NPS Basics: Complete Guide to National Pension System in India (2025)

TL;DR

NPS: Government-backed retirement scheme for all Indians
Tier 1: Retirement account (lock-in till 60), extra ₹50K tax deduction
Tier 2: Voluntary savings (no lock-in, no extra tax benefit)
Tax benefit: Up to ₹2 lakh deduction (₹1.5L + ₹50K NPS-exclusive)
Returns: 10-12% historically (varies by allocation)
Catch: 60% lump sum at retirement, 40% must buy annuity (pension)
Ideal for: Salaried professionals seeking tax savings + retirement corpus

Introduction

The National Pension System (NPS) is one of India's most underrated retirement investment options. Despite offering an exclusive ₹50,000 tax deduction, many investors skip it due to perceived complexity or restrictive rules.

This comprehensive guide demystifies NPS, covering everything from account opening to retirement withdrawal, helping you decide if it's right for your financial goals.

What is NPS?

NPS is a voluntary, market-linked retirement savings scheme launched by the Government of India in 2004 (initially for government employees, opened to all in 2009).

Key Features:

Regulated by Pension Fund Regulatory and Development Authority (PFRDA)
Low-cost retirement solution
Choice of fund managers and asset allocation
Portable across jobs and locations
Tax-efficient

Think of it as: A long-term retirement SIP with tax benefits and mandatory annuity at exit.

NPS Account Types

Tier 1 Account (Primary Retirement Account)

Characteristics:

Lock-in till age 60 (partial withdrawal allowed in specific cases)
Mandatory account for NPS participation
Eligible for tax benefits under Section 80CCD(1B)
Cannot withdraw freely

Who should open: Everyone planning for retirement and wanting tax benefits.

Tier 2 Account (Voluntary Savings)

Characteristics:

No lock-in period
Withdraw anytime without penalty
No tax benefits (taxed as per income slab)
Requires active Tier 1 account

Who should open: Those wanting NPS flexibility without lock-in (essentially a low-cost mutual fund alternative).

Most investors focus on Tier 1 for retirement and tax benefits.

Tax Benefits: The Biggest NPS Advantage

NPS offers the highest tax deduction among all retirement products under the new tax regime.

Old Tax Regime

Section	Limit	Investment Options
80C	₹1,50,000	PPF, ELSS, EPF, LIC, etc.
80CCD(1B)	₹50,000	NPS Tier 1 only
Total	₹2,00,000

NPS gives you an EXTRA ₹50,000 deduction over and above 80C.

Example (30% tax bracket):

Invest ₹50,000 in NPS Tier 1
Tax saved: ₹50,000 × 30% = ₹15,000
Effective cost: ₹35,000 for ₹50,000 investment
Instant 42.8% return via tax saving!

New Tax Regime (2023 onwards)

Most 80C deductions are not available, BUT:

Employer's NPS contribution: Up to 14% of salary (for private sector, 10% earlier)
Employee's NPS contribution: Not allowed under new regime for most sections

Verdict: Old tax regime is better if you're maximizing NPS benefits.

Asset Allocation: Equity (E), Corporate Debt (C), Government Bonds (G), Alternative (A)

NPS allows you to invest across four asset classes:

Asset Classes Explained

Equity (E):

Invests in stock market (Nifty 50, Sensex)
Higher risk, higher returns
Limit: Up to 75% of portfolio

Corporate Bonds (C):

AAA-rated corporate debt
Moderate risk, stable returns
No upper limit

Government Securities (G):

Central/State government bonds
Low risk, stable returns
No upper limit

Alternative Assets (A):

REITs, InvITs, etc.
Higher risk, diversification
Limit: Up to 5%

Auto Choice (Lifecycle Fund) vs Active Choice

Auto Choice (Recommended for Beginners):

Allocation changes automatically with age
Aggressive (up to age 35): 75% equity
Moderate (36-45 years): 50% equity
Conservative (46-55 years): 25% equity

Active Choice (For Experienced Investors):

You decide allocation (change once per year)
Can go up to 75% equity till age 50
Then gradually reduced to 50% by age 60

Example Active Choice Allocation (Age 30):

Equity: 70%
Corporate Bonds: 20%
Government Bonds: 10%

NPS Returns: Historical Performance

Fund Manager Returns (10-Year CAGR, 2014-2024)

Equity Funds (Class E):

Fund Manager	10Y CAGR
SBI Pension	13.2%
HDFC Pension	12.8%
ICICI Pru Pension	13.5%
UTI Retirement	12.4%
LIC Pension	11.9%

Corporate Bonds (Class C):

Fund Manager	10Y CAGR
SBI Pension	8.9%
HDFC Pension	9.1%
ICICI Pru Pension	9.2%

Government Bonds (Class G):

Fund Manager	10Y CAGR
SBI Pension	8.4%
HDFC Pension	8.6%

Average NPS Returns (70% Equity, 30% Debt):

10-Year: ~11.5% CAGR
15-Year: ~10.8% CAGR

Comparison:

PPF: 7.1% (2024)
EPF: 8.25% (2024)
NPS (Aggressive): 11-13%

NPS beats traditional retirement products on returns.

