Tier 1 and Tier 2 NPS — Safety Net or Secret Strategy?
The NPS was introduced by the Government of India to encourage individuals to build a retirement corpus through regular contributions over their working years. Unlike a Guaranteed Pension Plan, where returns are fixed in advance, NPS returns depend on market performance and fund allocation. When you enroll in NPS, you start with a Tier 1 account, which is the foundation of the scheme. It is a pension savings account where your money is locked in until retirement, with limited options for early withdrawal.
The Tier 2 account, on the other hand, is an optional add-on that you can open only if you already have an active Tier 1 account. Think of it as a flexible savings account linked to your NPS profile. You can deposit and withdraw from it at any time, making it function more like a regular investment account than a pension fund.
Both accounts are managed under the Pension Fund Regulatory and Development Authority (PFRDA) and offer investment choices across equity, corporate bonds, and government securities.
Difference Between Tier 1 and Tier 2 in NPS
Tier 1 vs Tier 2 NPS offers different benefits to individuals. Both accounts are meant to help you save for the future, but they can differ in aspects. To know more about NPS Tier 1 vs Tier 2, take a quick look:
| Feature |
NPS Tier 1 |
NPS Tier 2 |
| Type
|
Mandatory pension account
|
Voluntary investment account
|
| Contribution Requirement
|
Minimum ₹1,000 per year
|
No minimum contribution
|
| Lock-in Period
|
Until the age of 60
|
No lock-in period
|
| Tax Benefits
|
Yes (Sections 80C and 80CCD(1B))
|
No additional tax benefits
|
| Withdrawals
|
Restricted, partial withdrawals allowed
|
Unrestricted withdrawals
|
| Annuity Purchase
|
Mandatory 40% annuity purchase at retirement
|
No annuity purchase requirement
|
| Flexibility
|
Limited
|
High
|
| Investment Management
|
Professional
|
Professional
|
Key Features and Benefits of an NPS Tier 1 Account
The Tier 1 account is the core of your NPS journey. Here is a closer look at what it offers.
Investment
Active Choice: You decide how to divide your contributions across equity (E), corporate bonds (C), and government securities (G). Equity is capped at 75% of the total contribution. Auto Choice: The fund allocation is done automatically based on your age. As you get older, the proportion of equity reduces gradually.
Aggressive, Moderate, and Conservative Life Cycle Funds: These are sub-options within the Auto Choice that allow you to pick how aggressively your money is invested based on your risk appetite.
Premature Closure
After completing 3 years in the scheme, partial withdrawal of up to 25% of your own contributions is allowed for specific reasons like higher education, marriage of a child, purchasing a home, or a critical illness.
You can make a maximum of 3 partial withdrawals over the entire tenure of the account. If you wish to exit completely before the age of 60, you must use at least 80% of the corpus to purchase an annuity, and only 20% can be withdrawn as a lump sum.
Retirement Saving Account
Contributions can be made by the employee and the employer, especially in cases of corporate NPS accounts.
The government also contributes to the Central and State Government employees in certain schemes.
Regular contributions over the years, combined with the power of compounding, can help build a sizeable retirement fund.
Using an NPS calculator can give you a fair idea of what your corpus will look like at retirement based on your current age, monthly contribution, and expected returns.
Maturity
Withdraw up to 60% of the total corpus as a lump sum, which is completely tax-free.
Use the remaining 40% to purchase an annuity from a PFRDA-approved life insurer to receive a regular pension.
If the total corpus is less than ₹5 lakh, you can withdraw the entire amount as a lump sum. You also have the option to defer the lump sum withdrawal and annuity purchase until the age of 75.
Key Features and Benefits of an NPS Tier 2 Account
The Tier 2 account works quite differently from Tier 1 and is suited for people who want a flexible investment plan option alongside their pension savings.
Quick Access To Cash
- Parking surplus funds when you do not have a better investment option at hand.
- Emergency savings that you might need to access on short notice.
- Short-term financial goals where you want a decent return without locking your money in.
Flexible Investment Option
- You can switch between fund managers and investment options freely.
- There is no upper limit on how much you can contribute.
- The account can be activated and deactivated based on your financial needs.
- It is not mandatory to contribute every year once the account is opened.
While the Tier 2 account does not offer the same tax benefits as the Tier 1 account (except for Central Government employees who invest for a 3-year lock-in period), it still offers decent returns compared to a regular savings account, depending on the fund allocation.
