Pension Schemes
Welcome to the Chapter on Pension Schemes.
On this page, we look at how different Pension Schemes from the Government help you build your wealth.
We look at Public Provident Fund (PPF), Employee Provident Fund (EPF) and National Pension System (NPS).
In case you already know about these schemes and just want to invest, you can choose one of our recommended brokers below to manage all investments more easily.
Public Provident Fund (PPF)
The Public Provident Fund (PPF) scheme was introduced in 1968 to mobilise small savings into an investment and use it to build a retirement corpus.
The account can be opened with the Post Office or with designated banks. All you need to do is submit an application form along with the required KYC documents and make the initial deposit. The account can be opened with an initial deposit of Rs. 100 only.
PPF account comes with an initial tenure of 15 years. It can further be extended by a block period of five years at a time. You can do such extensions as many times as you prefer.
Only for Individuals
The account can be opened by individual Indian citizens only. Two people cannot open a joint account. Moreover, NRIs or HUFs cannot open an account.
Interest Rate
The current interest rate is 7.1% per annum and is compounded annually and paid on 31st March. The interest is calculated on the lowest balance between the close of the fifth day and last day of every month.
Investments
You can make a minimum investment of Rs. 500 and a maximum of Rs 1.5 lakh in each financial year. You can either make the investments in a lump sum or in a maximum of 12 instalments.
Annual investments above Rs. 1.5 lakh do not earn any interest and are not eligible for tax deductions. The investments can be made by cash, cheque, demand draft or by online fund transfer.
Tax Effects
Your contributions to the PPF accounts of yourself, spouse and children are eligible for deduction under Section 80C upto Rs. 1.50 lakh. There is at present no tax on the corpus amount you accumulate at maturity including the interest.
Withdrawal
There are no restrictions on your corpus at maturity. It is fully available to you. There is no requirement to buy any annuity or pay any tax.
You can also withdraw the amount in your PPF account from the seventh year onwards and there are no restrictions on how you can use this money.
The PPF account has a lock-in period of 4 years. You can also make withdrawals up to a maximum of 50% of the amount that is in the account at the end of the 4th year. Further withdrawals can be made only once in a financial year.
Loan Against PPF
You can take a loan against your PPF account between the 3rd and 5th year. The loan amount can be a maximum of 25% of the amount in the account. A second loan can be taken before the 6th year if the first loan has been repaid in full. The maximum tenure of such loans cannot exceed 36 months.
Employee Provident Fund (EPF)
The Employees Provident Fund (EPF) helps in building the retirement corpus for employees working in establishments with 20 or more employees and certain other organisations that employ less than 20 people, subject to certain conditions and exemptions.
The EPF is the primary pension scheme under the Employees’ Provident Funds and Miscellaneous Provisions Act of 1952, and is managed by the Employees’ Provident Fund Organisation (EPFO).
How it Works
Under this scheme, the employer contributes 10-12% of the employee’s salary towards the employee’s retirement fund. The employee makes an equal contribution, though she can voluntarily make a larger contribution.
On retirement, the employee gets a lump sum amount including her own and the employer’s contribution with interest on both.
The EPF is in a way is only available for employees whose pay is less than Rs. 15,000 per month. Those who are drawing more than that can become members with the permission of the Assistant PF Commissioner if the employer agrees.
Contributions to the EPF
The contribution paid by an employer in the private sector is usually 12% of basic salary. In the public sector, the dearness and retaining allowances are also added to get to the amount. The employer usually deducts an equal amount from the employee’s salary before paying it out to her and puts it in the EPF.
The employee can voluntarily make a contribution higher than 12% of basic salary. The employer does not have to match this voluntary contribution and can limit their contribution to the statutory 12% rate only. This voluntary contribution is placed in the Voluntary Provident Fund (VPF) and accounted for separately from the EPF.