The Annuity Requirement: NPS's Biggest Drawback

At age 60, you cannot withdraw 100% of your NPS corpus. Here's the rule:

Withdrawal Rules (At Age 60)

Option 1: Retire at 60

60% lump sum withdrawal (tax-free)
40% must buy annuity (pension product)

Option 2: Continue NPS till 70

Defer withdrawal, keep contributing
Same 60-40 rule applies at exit

Option 3: Premature Exit (Before 60)

Allowed only after 10 years
20% lump sum withdrawal (tax-free)
80% must buy annuity

What is Annuity?

An annuity is a pension product where you pay a lump sum to an insurance company, and they give you monthly income for life.

Example:

NPS Corpus at 60: ₹1 crore
Lump sum (60%): ₹60 lakh (yours, tax-free)
Annuity purchase (40%): ₹40 lakh
Monthly pension: ~₹25,000/month (6-7% annuity rate)
Pension is taxable as income

Why Annuity is Controversial

Cons:

Low annuity rates (6-7% vs 11-13% in NPS growth phase)
Taxable pension (no tax benefit on monthly income)
Tied to one insurance company
Inflation erodes fixed pension

Pros:

Guaranteed income for life
Spouse can continue pension after your death (joint life option)
Removes longevity risk (won't outlive corpus)

Workaround: Withdraw maximum 60% at 60, invest in debt funds for flexibility, and buy annuity for 40% as mandatory income.

NPS vs EPF vs PPF: Comprehensive Comparison

Feature	NPS (Tier 1)	EPF	PPF
Eligibility	All citizens	Salaried	All citizens
Lock-in	Till age 60	Till retirement	15 years
Tax on Contribution	80CCD(1B) ₹50K extra	80C ₹1.5L	80C ₹1.5L
Tax on Maturity	60% tax-free, 40% annuity	100% tax-free	100% tax-free
Returns (10Y)	11-13%	8.25%	7.1%
Investment Control	Yes (asset allocation)	No	No
Withdrawal	Restricted	Specific cases	After 5Y (partial)
Pension Mandatory	Yes (40%)	No	No
Cost	Low (0.01% fund mgmt)	Free	Free
Portability	High (change jobs easily)	Moderate	N/A

Verdict:

EPF: Best for salaried (employer match = free money)
PPF: Best for complete safety and tax-free maturity
NPS: Best for higher returns + extra tax deduction

Ideal Strategy: Contribute to all three!

EPF: Employer-mandated (12% of basic)
PPF: ₹1.5 lakh/year (80C)
NPS: ₹50,000/year (80CCD(1B))

Step-by-Step: Opening an NPS Account

Online via eNPS Portal

Visit: https://enps.nsdl.com/eNPS/NationalPensionSystem.html
Choose: Tier 1 account
Registration: Enter Aadhaar, PAN, mobile, email
Complete eKYC: Aadhaar OTP verification
Nominee: Add nominee details
PRAN: Get Permanent Retirement Account Number (PRAN)
First Contribution: Minimum ₹500 (₹1,000 for Tier 2)

Offline via Banks/POP-SP

Point of Presence (POP): Banks, post offices

Fill NPS Subscriber Registration Form
Submit KYC documents
Make initial contribution
PRAN issued in 7-10 days

Contribution Frequency

Unlike SIP, NPS has flexible contributions:

Minimum: ₹500/year (to keep account active)
No maximum limit
Contribute anytime (online via eNPS)
Set up auto-debit for monthly SIP

Choosing Fund Managers

NPS allows you to select fund managers for each asset class:

Available Fund Managers (2025):

SBI Pension Funds Pvt Ltd
HDFC Pension Management Co Ltd
ICICI Prudential Pension Funds Management Co Ltd
Kotak Mahindra Pension Fund Ltd
LIC Pension Fund Ltd
UTI Retirement Solutions Ltd
Aditya Birla Sun Life Pension Management Ltd

How to Choose:

Compare 5-year and 10-year returns (equity and debt)
Check consistency (not just top performer in one year)
SBI, HDFC, and ICICI Pru have historically performed well

Pro Tip: You can change fund manager once per year (no charge).

