What Is NPS Interest Rates?

5paisa Research Team

Last Updated: 22 Aug, 2023 04:08 PM IST

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Introduction

Proper and meticulous financial planning is necessary to enjoy a worry-free life after retirement. Fortunately, several options are available to secure finances for the post-retirement phase. The government also supports various financial schemes customised for this purpose.

One such option is the National Pension Scheme (NPS), which allows individuals to invest and save for life after retirement. Unlike most government schemes, NPS does not have a fixed rate of return. NPS interest rates vary depending on market performance. Learn more about National Pension Scheme interest rates in this blog.

What are NPS Interest Rates?

The contributions to the scheme and the selected asset classes determine the interest or return earned from NPS. The returns generated on NPS investments are linked to the market as the funds are invested in equities and debt. NPS interest rates applicable to investors depend on their contribution amount and asset class.

How is NPS calculated?

NPS interest rates are calculated on a monthly compounding basis. To illustrate this point better, consider this example.

Example:

Suppose X, who is 25 years old, wishes to invest Rs. 5,000 every month in the NPS scheme with an expected rate of return of 10%. Per NPS rules, they plan to retire at 60 and use 40% of the corpus to purchase an annuity.

To determine the accumulated corpus at age 60, we can use the Future Value of Annuity (FVA) calculation method.

For X,

Principle (P) = Rs 5,000
Rate (r) = 10% per year or 0.83% per month
Period (N) = 420 months (35 years until retirement)
FVA = (5000* (1 + 0.0083) ^ 420-1)/ 0.0083
FVA = Rs 1,89,83,190.26

Therefore, the contribution made is Rs 21 lakh, and the interest earned is Rs 1.68cr.

●    A total of Rs 75.93 lakhs is used to buy an annuity out of the Rs 1.89 crore.
●    In her 60th year, X will receive Rs 1.13 crores in accumulated income.
●    The Rs. 1.13 crores will represent 60% of the retirement corpus, which is tax-exempt.
●    Approximately 40% of the accumulated sum will be paid as a monthly pension to X for their chosen period.

Types of NPS Accounts

There are two types of NPS accounts: Tier 1 and Tier 2.

●    Tier 1 NPS account is mandatory for all NPS subscribers and has a lock-in period until the investor reaches the age of 60.
●    Tier 2 NPS account, on the other hand, is a voluntary savings account that allows withdrawals without restrictions.

Tier 1 and Tier 2 (table)

Below is a table illustrating the difference between Tier 1 and Tier 2 accounts

 NPS Tier 1 NPS Tier 2 NPS subscriptions begin with opening Tier 1 accounts with permanent retirement account numbers (PRANs). Those can only open the NPS Tier 2 account with Tier 1 accounts. There is a 60-year lock-in period for investments in NPS Tier 1 accounts. Tier 2 accounts are voluntary accounts with flexible withdrawal and exit policies. Before 60, you can withdraw parts of your savings for specific purposes or prematurely exit (see below). The Tier 2 account does not lock in savings like the Tier 1 account. Withdrawals are possible at any time from the Tier 2 account. Investing and saving under NPS Tier 1 allows you to claim income tax deductions under various sections. Investing in Tier 2 NPS has no tax benefits; you cannot claim deductions, and the corpus is taxed when you withdraw it.

Current NPS Interest Rates

Both Tier I and Tier II NPS accounts currently offer the following interest rates:

1.    NPS Tier 1 Returns

 Classes of Assets Returns of 1 year Returns of 5 years Returns of 10 years Corporate Bonds (Class C) 12.46%–14.47% 9.27%–10.15% 10.05%–10.64% Equity (Class E) 15.33%–18.81% 13.11%–15.72% 10.45%–10.86% Alternative Assets (Class A) 3.98%–16.73% - - Government Bonds (Class G) 12.95%–14.26% 10.29%–10.88% 9.57%–10.05%

2.    NPS Tier 2 Returns

 Classes of Assets Returns of 1 year Returns of 5 years Returns of 10 years Corporate Bonds 12.71%–16.36% 9.55%–10.17% 9.86%–10.60% Equity 15.19%–17.92% 13.05%–15.83% 10.35%–10.58% Government Bonds 12.61%–13.42% 10.40%–12% 9.59%–10.07%

Interest Rates of NPS from Top Pension Fund Companies

The following table shows the interest rates from top pension fund managers for NPS:

1.    ICICI Prudential Pension Fund Management Co. Ltd.

 Funds Returns of 1 year Returns of 3 years Returns of 5 years Returns since Inception Equities of Tier 1 17.50% 9.57% 14.44% 11.91% Government Securities- Tier 1 13.45% 11.33% 10.68% 9.41% Corporate Bonds – Tier 1 14.03% 9.98% 9.98% 10.64% Alternative Assets – Tier 1 6.25% 7.55% - 7.37% Government Securities– Tier 2 13.42% 11.28% 10.64% 9.53% Equities of Tier 2 17.92% 9.74% 14.54% 10.24% Corporate Bonds – Tier 2 14% 9.83% 9.87% 10.49%