If the establishment employs less than 20 employees or meets certain other conditions as notified by the EPFO, then the contribution for both employer and employee is limited to 10% each of the salary.
Interest
The EPFO uses an annual interest rate. This is divided by 12 (the number of months in a year) to get to the interest that accrues each month. However, the interest accrued in a given month is only credited to the account at the end of the financial year. The interest offered in the financial year 2019-20 was 8.5%.
Charges
Of the total employer’s contribution, 8.33% is placed in the Employees’ Pension Scheme. If the salary is less than Rs. 15,000, then 8.33% of the full salary is transferred. However, if the salary is more then only 8.33% of Rs. 15,000, i.e. Rs 1,250 is transferred into the EPS each month.
On retirement, the employee gets her full share plus the balance of the employer’s share put in the EPF account.
Universal Account Number (UAN)
UAN is a mandatory number allotted by EPFO and acts as the single number that is used to link the different member identification numbers or EPF account numbers that an employee may be allotted by different organisations. It makes transfer and withdrawals easier. If you change jobs, all you need to do is to furnish your existing UAN to your new employer.
Tax Effects
Your contribution as an employee to the EPF is eligible for deduction upto Rs. 1.50 lakh under Section 80C, subject to the limit of Rs. 1.50 lakh under Section 80CCE.
The accumulated balance on maturity including the interest added over the years is also fully exempt.
Withdrawal
The pension amount can be claimed after you have retired from service after crossing 55 years of age. The balance will include your and your employer contributions and the accrued interest.
A contributor can also withdraw up to 90% of the accumulated balance after reaching the age of 54 years.
You can also withdraw the balance in your EPF account if you do not transfer it from your previous employer to current one on changing jobs.
If you are unemployed for one month, you can withdraw 75% of your corpus and if you remain unemployed for 60 days or more, you can also withdraw the balance 25%.
But if you withdraw any amount before five years had passed since contributions had started, either under the same employer or different employers, then the entire amount withdrawn becomes taxable. If withdrawn amount is more than Rs. 50,000, then tax is deducted at source at the rate of 10%.
There are certain restrictions on where you can use the withdrawn amount if you are still employed. You can use it to buy a plot or a house, to construct a house, for repayment of home loan, and for other reasons such as marriage, education, illness, etc. subject to specified limits.
There are no such restrictions when you take out the amount after retirement. You can use it for any purpose you think fit.
If you have the Universal Account Number (UAN) that lets you transfer your EPF account, then you can use Form 19 to fill in the request online on the e-Sewa portal and get your funds directly in your KYC verified account.
Advances
The EPFO allows you access to your fund corpus even during your employment for certain expenditures such as buying a house, repaying a home loan, medical needs, education or other expenses such as marriage of children.
The amount of advance you can take depends on the specific situation, your years of service, and so on. Since it is an advance, you don’t have to pay any interest or even repay the advance.
You can simply apply online on the Member e-Sewa portal.
The EPFO also allows contributing employees who have completed three years since contributions had started to use 90% of their fund corpus to make real estate investments.
National Pension System (NPS)
The National Pension System or NPS was launched to replace the earlier pension system for government employees who had joined from the year 2004 onwards. Here, government employees compulsorily contribute 10% of their basic salary to the NPS fund, while the government also makes a matching contribution.
The NPS was rolled out for the public in 2009. Anyone between the ages of 18 and 65 years can join the scheme. The scheme as a minimum lock-in period of 10 years.
The Scheme is regulated by the Pension Fund Regulatory and Development Authority (PFRDA).
Only for Individuals
The account can be opened only in individual capacity and cannot be opened or operated jointly or for and on behalf of HUF.
The NPS is available for Indian Citizens and Non-Resident Indians. However, it is not available for Overseas Citizens of India (OCI) and Person of Indian Origin (PIO).
Every individual subscriber is issued a Permanent Retirement Account Number (PRAN) card which has a 12 digit unique number. This allows seamless portability across jobs and locations. You can simply use this number to ensure to ensure payments are made to your unique account.
