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NPS or National Pension Scheme: All details on this retirement planning scheme

The National Pension Scheme or NPS is a relatively recent retirement-saving scheme introduced by the Govt of India and regulated by the PFRDA.  It is open for all citizens of India in the working age. The objective of this scheme is to provide pension income through market-based returns. The Government offers some significant and exclusive tax benefits on the NPS scheme to encourage citizens to save for retirement. After Budget 2019, NPS tax status is now EEE.

NPS Scheme details in one infographic

The infographic below presents all NPS pension scheme details in a concise and easy-to-read way. It answers questions such as what is the NPS scheme, how NPS works, what are NPS tier 1 and tier 2 accounts, NPS tax benefits and the various contribution, investment and withdrawal rules.

Summary of all NPS scheme details in one image

In the rest of this blog, we explain these points in greater detail. We strongly suggest that you also have a look at our free, downloadable NPS excel calculator, to see how the different NPS rules work out practically.

What is NPS

NPS is a retirement-planning/pension scheme introduced by the Government of India. It is regulated by the PFRDA (Pension Fund Regulatory and Development Authority).  The scheme was initially introduced for Central Government Employees who have joined service after 1 Jan 2004. Since then many State Governments have also introduced NPS for their employees. NPS is mandatory for government employees.

The scheme was opened for All Citizens of India in May 2009. Corporate NPS was also formally introduced in Dec 2011. Under the corporate model, core NPS can be customized to suit the needs of different organizations and their employees. For the private sector – All Citizens and Corporate – NPS is purely voluntary. However since the government wants to encourage saving for retirement, hence a host of NPS tax benefits have been provided to encourage individuals and corporate to participate in the NPS pension scheme. 

The NPS is a defined contribution scheme.  This means that only the contributions (whether from employee or employer) are fixed or known in advance. There is no fixed rate of return. Rates of return are linked to the performance of equity and debt markets. This makes NPS different from defined benefit pension schemes such as EPF where the rate of return is fixed. 

Given the wider applicability of the NPS All Citizens Model, unless otherwise mentioned, in this blog we focus on the NPS All Citizens Model when we discuss the different rules and regulations. Also, this blog is exclusively focused on the question of ‘what is NPS.’ But to gain a better understanding of why the NPS scheme has been designed the way it has been and why it is important from a larger perspective, we strongly recommend that you read our blog on Motivations for writing about NPS.

How NPS works

NPS intermediaries

The NPS pension scheme has an unbundled architecture. What that means under the NPS scheme, the role of the government is only to ensure that there are adequate checks and balances in the system. The government plays this role through the regulator – PFRDA. All other parts of the value chain such as record-keeping, fund management fund transfers and custodial services have been outsourced through a competitive bidding process to specialized players in each area. This helps to keep NPS costs low and provides operational efficiency.

In the chart below, we show the different NPS intermediaries and their role in the NPS pension scheme. We refer to these NPS intermediaries frequently while explaining the different aspects of the NPS system.
Roles and function of different intermediaries in the NPS system

  • CRAs: NSDL and Karvy are the two CRAs appointed by PFRDA
  • POP/POP-SPs: Nearly 85 major financial institutions (banks and non-banks) have been designated as POPs under the All Citizens Model. The list can be found on CRA websites: NSDL POP locator and Karvy POP locator.
  • Trustee Bank: Axis bank is the NPS trustee bank, subject to a review in 2020
  • Custodian: Stock Holding Corporation of India is the custodian registered by PFRDA
  • PFMs: There are currently 8 PFMs for the Private Sector: HDFC Pension, ICICI Prudential Pension, Kotak Mahindra Pension, LIC Pension, Reliance Capital Pension, SBI Pension, UTI Retirement Solutions, and Birla Sunlife Pension. Fund performances can be tracked on the NPS Trust Website.
  • ASPs: There are currently 8ASPs empanelled by the PFRDA: Life Insurance Corporation of India, HDFC Life Insurance, ICICI Prudential Life Insurance, SBI Life Insurance, Star Union Dai-ichi Life Insurance, Bajaj Allianz Life Insurance, Edelweiss Tokio Life Insurance Company, and India First Life Insurance Company Limited. 

