Retirement is a time in our lives that we often dream of with great excitement. We want to relax and spend quality time with our loved ones, but we can’t ignore the aspect of finance. How will we sustain our regular expenses of bills and medicine after our regular monthly salary stops? This is where the importance of a well planned retirement comes into play,
A well structured retirement account or pension is essential to ensure a financially sound future after our active working life comes to an end.
The most popular method of creating a stable retirement fund in India is the National Pension System. The following guide covers all the fundamentals of the National Pension System which will help you in making informed decisions on how to use your active working years to build a financially independent post-retirement period.
What is the National Pension System?
The National Pension System is a voluntary public pension system which encourages residents to save for their retirement needs. By opening a Tier-1 NPS account you invest in a diversified financial portfolio which is a mix of financial assets such as equities, corporate and government bonds based on your risk appetite and asset allocation.
By investing regularly, over a period of time the value of the corpus increases due to compounding. But when does the real magic happen? When you actually retire and start your payouts, that is when the superannuation and rules on exit come into play.
Understanding Superannuation
In layman’s terms superannuation refers to the process when an employee reaches the age of retirement and stops working for an employer. In financial management and pension accounts superannuation serves as a reference to the cut off point of wealth accumulation for when the pension payouts shall commence
When a subscriber reaches the standard retirement age as set by NPS (approximately 60 years old) a superannuation or exit process takes place wherein your accumulated corpus is divided into two parts to secure your future.
Annuity and Payouts – How Does it Work?
When a subscriber reaches the age of superannuation, the entire pension corpus is divided as per a certain structure decided by the Pension Fund Regulatory and Development Authority (PFRDA). A certain percentage of the corpus (as decided by the subscriber and/or insurance company) is used to buy an annuity while the rest is paid as a lump sum, subject to the terms and conditions of the insurance company.
- Lump Sum Withdrawal – On reaching the superannuation age the subscriber has the option to withdraw up to 60% of the accumulated pension corpus.
- Purchase of Annuity in NPS – The remaining 40% or more is used to purchase an annuity in NPS.
An annuity is a lifelong pension plan offered by life insurance companies wherein the buyer pays a certain amount as a lump sum or regular premium, and the insurance company pays the nominee a certain amount every year or month for as long as the policy is active
The annuity plan bought via the pension corpus is a direct replacement for your regular monthly salary after retirement. With an annuity, you will never have to worry about running out of money after retirement! The monthly annuity income received is based on the size of the corpus, the prevailing interest rates and the type of annuity chosen.
There is a range of annuity plans available with different terms and payout structures, some of which pay the nominee the guaranteed purchase amount while some have other terms and conditions. The annuity plans and their terms vary for different insurance companies; therefore, it is important to compare and choose the annuity that best suits your needs.
Taxation Under New Income Tax Act, 2025
When it comes to investments, taxation is an important consideration. While evaluating your options, it is important to consider how taxation will work.
- Under the New Income Tax Act, 2025, there are certain provisions that allow tax deductions depending on your tax filing status and which section you fall under. For instance, when an employer makes contributions towards their employee’s pension, the employer may claim tax deductions under a certain section.
- Under the annuity and new pension system, the lump sum amount received (up to 60%) is generally tax-free; however, the regular pensions received will be considered as income and will be taxed as per your income tax slab for that financial year. Taxation rules and slabs vary by individual and country; therefore, it is best to consult a tax specialist to determine your tax liability.
The Role of Discipline
Discipline plays a large role in retirement planning. One of the most common mistakes made by young professionals is to procrastinate on retirement planning. Since many people believe they have decades before retirement, it seems like a distant concept, but once retirement age dawns on you, you may find yourself with no savings for post-retirement life. The earlier you start investing, the more you will have saved for your post-retirement life due to the power of compounding
Reviewing the portfolio at regular intervals is also important to rebalance the assets in line with one’s financial goals and life stage. As we grow older, the need to have safer assets increases which reduces the risk of high market volatility; balancing growth and income-generating assets is the key to a financially stable retirement.