The National Pension System (NPS) is one of India’s most effective tools for long-term retirement planning. Designed and regulated by the Pension Fund Regulatory and Development Authority (PFRDA), NPS allows individuals to systematically invest during their working years and build a retirement corpus that provides financial security in later life.
It combines the benefits of market-linked growth with tax efficiency, making it a preferred choice for salaried professionals and self-employed investors seeking disciplined wealth creation.
What Is NPS?
The NPS is a voluntary, defined contribution retirement savings scheme available to all Indian citizens between 18 and 70 years of age. Subscribers contribute regularly to their NPS account, and the accumulated funds are invested in different asset classes like equity, corporate bonds, and government securities, based on the investor’s choice.
NPS offers two types of accounts:
- Tier I Account – The primary retirement account with withdrawal restrictions, eligible for tax benefits.
- Tier II Account – A voluntary savings account with flexible withdrawals but no tax deductions.
Investment Choices in NPS: Active and Auto Options Explained
One of the most powerful features of the National Pension System (NPS) is the flexibility it gives investors to decide how their money is allocated. NPS allows two approaches: Active Choice and Auto Choice (Lifecycle Funds).
Both have distinct advantages depending on an investor’s comfort with managing risk and their level of financial involvement.
1. Active Choice – You Decide the Mix
Under the Active Choice, investors can actively decide how their contributions are invested among the following asset classes:
| Code | Asset Class | Description | Risk Level | Maximum Allocation |
|---|---|---|---|---|
| E | Equity | Invests in stocks and equity-related instruments; offers higher long-term growth potential. | High | Up to 75% (varies by age) |
| C | Corporate Bonds | Debt instruments issued by companies; moderate returns with lower volatility. | Moderate | No upper limit (within total 100%) |
| G | Government Securities | Invests in government bonds; stable but lower returns. | Low | No upper limit (within total 100%) |
| A | Alternative Investments | Includes REITs, InvITs, etc., for diversification. | Moderate–High | Up to 5% |
Key points:
- You have full control over your asset allocation.
- The maximum equity allocation reduces with age (to manage risk).
- You can change your allocation or switch fund managers up to two times a year.
This choice is ideal for financially aware investors who want to align NPS with their personal asset allocation strategy.
2. Auto Choice – Lifecycle Funds
If you prefer a hands-off approach, the Auto Choice automatically manages your asset allocation based on your age and risk appetite.
As you grow older, the system gradually shifts your investments from equity to debt, reducing portfolio volatility closer to retirement.
There are three variants under Auto Choice, depending on your risk profile:
| Lifecycle Option | Suitable For | Equity Exposure (at age 35) | Description |
|---|---|---|---|
| LC75 – Aggressive | Investors comfortable with higher equity exposure | 75% | Starts with high equity allocation and gradually decreases to 15% by age 55. |
| LC50 – Moderate | Balanced investors seeking growth with stability | 50% | Starts with moderate equity allocation, reducing to 10% by age 55. |
| LC25 – Conservative | Risk-averse investors nearing retirement | 25% | Keeps equity exposure low and focuses on debt and government securities. |
Key advantages:
- Automatically rebalances your portfolio each year.
- Reduces emotional decision-making during market volatility.
- Perfect for long-term investors who want a “set it and forget it” approach.
Choosing Between Active and Auto Options
| Feature | Active Choice | Auto Choice |
|---|---|---|
| Control | Full control over allocation | Automated, based on age |
| Risk Management | Manual rebalancing needed | Auto-rebalanced annually |
| Best For | Experienced investors | Beginners and hands-off investors |
| Flexibility | High | Moderate |
| Maintenance | Requires periodic review | Minimal maintenance |
Takeaway:
- Active Choice suits investors who understand asset allocation and want to manage it themselves.
- Auto Choice is ideal for most investors, as it automatically maintains a prudent mix of equity and debt over time.
- Younger investors can start with LC75 (Aggressive) and gradually switch to LC50 or LC25 closer to retirement.
NPS Returns: How It Performs
Unlike traditional pension plans with fixed returns, NPS returns are market-linked and depend on fund performance. Historically, NPS funds have delivered 8% to 10% annualized returns over the long term.
| Asset Class | 10-Year CAGR (Approx.) | Risk Level |
|---|---|---|
| Equity (E) | 10% – 12% | High |
| Corporate Bonds (C) | 8% – 9% | Moderate |
| Government Securities (G) | 7% – 8% | Low |
| Overall NPS Portfolio | 8% – 10% | Balanced |
Tax Benefits of NPS
NPS is one of the most tax-efficient investment options under the Income Tax Act:
- Section 80CCD(1): Deduction up to ₹1.5 lakh (part of Section 80C limit).
- Section 80CCD(1B): Additional deduction of ₹50,000, exclusively for NPS.
- Section 80CCD(2): Employer contribution up to 10% of salary (Basic + DA) is also tax-deductible.
At maturity (age 60):
- 60% of the corpus can be withdrawn tax-free,
- 40% must be used to buy an annuity, which provides a lifelong pension.
Limitations of NPS
1. Limited Liquidity
Withdrawals before age 60 are highly restricted. Only partial withdrawals (up to 25%) are allowed under specific conditions like education, marriage, or house purchase.
2. Compulsory Annuity Purchase
At retirement, only 60% of the corpus can be withdrawn; the remaining 40% must be used to buy an annuity, which typically yields 6–7% returns that are taxable.
3. Tax on Annuity Income
Although contributions and corpus growth are tax-exempt, annuity income is taxable as per your income slab during retirement.
4. Restricted Equity Exposure
Even after regulatory updates, maximum equity exposure is capped at 75% for active investors. This limits potential upside for younger, risk-tolerant investors.
From 1 October 2025, under the newly introduced Multiple Scheme Framework (MSF), non-government sector subscribers will be allowed to invest up to 100% of their contributions in equities
5. Limited Flexibility
You can switch fund managers only once a year. Compared to mutual funds, NPS lacks flexibility for tactical allocation or thematic investing.
6. Complex Structure
Multiple intermediaries—Central Recordkeeping Agency (CRA), Points of Presence (PoPs), Fund Managers, and Annuity Providers—can make the system difficult for new investors to navigate.
7. No Guaranteed Returns
As NPS is market-linked, there’s always the risk of short-term volatility affecting returns, especially near retirement if allocation isn’t properly adjusted.
How to Invest in NPS
You can invest in NPS through:
- Online: Via eNPS portal, net banking, or official apps.
- Offline: Through banks, post offices, or registered POPs (Points of Presence).
Takeaways
- Tax benefits up to ₹2 lakh make it highly efficient.
- Suitable for long-term retirement goals, but early withdrawals are restricted.
Looking to build a personalized retirement plan using NPS and mutual funds?
Connect with CapitaGrow for expert guidance on combining long-term compounding with tax-efficient investing.