Permanent Retirement Accounts and Account Numbers ( PRA and PRAN)

NPS is based on Personal retirement accounts (PRAs) created for individual members. Any investor under NPS is called a subscriber. Every NPS subscriber is allotted a unique 12-digit PRAN or Permanent Retirement Account Number. Every NPS subscriber also gets a PRAN card with their PRAN and other details.

A snapshot of the PRAN card

A screenshot of what the NPS PRAN card looks like
The PRAN is easily portable across employers and geographies. This means that a subscriber's PRAN will remain same even if the subscriber switches employers (even between Government and corporate sector), becomes self-employed or changes locations. Under one PRAN, a subscriber can have two kinds of accounts: Tier 1 and Tier 2 account. We discuss these in the next section.

NPS Tier 1 and Tier 2 accounts

NPS Tier 1 account

NPS Tier 1 account is the retirement account.  It is also a mandatory account under NPS i.e. any NPS subscriber needs to necessarily have a Tier 1 account.  

Very broadly, NPS Tier 1 works in the following way: Subscribers contribute towards NPS Tier 1 account during their working life. They invest these saving in various market-based instruments such as equities, government bonds, corporate bonds, and alternative assets. This corpus (which is a sum of contribution plus returns) is available to the subscriber on retirement or exit from NPS scheme. Contributions to the Tier 1 account can come solely from the individual or it can be a combination of employer and employee compensation (in cases where the scheme has been adopted within the organization whether government or corporate).

NPS Tier 1 account fulfills an important government objective of extending old age security to all its citizens. Therefore the government offers several tax benefits for NPS Tier 1 account to incentivize participation. NPS Tier 1 account has an EEE (Exempt-exempt-exempt) tax status. We discuss this more in the tax benefits section.

At the same time since the aim of the scheme is to ensure that investors save for retirement, therefore there are also some restrictions on NPS Tier 1 investment related to minimum contribution rules every year and strict withdrawal rules as we discuss later.

NPS Tier 2 account

NPS Tier 2 account is a wealth-building product just like mutual funds. Opening an NPS Tier 2 account is optional.  Any subscriber who has an NPS Tier 1 account has the option to open an NPS Tier account if they want. 

NPS Tier 2 account allows investors to access the same investment options that are available under the NPS Tier 1 account but with much greater flexibility. There are no restrictions on withdrawal from Tier 2 account and no minimum balance requirement. However, at the same time, there is no tax exemption for investing in the Tier 2 account.

The Tier 2 account can be operated completely independently of the Tier 1 account – a subscriber can choose a different investment pattern, have different nominees and a different bank account linked to the Tier 2 account.

NPS eligibility

All citizens of India between 18-65 years of age can join NPS. This is the age as on the date of submission of the application to the POP/ POP-SP.

Resident Indians can open both Tier 1 and Tier 2 account. Tier 2 accounts can be activated only if the subscriber already has a Tier 1 account or has applied for it. Application for opening Tier 1 and Tier 2 account can also be submitted together.

NRIs can only open the Tier 1 account. 

However, OCI (Overseas Citizens of India) and PIO (Person of Indian Origin) cardholders and HUFs are not eligible for opening of the NPS account. If there is any change in the citizenship status of NRIs then they need to close their NPS account.

Check our post on How to open NPS account.

NPS tax benefit

The government has provided a host of tax benefits for investing in NPS Tier 1 account. However, they are no notable tax benefits for investing in NPS Tier 2 account. We have done a detailed post on NPS tax benefit with examples and all updated rules. Here we summarise the main points.

Tax Benefit on NPS - an illustration

NPS tax rules and EEE tax benefit explained in one image

NPS Tier 1 tax benefit

Investments in NPS Tier 1 account are EEE (Exempt-exempt-exempt) i.e. contributions, returns and withdrawals from NPS Tier 1 account are tax-exempt up to certain limits.  