Types of Account
There are two types of NPS accounts: Tier I and Tier II.
- The Tier I account is a mandatory permanent retirement account into which the accumulations are deposited and invested as per the option chosen by the subscriber.
- The Tier II account is an optional account available for Tier I accountholders. Withdrawals are permitted from this account as per the needs of the subscriber as and when claimed.
The Tier-I account is for retirement purpose and matures when you retire at the age of 60. You can also postpone the withdrawal for three additional years or chose to contribute till the age of 70 years to build a bigger corpus.
Contribution
There is no maximum limit on how much you contribute.
- Minimum Account Opening Contribution: Rs. 500 (Tier I) and Rs. 1,000 (Tier II)
- Minimum Amount Per Contribution: Rs. 500 (Tier I) and Rs. 250 (Tier II)
- Minimum Total Annual Contribution: Rs. 6,000 (Tier I) and Rs. 2,000 (Tier II)
- Minimum Contributions Per Year: 1 per year for both accounts
Investment Choices
The money you contribute to the NPS is put in different funds based on your preferences. The funds are segregated based on the two options you can choose in which to put your contribution:
Auto Choice: Here the investment of funds is done automatically based on the age of the subscriber. You have the choice of three lifecycle funds:
- Aggressive Life Cycle Fund (LC75): Here, the maximum exposure to Equity Investments is 75% till age 35 and gradually reduces as per the age of the subscriber
- Moderate Life Cycle Fund (LC50): Here, the maximum exposure to Equity Investments is 50% till age 35 and gradually reduces as per the age of the subscriber.
- Conservative Life Cycle Funds (LC25): Here, the maximum exposure to Equity Investments is 25% till age 35 and gradually reduces as per the age of the subscriber.
Active Choice: Here you have to decide on the asset classes in which the contributed funds are to be invested and their percentages. The four asset classes are:
- Asset Class E: Investments are in predominantly equity market instruments
- Asset Class C: Investments are in fixed income instruments other than Government securities
- Asset Class G: Investments are in Government securities
- Asset Class A: Investment in Alternative Investment Schemes such as CMBS, MBS, REITS, AIFs, InvIts, etc.
Note: Here is what the acronyms in Asset Class A mean.
- CMBS = Commercial Mortgage-Backed Securities
- MBS = Mortgage-Backed Security
- REITS = Real Estate Investment Trust
- InvITs = Infrastructure Investment Trusts
You can choose to invest your entire pension wealth in Asset Classes C (debt instruments) or G (Government securities) and up to a maximum of 50% in Asset Class E (equity) and upto a maximum of 5% in Asset Class A (Alternative Investment Schemes).
You may also distribute your pension wealth across Asset Classes E, C, G and A, subject to conditions prescribed by the PFRDA.
Option to Change
You have the option to change your scheme preferences. Changing the investment option (Auto or Active) or asset allocation (Aggressive, Moderate or Conservative for Auto Choice and Asset Classes E, C G and A for Active Choice) can happen twice in a financial year.
Choosing a different Pension Fund can happen once in a financial year.
You can also choose different Pension Funds and Investment Options for your Tier I and Tier II accounts.
Fund Managers
Your contributions made to NPS are managed by designated Pension Fund Managers (PFMs) who are responsible for the investments in company stocks, government bonds and money market instruments. The value of your retirement corpus would depend upon the returns that their investments generate over the investment period.
Here is the list of funds managers:
Pension Funds (PFs) for the Government
- LIC Pension Fund Limited
- SBI Pension Funds Pvt. Ltd.
- UTI Retirement Solutions Ltd.
Pension Funds (PFs) for Private Sector
- Birla Sun Life Pension Management Ltd.
- HDFC Pension Management Co. Ltd.
- ICICI Prudential Pension Fund Management Co. Ltd.
