Building a Retirement Nest with NPS

The National Pension System (NPS) is a low-cost, flexible retirement scheme in India offering market-linked growth, tax benefits, and steady income. Suitable for all age groups, it helps build a secure retirement corpus with better returns than traditional options like PPF or FDs[EasyDNNnews:PaidContentStart]

Planning for retirement is a lifelong journey, and the earlier you start, the more comfortable your 'golden years' can be. India's National Pension System (NPS), a low-cost pension scheme, is one of the options for individuals– from young professionals in their 20s and 30s to those in their 50s and even 60s – to build a secure retirement corpus. NPS combines flexible investment options, tax benefits, and long-term compounding to deliver a retirement income stream. It offers the best of both worlds: lower risk than pure equities with higher returns than traditional fixed-income options like PPF or FDs. 

In this article, we'll explore how NPS works (Tier 1 and Tier 2 accounts), its tax implications, investment choices, historical performance, and examples illustrating why NPS is a powerful tool for retirement planning at any age. 

NPS Structure: Tier 1 and Tier 2 Accounts 

NPS operates through two types of accounts – Tier 1 and Tier 2 – each serving different needs:
Tier 1 Account: This is the primary pension account meant for long-term retirement savings. It comes with restrictions on withdrawal until retirement age (60) and offers tax benefits on contributions. Think of Tier 1 as a locked piggy bank for your old age – you commit money here and generally leave it until you retire (age 60) in normal circumstances.
Tier 2 Account: This is a voluntary investment account that acts like a savings account adjunct to Tier 1. It offers greater flexibility – you can invest and withdraw freely – but no special tax breaks (for most investors). Tier 2 can be opened only if you have an active Tier 1 account, and it's useful if you want an open-access investment using NPS funds (similar to mutual funds) without the lock-in. 

In summary: Tier 1 is a mandatory pension account with a long-term lock-in and tax incentives, ideal for building a retirement nest egg. Tier 2 is an optional savings account offering liquidity but no tax breaks. Both accounts can be managed under the same NPS umbrella and offer the same investment options (fund managers and asset classes). 

Notably, NPS is a low-cost investment avenue – the pension fund managers charge a tiny fee (only 0.01 per cent of assets) and custodial fee ~0.0032 per cent, making it far cheaper than most mutual funds. This ensures more of your money stays invested and growing. 

Tax Treatment on Withdrawal (Tier 1 at Retirement): NPS follows an Exempt-Exempt-Tax (EET) model, but with a major tax relief at maturity introduced in recent years. When you reach the age of 60 (standard maturity) and decide to exit NPS, you are allowed to take out up to 60 per cent of your accumulated corpus as a lump sum. This portion is fully exempt from tax. 

Where Are NPS Contributions Invested? – Asset Classes in NPS
When you invest in NPS (Tier 1 or Tier 2), your money doesn't just sit idle; it is invested by professional Pension Fund Managers (PFMs) into various assets. NPS investments are broadly divided into four asset classes as per PFRDA guidelines. 

Asset Class E (Equity): Funds in this class are invested in the equity market – primarily stocks of companies. NPS equity investments are mainly in indexed equities or stocks that trade in the F&O segment, ensuring a focus on relatively stable, large companies. 

This asset class offers the highest growth potential but also comes with market volatility. Over the long run, equity tends to deliver higher returns than other classes, which helps beat inflation. However, to protect investors, the maximum allocation to equity is capped at 75 per cent of your contributions (in Tier 1). 

Asset Class C (Corporate Bonds): This portion goes into high-quality corporate debt – essentially bonds and debentures issued by companies (typically with minimum credit rating of 'A' or above). 

Asset Class G (Government Securities): This is the safest class, investing in sovereign bonds – Central and State government bonds, and related securities. 

These are backed by the government, so default risk is minimal. The returns mainly come from interest (coupon) and are relatively stable. Government securities (gilts) can protect the portfolio during equity downturns. NPS permits up to 100 per cent allocation to G-sec if desired. 

Typically, a higher G allocation is suitable for conservative investors or people closer to retirement. Asset Class A (Alternative Assets): Introduced more recently, this class allows exposure to alternative investment funds such as REITs (Real Estate Investment Trusts), INVITs (Infrastructure Investment Trusts), and other permitted alternative assets. The allocation to Class A is capped at 5 per cent of the portfolio because these are higher risk and less liquid. Alternatives can provide diversification and potentially higher returns uncorrelated with traditional equity/ debt markets. Not all subscribers opt for this class, but it's there for added diversification for those who want it. 