Tax benefit on NPS  Tier 1 contributions:

  1. Self contribution to NPS account of up to 10% of salary (basic + DA) or 20% of gross income (in case of self-employed individuals) is tax-deductible under Section 80 CCD(1) of the Income Tax Act. This comes within the overall ceiling of Rs. 1.5 lakh under Sec 80 CCE. For NRIs, this amount is 10% of gross income from Indian sources.
  2. For salaried employees, employer contribution up to 10% of salary (Basic +DA), without any upper limit, is also eligible for deduction from income tax, under Section 80 CCD(2). For Central Government employees, this limit is 14% of salary.
  3. From FY 2015-16, investors can claim an additional income tax deduction, for an amount of up to Rs 50,000 invested in NPS Tier 1 under Section 80CCD(1B).
Two of these tax exemptions – on the employer contribution under Section 80CCD(1) and on investment of up to Rs 50,000 under Section 80CCD(1B) – are additional benefits available only for NPS Tier 1 investments making this scheme attractive for high-income taxpayers.

Tax benefit on NPS  Tier 1 returns:

Any returns earned on your investment corpus are completely tax-free as long as they stay within NPS and are not withdrawn. In the NPS investment options section, we discuss how under NPS you can change your asset allocation two times in a year and change your Pension fund manager once in a year. These changes have no tax implications but that automatically puts the NPS Tier 1 account at an advantage over mutual funds where the same transactions would incur tax and exit load.

Tax benefit on NPS Tier 1 withdrawals:

  1. Any amount that is used to purchase an annuity at the time of withdrawal can be withdrawn tax-free. However, the tax will have to be paid on the annuity income in the subsequent years at the marginal income tax rate.
  2. Up to 60% of the NPS corpus at exit can be withdrawn as a lump sum amount tax-free. This limit used to be 40% before and was recently increased after Budget 2019. If you look at the NPS withdrawal rules, then you will find that the maximum amount that can be withdrawn as a lump sum under the various exit scenarios is 60%. So with this increase in the limit (from 40% to 60%) in Budget 2019 NPS withdrawals have become tax-free. 

NPS Tier 2 tax benefit

Under the All citizens model, there is no tax benefit on Tier 2 contribution. However contribution of Central Government Employees to NPS Tier 2 account is eligible for income tax deduction under Section 80C (so up to a limit of 1.5 lakhs), subject to a lock-in period of 3 years.   

No tax is incurred while you are invested in the Tier 2 account. Just like we discussed for the Tier 1 account, this automatically gives the Tier 2 account a tax advantage over other investment options such as mutual funds.

Withdrawals from Tier 2 account are taxed. However, the exact method of taxation is unclear, which in our opinion limits the appeal of NPS Tier 2 account.  For instance, it is unclear whether the gains will be taxed at marginal income tax rate (as is the case with FD) or they will be taxed like non-equity mutual funds or whether investment options will be taxed component-wise (equity component as equity mutual fund and others as non-equity mutual funds).

NPS contributions

Contribution to NPS account can be self-contribution or it can be a combination of self plus employer contribution. 

NRIs can make contributions from either their NRE (repatriable) or NRO (non-repatriable) account and this would determine whether the final corpus is repatriable or not. Contributions made by NRI are subject to regulatory requirements as prescribed by RBI and FEMA from time to time.

Minimum contribution for NPS Tier 1 account: 

NPS Tier 1 account has stringent minimum contribution requirements since the government wants to ensure that subscribers contribute regularly for their retirement.
  • Minimum amount per contribution - Rs. 500
  • Minimum contribution per Financial Year - Rs. 1,000
  • Minimum number of contributions in a Financial Year – one
If a subscriber does not meet these criteria, then the account will be frozen from the 2nd year onwards and the facilities provided by CRA such as online view of the account, etc. will be restricted. To unfreeze the account, the subscriber has to pay the total of minimum contributions for the period of freeze, the minimum contribution for the year in which the account is reactivated and a penalty of Rs.100. A frozen account shall be closed when the account value falls to zero.   

Minimum contribution for NPS Tier 2 account

The requirements for Tier 2 account are less stringent:
  • Minimum amount for first contribution – Rs 1000
  • Minimum amount per contribution for subsequent contributions - Rs. 250
  • No minimum balance required
There is no minimum contribution per financial year requirement for the Tier 2 account, so the subscriber does not need to deposit funds every year.

NPS withdrawal rules

NPS Tier 1 withdrawal rules are strict to discourage dilution of savings before retirement. Also, subscribers are required to use a portion of their retirement corpus to purchase an annuity. An annuity is a financial product in which the investor pays a lump sum amount today and gets a regular stream of income in later years. This requirement ensures that the subscriber gets some regular income during retirement.
We have discussed NPS withdrawal rules in a separate detailed blog post. Here we summarise the main points.