Tax Benefits on NPS Tier 1 and Tier 2 Contributions
Similar to certain life insurance policies that offer tax deductions under Section 80C, NPS Tier 1 and Tier 2 also provide significant tax-saving opportunities along with retirement benefits.
NPS Tier 1 Tax Benefits:
- Section 80CCD(1): Contributions up to 10% of salary (for salaried individuals) or 20% of gross income (for self-employed) are eligible for deduction, within the overall ₹1.5 lakh limit under Section 80C.
- Section 80CCD(1B): An additional deduction of up to ₹50,000 per year is available, over and above the ₹1.5 lakh limit. This is exclusive to NPS investors.
- Section 80CCD(2): Employer contributions up to 10% of salary (14% for Central Government employees) are also deductible. This deduction is not subject to the ₹1.5 lakh limit.
- On Maturity: 60% of the corpus withdrawn at retirement is completely tax-free. The 40% used for annuity purchase is also exempt at the time of purchase, though the annuity income received post-retirement is taxable as per your income slab.
NPS Tier 2 Tax Benefits:
- For Central Government employees, contributions to Tier 2 with a 3-year lock-in period are eligible for deduction under Section 80C, up to ₹1.5 lakh.
- For all other investors, there are no tax deductions available on Tier 2 contributions.
- An NPS scheme calculator can also help you understand how your tax-saving contributions translate into long-term wealth creation.
NPS Tier 1 and Tier 2: Which Is the Better Option?
The NPS Tier 1 scheme is an investment in one’s future retirement period. One locks their funds away for a prolonged duration, but there is substantial growth in returns on investment. This is similar to growing a tree, which may take years to mature, but then one reaps the benefits.
NPS Tier 2 is more like a regular savings account. You can put money in or take it out whenever you want. It is like having quick access to your cash for emergencies or small goals. But remember, your money doesn’t grow as fast as it does in Tier 1.
National Pension Scheme Tier 1 vs Tier 2, which one should you choose? It depends on your goals. If you’re saving for your retirement plan and want the best growth potential with tax benefits, Tier 1 is ideal. But if you need easy access to your money and don’t mind lower returns, Tier 2 might be better. Many people have to balance their needs.
FAQs on NPS Tier 1 and Tier 2 Accounts
1
Which NPS is best, tier 1 or tier 2?
For retirement savings and tax benefits, Tier 1 is the better option. For flexible investing without lock-in restrictions, Tier 2 works well. Ideally, both can be used together based on your financial goals.
2
Who can open an NPS tier 1 or tier 2 account?
Any Indian citizen between the ages of 18 and 70, whether salaried or self-employed, can open a Tier 1 account. A Tier 2 account can only be opened by someone who already has an active Tier 1 account.
3
What are the withdrawal rules for NPS tier 1 and tier 2 accounts?
Tier 1 allows partial withdrawals after 3 years, subject to specific conditions and a 25% cap on own contributions. Full withdrawal at maturity (age 60) allows up to 60% as a lump sum, and 40% must be used for annuity purchase. Tier 2 has no withdrawal restrictions; you can withdraw any amount at any point in time.
4
Can I switch between NPS Tier 1 and Tier 2 accounts?
You cannot convert a Tier 1 account into a Tier 2 account or vice versa. However, you can manage both accounts simultaneously under the same Permanent Retirement Account Number (PRAN) and freely shift investments across fund managers and asset classes within each account.
5
Is there any option to appoint nominees for the NPS Tier 1 and Tier 2 accounts?
Yes, it is indeed possible to have one or even more nominees for your NPS Tier 1 as well as Tier 2 accounts. In case the account holder passes away, then the nominees will be entitled to receive the accumulated corpus. It should also be noted that you can change your nominees whenever you want.
6
Who qualifies for NPS investments?
Those who qualify to make investments in NPS include:
- Indian citizens residing in India, between the ages of 18 and 70.
- Non-Resident Indians (NRIs) are allowed to invest in Tier 1 NPS, but NRIs cannot have a Tier 2 NPS account.
- Salaried persons (public and private sector), along with self-employed persons, are permitted to make investments.
- Those who are not eligible to participate in NPS include Persons of Indian Origin (PIO) and Overseas Citizens of India (OCI).
7
Is it possible to invest in both Tier 1 and Tier 2 accounts at the same time?
Yes, of course. One can save money in both accounts simultaneously. This is because many people prefer to benefit from the tax concessions provided by Tier 1 while having access to an additional and easily withdrawable amount of money in Tier 2. There are no regulations restricting savings in either account alone.