The performance of your NPS account will thus depend on how much you allocate to each asset class and how well the fund managers perform in those classes. Historically, equities (E) provide growth, corporate bonds (C) and gilts (G) provide stability and steady returns, and alternatives (A) provide a small kicker (with higher risk). In the next section, we'll see how you can set this allocation as per your preference or age. 

Active Choice vs Auto Choice: Setting Your Asset Allocation
NPS recognizes that not everyone has the time or knowledge to actively manage their retirement portfolio. Therefore, it offers two modes of asset allocation for your NPS contributions. 

Active Choice: You decide the allocation percentages to E, C, G, and A as per your own strategy. This gives you full control. You could, for example, choose 75 per cent in Equity, 15 per cent in Corporate Bonds, 10 per cent in Government Bonds when you are young (aggressive stance), and you can rebalance or change this allocation up to four times a year (recently increased from two times). Active Choice is suitable if you understand asset classes and want to tailor the risk-exposure to your needs. NPS imposes limits to protect investors – e.g., Equity cannot exceed 75 per cent (and this cap actually tapers down after age 50: the maximum equity per cent reduces by 2.5 per cent each year beyond 50, reaching 50 per cent by age 60). 

Auto Choice: If you don't want to actively manage the mix, NPS offers an automated 'Life-cycle fund' approach. 

In Auto Choice, the allocation to equity and other classes changes as per your age – starting aggressive when you are younger and becoming conservative as you approach retirement. It's a 'set-and-forget' option best for those who are not sure how to allocate or prefer NPS to handle it. With Auto Choice, NPS will automatically rebalance your portfolio each year on your birth date to adjust the asset mix according to the chosen lifecycle plan. 

NPS Returns: Historical Performance of Asset Classes
NPS is a market-linked scheme, so returns are not fixed (unlike, say, EPF which declares a set interest). Your returns will depend on the market performance of stocks and bonds, and the skill of fund managers. Fortunately, over the long run, NPS has delivered competitive returns, often beating traditional savings options due to its equity component and low costs. Let's look at some recent and historical performance data (as of 2024-2025): 

Equity (Scheme E) Returns: NPS equity funds have generally mirrored the long-term equity market growth. Over longer periods, the returns have been double-digit. The 5-year median CAGR for NPS Tier 1 equity schemes was about 23.46 per cent per annum. Nonetheless, most of the return is primarily due to the better performance of the equity market post Covid-19. If we take the median return of ten years, it is only 11.64 per cent. 

However, equity can be volatile year to year. In the last six months, due to market volatility, most NPS equity funds have generated negative returns in double digits, except for – Kotak Pension Fund’s equity plan – which delivered a negative return of -8.8 per cent in the last six months.  This shows that while long-term returns are high, short-term returns can fluctuate. Overall, if one stays invested through cycles, NPS equity has the potential to yield around 10-12 per cent annual returns over decades, based on historical trends. This fuels the growth of the retirement corpus. 

Corporate Bond (Scheme C) Returns: NPS corporate Debt Funds tend to offer stable returns reflecting interest rates and credit spreads. Historically, NPS Scheme C has yielded around 8 per cent per annum on average. For example, the 5-year average return for Tier 1 corporate bond funds was about 8.08 per cent per annum as of March 2025 and 8.4 per cent for 10 years ending the same time. 

These returns are in line with, or slightly better than, many fixed income instruments. Since corporate bonds carry some credit risk, they usually yield a bit more than government bonds. NPS fund managers largely stick to high-rated bonds (A or above). 

Government Securities (Scheme G) Returns: The gilt portfolio in NPS (Scheme G) has delivered returns generally in the range of 7–9 per cent per annum historically. Over the 5-year horizon up to 2025, Tier 1 G funds averaged about 7.84 per cent CAGR. For ten years it is 8.55 per cent, slightly better than Corporate Bonds. 

In some recent one-year periods, G-sec funds did exceptionally well (when interest rates dropped, bond prices rose – e.g., one-year returns were in double digits. Conversely, if interest rates rise, the G fund returns can dip in the short term (even become low single digits or near-flat) due to bond price fall, but interest accrual continues. 

Alternate Assets (Scheme A) Returns: Since this category is newer and a small part (max 5 per cent), its impact on overall returns is limited. These investments (REITs, etc.) can produce high yields in good times but can also be volatile. Given the cap at five per cent, even an outperformance or underperformance here won’t drastically change your total NPS returns. It’s mostly an add-on for diversification. 

It’s important to note that NPS returns are net of very low fees, so almost all the market gains accrue to investors. Over the long term, the combination of equity and debt in NPS has the potential to generate an attractive risk-adjusted return. 

