirement.
NPS Tier I
There is severe restriction on withdrawing your money before the age of 60, because it is necessary to invest 80% of your money in an annuity with Insurance Regulatory Development Authority (IRDA) if you withdraw before 60. You can keep the remaining 20% with you.
When you attain the age of 60, you have to invest at least 40% in an annuity with IRDA; the remaining can be withdrawn in lump-sum or in a phased manner.
NPS Tier II Account
The first thing about the NPS Tier II account is that you need to have a Tier I account in order to open a Tier II account.
The Tier II account makes it easy for you to withdraw your money before retirement because there is no limit on the withdrawals you can make from the Tier II account.
You need to maintain a minimum balance of Rs. 2,000, and you can transfer money from the Tier II account to Tier I account, but not the other way around.
There is a Rs. 350 CRA (Credit Record Keeping Agency) charge which is not present in the Tier II account, but the rest of the fees remain the same
Asset Allocation and Categories in the NPS
There is an Active Choice option, and an Auto Choice option. If you select Auto Choice then your money is invested in a certain percentage in the various classes based on your age.
Here are the three investment classes:
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Will only invest in Central and State government bonds.
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Fixed income securities of entities other than the government
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Fixed income securities of entities other than the government
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In the Active Choice you can select how much of your money will be invested in the different classes with a cap of 50% in Class E.
Now, there are pension funds that will manage your money, and in either of these options you have to select the fund manager who will manage your fund. So even if you select the Auto Choice, you still have to tell them which fund manager you want to manage your money.
What is the minimum amount needed to invest in the NPS?
For a Tier I NPS account you need to contribute a minimum of Rs. 6,000 per year, and make at least 4 contributions in a year. The minimum amount per contribution can be Rs. 500.
Minimum amount for opening Tier II account is Rs. 1,000, minimum balance at the end of a year is Rs. 2,000, and you need to make at least 4 contributions in a year.
For more information, please contact us.