- Kotak Mahindra Pension Fund Ltd.
- LIC Pension Fund Ltd.
- SBI Pension Funds Pvt. Ltd.
- UTI Retirement Solutions Ltd.
Tax Effects
Your contribution as an employee to the NPS qualifies for deduction upto Rs. 1.50 lakh under Section 80CCD(1), subject to the restriction of Rs. 1.50 lakh under Section 80CCE. However, unlike the other two schemes, under section 80 CCD(1B), there is an additional deduction of Rs. 50,000 if you contribute to the NPS over and above the basic limit of Rs. 1.50 lakh.
The benefit of NPS lies for people earning higher salaries. You can reduce your tax liability if your employer puts up to 10% of your basic salary in the NPS under Section 80CCD(2). There is no upper limit for this deduction. For example, if your basic salary is Rs. 50,000 per month and you are in the 30% bracket, you can cut your tax outgo by almost Rs. 18,720 if your company contributes 10% of your basic salary to the NPS.
Upon maturity, 40% of the corpus is fully exempt from tax. You have to compulsorily purchase an annuity from an insurance company for minimum 40% of the corpus at the time of retirement or at the end of the extended period. This amount is exempt from tax. The balance 20% is fully taxable which you can avoid if you use the amount to purchase an annuity. This means if you buy an annuity for 60% of the corpus instead of the mandatory 40%, you don’t need to pay any tax on the entire corpus.
Withdrawal
You can withdraw 25% of the balance in your Tier I account, provided the amount is restricted to your contributions and the interest accrued on the same, and not your employer’s.
You can withdraw the money once you reach the age of 60 or you can postpone the withdrawal for three more years. You can also choose to contribute till the age of 70 years to build a bigger corpus.
There are no restrictions or withdrawal limits in Tier II accounts. But government employees can use their contribution to get tax benefits under section 80C provided that contribution is not touched for at least three years.
Exit from NPS
Before 60 Years (Joined between 15-60 years of age) or After 60 Years BUT Before 3 Years of Joining (Joined between 60-65 years of age)
At least 80% of the accumulated pension wealth needs to be utilised to purchase an annuity providing for monthly pension of the subscriber and the balance (20%) is paid as a lump sum payment. If total corpus does not exceed Rs. 1 lakh, then the subscriber has the option to withdraw the whole corpus as a lump sum.
On Reaching 60 Years (Joined between 15-60 years of age) or After 3 Years of Joining (Joined between 60-65 years of age)
At least 40% of the accumulated pension wealth needs to be utilised for purchase of an annuity providing for monthly pension of the subscriber and the balance (60%) is paid as a lump sum payment. If the total corpus does not exceed Rs. 2 lakh, then the subscriber has the option to withdraw the whole corpus as a lump sum.
Annuity Service Providers
The list of Annuity Service Providers are:
- Life Insurance Corporation of India
- SBI Life Insurance Co. Ltd.
- ICICI Prudential Life Insurance Co. Ltd.
- Star Union Dai-ichi Life Insurance Co. Ltd.
- HDFC Standard Life Insurance Co. Ltd
Annuity Options
Here are the annuity options you can choose at the time of exit.
- Pension (Annuity) payable for life at a uniform rate to the annuitant only
- Pension (Annuity) payable for 5, 10, 15 or 20 years certain and thereafter as long as you are alive
- Pension (Annuity) for life with return of purchase price on death of the annuitant (Policyholder)
- Pension (Annuity) payable for life increasing at a simple rate of 3% p.a.
- Pension (Annuity) for life with a provision of 50% of the annuity payable to spouse during his/her lifetime on death of the annuitant
- Pension (Annuity) for life with a provision of 100% of the annuity payable to spouse during his/her lifetime on death of the annuitant
- Pension (Annuity) for life with a provision of 100% of the annuity payable to spouse during his/her lifetime on death of the annuitant and the return of the purchase price to the nominee