NPS withdrawal rules - an illustration

A summary of all NPS withdrawal rules explained in one image

NPS Tier 1 withdrawal rules 

Five kinds of withdrawal are possible from NPS Tier 1 account:
  • Normal exit:  This is an exit from NPS at the age of 60/superannuation. On normal exit, a subscriber needs to use at least 40% of the accumulated corpus to purchase an annuity. The remaining (i.e. up to 60%) can be withdrawn as lump sum amount.
  • Deferral/Continuation: This is a special case of a normal exit. At the time of retirement, NPS subscribers can opt for deferral (extending account without further contribution) or continuation (extending account with further contribution). In these cases, the rules for normal exit apply at the end of the deferral/ continuation period.
  • Premature Withdrawal: This is an exit from NPS before the age of 60/superannuation. On premature exit, a subscriber needs to use at least 80% of the accumulated corpus to purchase an annuity. The remaining (i.e. up to 20%) can be withdrawn as lump sum amount.
  • Exit due to death of subscriber: In this case, 100% of the accumulated corpus is paid out to the nominees/legal heir of the subscriber as mentioned in the NPS nomination form. However, nominees can opt for an annuity if they so wish.
  • Partial Withdrawal: This is the case where you can withdraw a part of your corpus but still continue with the account. Partial withdrawals are only allowed for specific purposes and with the condition that the subscriber should have been in NPS for at least 3 years. We list these purposes in the detailed post on NPS withdrawal rules. Partial withdrawals are only allowed for a maximum of 3 times during the tenure of the account and withdrawals of only up to 25% of contributions made by the subscriber (without considering returns) are allowed at one time. 
You may have noticed that in the NPS eligibility section we had said that all citizens between18-65 are eligible to join NPS. But the normal exit is defined as exit at the age of 60. So then what about those citizens who have joined NPS between 60 and 65 years of age? In their case, the normal exit is defined as exit after at least 3 years of joining while premature withdrawal is defined as exit from NPS before that. 

NPS Tier 2 withdrawal rules 

Under the All Citizens model, there are no special withdrawal rules for NPS Tier 2 account. However, Tier 2 account can only exist together with the Tier 1 account. So Tier 2 accounts are automatically closed when you close the Tier 1 account even if the request for the same has not been submitted. 
Central government employees who have claimed a Section 80C deduction on their Tier 2 contribution have a lock-in period of 3 years. 

NPS investment options

NPS does not have a fixed rate of return. Instead, subscribers can choose from a menu of different investment choices – all of which offer returns related to the performance of equity and debt markets. Making so many investment choices may seem daunting at first but it is also an opportunity to build a portfolio best suited to a particular investor’s needs. To make the task of investing in NPS easier, we have also done an in-depth post on NPS investment options: Build the best NPS portfolio for your needs. Here we summarise the main points:

Constructing NPS portfolio

A description of how to build your best NPS investment portfolio

The different schemes under NPS

For NPS Tier 1, subscribers can invest in 4 asset classes: Equities (E), Government bonds (G), Corporate bonds (C) and Alternative assets (A). For NPS Tier 2, a subscriber can invest in 3 asset classes - all of the above asset classes other than Alternatives. 

8 pension fund managers have been chosen to offer schemes under NPS. Each pension fund manager offers 7 schemes: 4 for each asset class under Tier 1 and 3 schemes for Tier 2.

NPS subscribers can choose from any of these schemes. However, all asset class schemes in one account need to be the same Pension Fund Manager. Tier 1 and Tier 2 accounts can have different Pension fund managers. The Pension Fund Manager can be changed once in every financial year.

NPS asset allocation

The asset class schemes are the building blocks with which investors can build different kinds of portfolios for their retirement. For asset allocation, NPS offers two different kinds of options.

First is the Active-choice option in which investors can build their own portfolio. The only restriction is that the max weight on equities cannot exceed a certain level, Different levels have been pre-specified based on subscriber’s age as shown in the table above. The max weight on alternative assets cannot exceed 5%. There is no cap for the weight on government and corporate bonds.

