National Pension System

NPS is a government‑backed, defined‑contribution scheme that aims to provide a regular pension after retirement. It is regulated by the Pension Fund Regulatory and Development Authority (PFRDA) and is open to all Indian citizens, including NRIs, between the ages of 18 and 65.

The scheme has two distinct accounts – Tier I (the primary retirement account) and Tier II (a voluntary savings account). Tier I enjoys tax exemptions on contributions and earnings, while Tier II offers liquidity but limited tax benefits.

For the NISM exam, remember that NPS is classified under “Other Products” for taxation, distinct from EPF, PPF, or mutual funds. Questions often compare the tax treatment of Tier I versus Tier II, so keep the differences clear.

• Tier I: Mandatory exit at 60 years (partial withdrawal allowed earlier under conditions).
• Tier II: No exit restrictions, but earnings are taxable like any other investment.

Any Indian resident aged 18‑65 can open an NPS account. The only exclusion is for individuals who are already members of a government‑run pension scheme such as the Central Government Employees’ Pension Scheme (CGEPS).

When opening an account, the subscriber chooses a Point of Presence (POP) – a bank, post office, or registrar – to handle KYC and paperwork. The subscriber also selects a Central Recordkeeping Agency (CRA) that maintains the electronic record of the account.

Tier I accounts are mandatory for receiving a pension, while Tier II accounts are optional and function like a mutual‑fund‑style savings vehicle. The key exam distinction is that Tier I contributions are eligible for tax deductions, whereas Tier II contributions are not, unless the Tier II account is linked to an employer’s NPS scheme and qualifies for the 80CCD(1B) additional deduction.

• Eligibility check: Age, residency, and no existing government pension.
• Account choice: Tier I (tax‑favoured) vs. Tier II (flexible, taxable).

Under Section 80CCD(1), an individual can claim a deduction for up to 10% of their Gross Total Income (GTI) for contributions to Tier I, subject to the overall ceiling of Rs. 1.5 lakh under Section 80C. The employer’s contribution to the employee’s NPS account is also eligible for deduction, but it is capped at 10% of the employee’s salary (basic + DA).

Section 80CCD(1B) provides an additional exclusive deduction of up to Rs. 50,000 for contributions to NPS (both Tier I and Tier II) made by the employee, over and above the Rs. 1.5 lakh limit. This extra deduction is unique to NPS and is not available for any other retirement product.

It is essential for advisers to calculate the exact deductible amount because the “minimum” rule applies: the deduction cannot exceed the actual contribution, 10% of GTI, or the statutory ceiling, whichever is lowest.

• Employee contribution (Tier I) – eligible under 80CCD(1) and 80CCD(1B).
• Employer contribution – eligible only under 80CCD(1).
• Tier II employee contribution – eligible only under 80CCD(1B) (if linked to employer).

All earnings (interest, dividends, and capital gains) accumulated inside the NPS Tier I account grow tax‑free. Tax is levied only at the point of exit. The exit can occur in two ways: (i) purchase of an annuity, and (ii) partial withdrawal of up to 60% of the corpus before retirement.

When an annuity is bought, the annuity income is taxed as ‘Income from Other Sources’ in the hands of the retiree, based on the applicable slab rates. The remaining 40% of the corpus, if withdrawn as a lump sum, is tax‑exempt under Section 10(12) of the Income Tax Act, provided the subscriber has completed 60 years of age. If the lump‑sum is taken before 60, only 20% of the amount is tax‑exempt; the rest is added to taxable income.

For Tier II accounts, both the earnings and withdrawals are fully taxable in the year of receipt, similar to mutual fund units. This distinction is a frequent source of exam errors.

• Full exit at 60: 40% lump sum tax‑free, 60% annuity taxable.
• Early exit (<60): 20% tax‑free, 80% taxable.
• Tier II: All earnings and withdrawals taxable.

NPS offers two broad investment approaches: Active Choice and Auto Choice. In Active Choice, the subscriber decides the exact percentage allocation among Equity (E), Corporate Bonds (C), Government Securities (G), and Alternative Assets (A). In Auto Choice, the allocation is age‑based, shifting gradually from higher equity exposure to safer debt instruments as the subscriber ages.

The equity ceiling for Tier I is 75% of the total corpus, while Tier II allows up to 100% equity exposure. The asset‑class split influences the expected return and risk profile, which is a typical scenario in NISM case‑study questions.

Advisers must assess the client’s risk tolerance, investment horizon, and retirement goals before recommending an allocation. Remember that the portfolio is re‑balanced annually, and the subscriber can change the allocation only once a year.

• Active Choice – full control, must stay within equity ceiling.
• Auto Choice – age‑based glide path, easier for beginners.

Step 1 – Conduct KYC: Obtain PAN, Aadhaar, address proof, and photograph. The POP will verify these documents before opening the account.

Step 2 – Choose POP and CRA: Explain the role of the Point of Presence (e.g., bank or post office) and the Central Recordkeeping Agency (e.g., NSDL, CAMS). The client must select one CRA for the entire lifetime of the account.

Step 3 – Decide Tier and Investment Option: Discuss Tier I vs. Tier II, active vs. auto choice, and the appropriate asset allocation based on the client’s risk profile.

Step 4 – Set Up Contribution Mode: Contributions can be made via electronic transfer, cheque, or cash at the POP. Advise the client on the optimal contribution frequency (monthly/quarterly) to align with salary flow and maximize tax deductions.

Step 5 – Monitor and Review: Use the online portal of the chosen CRA to track account balance, asset allocation, and performance. Annual re‑balancing and the option to switch between active and auto choice should be reviewed during the financial plan review.

In the Union Budget 2023‑24, the government increased the exclusive deduction under Section 80CCD(1B) from Rs. 30,000 to Rs. 50,000. This change enhances the tax‑saving appeal of NPS relative to other retirement instruments.

The budget also clarified that the 40% tax‑free lump‑sum exemption at retirement applies only if the subscriber has completed 60 years of age and has been a member for a minimum of 10 years. For members exiting before 60, the 20% exemption rule remains unchanged.

Advisers must stay updated on these thresholds because exam questions often reference the latest limits. Always verify the current limit from the latest Finance Act before finalising a client recommendation.

• 80CCD(1B) limit: Rs. 50,000 (effective FY 2023‑24).
• Minimum 10‑year membership for full 40% exemption.
• No change to employer contribution tax treatment.

Advisers must ensure that the client’s suitability is documented, especially regarding risk tolerance and retirement horizon, before recommending NPS. The adviser’s recommendation must be in writing, citing the tax benefits, liquidity constraints, and investment risk.

All client interactions related to NPS must be recorded in the CRM, and copies of the KYC documents must be retained for at least five years as per SEBI guidelines. Any conflict of interest, such as receiving a commission from a specific POP, must be disclosed.

Periodic review statements should be provided at least annually, highlighting the growth of the corpus, tax‑deduction utilisation, and any changes in regulatory limits. Failure to maintain these records can attract penalties under SEBI (Investment Advisers) Regulations, 2013.

• Document suitability and risk profile.
• Retain KYC and advisory communication for 5 years.
• Disclose any commissions or incentives.
• Provide annual performance and tax‑benefit summary.