2.    LIC Pension Fund Limited

 Funds Returns of 1 year Returns of 3 years Returns of 5 years Returns since Inception Equities of Tier 1 15.33% 7.64% 13.11% 12.05% Government Securities- Tier 1 13.79% 12.70% 11.86% 11.78% Corporate Bonds – Tier 1 14.47% 10.05% 9.81% 10.54% Alternative Assets – Tier 1 9.67% 9.16% - 8.26% Equities of Tier 2 15.19% 7.54% 13.05% 9.47% Government Securities– Tier 2 13.27% 13.37% 12% 12.07% Corporate Bonds – Tier 2 16.36% 13.37% 12% 12.07%

3.    HDFC Pension Management Co. Ltd.

 Funds Returns of 1 year Returns of 3 years Returns of 5 years Returns since Inception Equities of Tier 1 18.81% 10.69% 15.72% 14.96% Government Securities- Tier 1 14.26% 11.80% 10.88% 10.72% Corporate Bonds – Tier 1 14.22% 10.36% 10.15% 10.71% Alternative Assets – Tier 1 8.78% 8.90% - 8.63% Equities of Tier 2 18.64% 10.59% 15.83% 12.72% Government Securities– Tier 2 13.38% 11.55% 10.73% 10.94% Corporate Bonds – Tier 2 13.70% 10.24% 10.16% 9.79%

How Does Asset Allocation Take Place under the National Pension Scheme?

NPS interest rates are heavily influenced by asset allocation. There are four types of asset classes involved in NPS. These types are illustrated in the following table.

 Asset Class Asset Type Class G Government Bonds Class E Equities Class C Corporate Bonds Class A Real Estate Investment Trusts (REITs), alternative investment funds, and Commercial mortgage-backed securities.

Under NPS, individuals can choose between two investment options.

Active Choice

It allows investors to actively select how their funds are allocated across different asset classes based on personal preferences and risk tolerance. This involves regular monitoring and adjusting the portfolio to optimise returns.

However, your allocation to individual investment options is subject to some restrictions.

●    A maximum of 5% may be allocated to Alternative Investment Funds (AIFs)
●    A maximum of 75% equity exposure is permitted in NPS

Please note that these are the maximum limitations under NPS Active Choice. Choosing a lower NPS allocation is always an option.

Auto Choice

It involves allocating funds automatically using a predetermined investment strategy. The strategy is usually based on age, risk tolerance, and investment goals. This method is often used in retirement accounts, where investors can choose to have their funds automatically allocated based on their age and expected retirement date.

NPS Auto Choice offers three asset allocation models. Life Cycle Funds differ in how much money is allocated to each asset class and how the allocation changes as you age.

●    Aggressive Life Cycle Fund (LC75)
●    Conservative Life Cycle Fund (LC25)
●    Moderate Life Cycle Fund (LC50)

Who Should Opt for the National Pension Scheme?

The National Pension System (NPS) is available to all Indian citizens aged between 18 and 60 years. Those seeking better returns on their retirement savings can take advantage of the current interest rates offered by the NPS. However, it is important for individuals to assess their risk tolerance and expected returns before making any investment decisions.

Factors Affecting NPS Interest Rates

Various factors, including market conditions, inflation, government policies, and the performance of underlying assets, influence NPS's interest rates. Additionally, changes in the economic environment, such as fluctuations in interest rates, can also impact NPS interest rates.

What are the tax benefits under NPS?

Here are the tax benefits available under NPS.

●    Contributions made to NPS are eligible for tax deductions under Section 80C of the Income Tax Act up to a maximum limit of Rs 1.5 lakhs.
●    An additional deduction of up to Rs 50,000 is available under Section 80CCD (1B) for contributions made to NPS.
●    The accumulated corpus and the annuity payments received from NPS are also eligible for tax benefits.

Conclusion

It is important to have a comprehensive financial plan for a secure post-retirement life. NPS is a government-endorsed option for ensuring a tension-free retirement. With market-linked returns from equity and debt investments, NPS returns can increase with market growth. Consider your risk tolerance, desired returns, and financial knowledge when choosing NPS investment options.

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Frequently Asked Questions

No, the interest on NPS is not fixed and can vary based on market conditions.

The lock-in period for Tier 1 NPS accounts is until the subscriber reaches the age of 60, while Tier 2 accounts have no lock-in period.

NPS has a lower risk than other investment options since it is a government-owned scheme.

A withdrawal from the NPS Trust is exempt from income tax at 60% of the total amount payable at the time of account closure or opting out of the pension plan under Section 10(12A) of the Income Tax Act, 1961.