NPS and Retirement Planning
Your strategy for retirement saving often depends on your age, income, and how far you are from retirement. NPS is flexible enough to be beneficial whether you start at 25 or at 55 – though the approach and outcome will differ. 

Start Early - If you are in your 20s or 30s, time is your greatest asset. Retirement may seem far away (20-40 years ahead), but this long horizon means that even small contributions now can grow huge by the time you retire, thanks to compounding. NPS is especially powerful for young investors because you can allocate aggressively to Equity (up to 75 per cent), capturing high growth for decades. 

NPS imposes a discipline - since you can’t easily withdraw Tier 1 funds until 60, it acts as a forced savings. By starting NPS early, you essentially lock away a portion of your income for your future self. This is actually a boon for someone who is not very disciplined, because it’s money you won’t spend impulsively. Over time, as income grows, you can increase contributions. Even irregular contributions help, but setting up a monthly system (some use NPS with a SIP-like approach) can ensure consistency. 

You might keep some equity allocation if you plan to continue investing even after 60 (since NPS allows extension), but generally, one would avoid a large equity crash close to retirement. 

Plan Withdrawals & Annuity - Start educating yourself on NPS withdrawal rules and annuity options. By 60, you’ll have to choose how to use the 60 per cent lump sum (you can take it at once or defer taking it, but any amount you take up to 60 per cent is tax-free) and select an annuity plan for the 40 per cent. Research various Annuity Service Providers and annuity variants (different plans offer different pension payouts, some with spouse pension, some with return of purchase price, etc.). The rates may change by the time you’re 60, but it’s good to have a plan. PFRDA allows you to defer annuity purchase or lump sum withdrawal up to 3 years if you want to time it, but by 60 you should have an idea. 

Top Up if Possible - If you find a shortfall in your target corpus, you could make last-minute additional contributions in your 50s (like allocating a portion of any accumulated savings into NPS for the tax-free withdrawal benefit). One interesting strategy for those who have amassed other savings – you might put some money into NPS just before retirement to utilize the 60 per cent tax-free withdrawal. 

Plan for Extension - If you are in good health and willing to work a bit longer, note that NPS allows you to extend your account and keep contributing up to age 70. You don’t have to withdraw at 60 exactly. This can be useful – for example, if you start at 55, you might opt to defer withdrawal to 65 or 70, giving your investments another 10-15 years of growth (maybe shifting to safer assets though). Meanwhile, you can retire at 60 and use other funds first, letting NPS marinate tax-free a bit more. This flexibility can be part of your plan if you start late. 

Simulated Monthly Pension
Based on the assumption that contributions are made till the age of 60 with an expected annual return on investment (ROI) of 10 per cent during the contribution phase, and that 60 per cent of the corpus is used to purchase an annuity yielding 6.5 per cent annually, the heatmap vividly highlights the power of starting early and contributing consistently to the NPS. For instance, a 25-year-old contributing ₹10,000 per month can expect a monthly pension of around ₹2.65 lakh, whereas someone starting at age 45 with the same contribution receives only about ₹20,604—nearly a 10x difference. This stark contrast illustrates how time and compounding play a crucial role in retirement planning. Moreover, the pension amount increases proportionally with higher monthly contributions, but the incremental benefit is significantly greater for younger investors due to the extended compounding period. Thus, the visualization reinforces the importance of starting early, contributing regularly, and taking advantage of the long-term benefits NPS has to offer under a disciplined and goal-oriented investment framework. 

Conclusion
The NPS is a versatile and powerful retirement planning tool for Indians across age groups. It provides a structured pathway to accumulate a pension corpus with equity-driven growth and debt-driven safety, all under a regulatory framework that ensures transparency and low costs. NPS’s Tier 1 account incentivizes long-term saving by combining tax benefits with restrictions that instill financial discipline, ultimately yielding a lump sum and lifelong annuity at retirement. By choosing an appropriate asset allocation (Active or Auto choice) and adjusting it as you age, you can let NPS tailor your portfolio from aggressive in youth to conservative in retirement. The historical performance of NPS funds – equity giving doubledigit growth and debt providing stable returns – shows that a balanced approach can effectively build a retirement corpus that outpaces inflation. NPS is particularly advantageous for young earners who start early and harness decades of compounding (a small sacrifice today can translate to lakhs or crores later). But it’s equally valuable for late starters to at least grab tax breaks and convert some savings into an assured pension. 

In a country where life expectancy is rising and nuclear families are the norm, planning for retirement security is vital. NPS plugs the gap by providing a government-endorsed, flexible, and well-regulated pension platform. It is “future you” thanking “present you” for setting aside money systematically. A pension is the best gift you can give your future self, and NPS is an efficient way to build it. 

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