NPS for Self-Employed and Freelancers

NPS is excellent for self-employed individuals who don't have EPF:

Benefits:

Build retirement corpus systematically
Tax deduction up to ₹2 lakh (₹1.5L + ₹50K)
Flexibility to contribute as per income (₹500 minimum/year)
Lower cost than traditional pension plans

Example Case:

Freelancer, age 30, earning ₹15 lakh/year
NPS contribution: ₹2 lakh/year
Time horizon: 30 years
Assumed return: 11% CAGR
Retirement corpus: ₹4.52 crore
Lump sum (60%): ₹2.71 crore (tax-free)
Annuity (40%): ₹1.81 crore → ₹1.13 lakh/month pension

Partial Withdrawals from NPS Tier 1

Though locked till 60, NPS allows partial withdrawal in specific cases:

Allowed Reasons (Up to 25% of Contributions)

Higher education (self, children, spouse)
Marriage (children)
Purchase/construction of house (first-time)
Medical treatment (specified illnesses)
Skill development/re-skilling

Conditions:

Account must be 3 years old
Maximum 3 withdrawals during NPS tenure
5-year gap between withdrawals (except medical)

Tax: Withdrawals are tax-free.

Common Mistakes to Avoid

Mistake 1: "I'll open NPS later, no urgency" Reality: Time is your biggest asset. Starting at 25 vs 35 makes a huge difference due to compounding.

Mistake 2: "I'll invest only ₹500/year (minimum)" Reality: That won't build a meaningful corpus. Aim for at least ₹50,000/year for tax benefits.

Mistake 3: "I'll put 100% in equity for maximum returns" Reality: As you age, you can't hold 75% equity (auto-adjusted). Start aggressive, but have a glide path.

Mistake 4: "NPS is worse than mutual funds because of annuity lock-in" Reality: The extra ₹50K tax deduction more than compensates for the annuity requirement for high earners.

Mistake 5: "I'll withdraw at 58 before the 60-40 rule applies" Reality: Premature exit (before 60) forces 80% annuity, which is worse. Wait till 60.

Should You Invest in NPS? Decision Framework

Invest in NPS if:

✅ You're a salaried professional in 20-30% tax bracket ✅ You've exhausted 80C limit (₹1.5L) and want additional deduction ✅ You're disciplined about retirement savings ✅ You're okay with 40% annuity mandate ✅ You have 10+ years till retirement ✅ You want low-cost, transparent investments

Skip or Minimize NPS if:

❌ You're in 5-10% tax bracket (limited tax benefit) ❌ You need liquidity (emergency fund pending) ❌ You're averse to any lock-in (even for retirement) ❌ You already have a large EPF/PPF corpus ❌ You're above 55 (limited compounding time)

Optimal NPS Strategy

For Young Professionals (Age 25-35)

Annual Contribution: ₹50,000 (for 80CCD(1B) benefit) Allocation: 75% Equity, 20% Corporate Bonds, 5% Government Bonds Tier 2: Optional, only if you have surplus beyond emergency fund

For Mid-Career (Age 36-50)

Annual Contribution: ₹75,000 - ₹1,50,000 Allocation: 60% Equity, 30% Corporate Bonds, 10% Government Bonds Tier 2: Consider for additional savings (no lock-in)

For Late Career (Age 51-60)

Annual Contribution: Maximize (₹2 lakh if possible) Allocation: 40% Equity, 40% Corporate Bonds, 20% Government Bonds Tier 2: Useful for short-term goals (3-5 years)

Conclusion

NPS is not perfect—the 40% annuity rule is genuinely restrictive compared to EPF/PPF's 100% tax-free withdrawal. However, its strengths make it compelling:

✅ Extra ₹50,000 tax deduction (₹15,000 saved for 30% bracket) ✅ Market-linked returns (11-13% vs 7-8% in PPF/EPF) ✅ Low cost (0.01% fund management + 0.25% admin fee) ✅ Choice and control (asset allocation, fund managers) ✅ Flexibility (freelancers, self-employed can build retirement corpus)

Final Word: Don't make NPS your only retirement investment. Use it as part of a diversified strategy:

EPF: Employer match (free money)
PPF: Tax-free, safe
NPS: Higher returns, extra tax benefit
Equity Mutual Funds: Wealth creation

A balanced approach ensures you have the best of all worlds.

Action Item: If you're in the 20-30% tax bracket and haven't opened NPS, do it before March 31 to claim this year's ₹50,000 deduction.

Disclaimer: Tax laws are subject to change. Consult a chartered accountant for personalized tax advice.