Second is the Auto-choice option. Under this option, the subscriber has to choose from three Life cycle funds. Each Life cycle fund is based on a pre-defined weight matrix - where weight has been specified for each asset class based on the age of the subscriber. The logic of each matrix is based on the life-cycle theory of investment. At a young age, a subscriber should invest more in risky assets and gradually move to less risky assets as their age advances.

There are 3 life-cycle funds/weight matrices for 3 different kinds of subscribers:

  • LC-75: This is for Aggressive investors who want to take high risk. The maximum equity weight is this weight matrix is 75% and for each age, weight on equities/risky assets is the highest.
  • LC-50:  This is for Moderate investors who want to take a medium amount of risk. The maximum equity weight is this weight matrix is 50% and for each age, weight on equities/risky assets is between LC-75 and LC-25.
  • LC-25: This is for Conservative investors who want to take low risk. The maximum equity weight is this weight matrix is 25% and for each age, weight on equities/risky assets is the lowest.
The exact weight matrices for each Life-cycle fund can be found in the NPS investment options post.

An NPS subscriber can change their Asset allocation (Auto vs. Active choice and the asset allocation percentages, in case of Active choice) two times in a financial year. 

Benefits of NPS:

While there are many unique aspects of the National Pension Scheme, there are 3 benefits that we would like to highlight in particular:

1. Tax benefit

We have already talked about the tax benefit offered by NPS in a separate section and in this detailed post. Here we would just like to reiterate that NPS provide some exclusive tax benefits – on the employer contribution under Section 80CCD(1) and on an investment of up to Rs 50,000 under Section 80CCD(1B) –  which are not available with any other investment, making this scheme attractive for high-income taxpayers.

2. Low costs

The  table below shows the costs charged by the different NPS intermediaries:
A list of all the charges for running an NPS account
As you can see some of these costs are charged as absolute rupee amounts while others are charged as a percentage of AUM, so it is difficult to summarise the cost in one number. Fortunately, the NPS trust has done the task for us. It has calculated the Equivalent Asset Fee or EAF for NPS here. This EAF is the equivalent per annum fee (as % of AUM) which would result is the same post-cost corpus as the costs in the NPS cost table. According to the assumptions taken by NPS trust, NPS EAF is 0.169% p.a. However, this number does not include the 0.005% p.a. fee which the NPS trust has started charging from 1st Aug 2019. Adding that number we reach an EAF of 0.174%.

If we compare this number with other products, we find that NPS has among the lowest costs when compared to the other retirement or wealth-building options available within India such as mutual funds, ULIPs or other pension plans. Mutual funds, for instance, have fees of 1% to 2.5% p.a. For ULIPs, costs are even higher.

When saving for a long-term goal such as retirement, the cost matters a lot. Over 35-40 years, the charges can shave off a significant amount from the corpus. Hence low costs in NPS are a big advantage. 

3. Flexible investment option with sizable allocation to equities

NPS investment options have been designed based on some of the world's best practices in the pension sector. We would like to highlight two aspects in particular:

  1. Sizable allocation to equities: In the long-run, equities are expected to generate much higher returns than debt. Hence it makes sense to have a significant amount of equities in your retirement portfolio especially when you are young and retirement is a long way off. Despite this many retirement products in India – most notably the EPF – offer debt-like returns. These have the advantage of being stable but they are quite low. NPS embraces equities allowing subscribers to have as much as 75% invested in equities when they are below 50. 
  2. Flexibility: NPS has multiple investment options to accommodate different investor preferences. While somebody with a high risk preference can invest more in equities, those with lower risk appetite can select debt-heavy options. There are also 3 Life-cycle funds where weights get chosen automatically for the subscriber based on widely-accepted life cycle theory of investment. These automatic investment options make the life of investors easier. 


In this post, we tackled the question of what is the NPS scheme. However, it is a vast topic. After all, we have this whole blog dedicated to it! In particular, we suggest that you look through our posts on NPS tax benefit, NPS withdrawal rules and NPS investment options to deep dive into some of the topics that we have discussed here. It will also be helpful to look at the NPS calculator to understand how these different rules work out in practice. Finally, if NPS looks interesting to you and you are ready to invest in it, then you may want to visit our post on How to open your NPS account.