NPS Tier 1 vs Tier 2 Account: Difference

Compare NPS Tier 1 vs Tier 2 to understand tax benefits, lock-in period, withdrawal rules, and flexibility. Choose the right NPS account based on your retirement planning and investment objectives.
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3 mins read
23-Dec-2024

The National Pension System (NPS) offers two account types to meet varied financial needs – Tier 1 and Tier 2 for different savings goal. Understanding the differences between NPS Tier 1 and Tier 2 accounts helps you choose wisely. In NPS Tier 1 vs Tier 2, Tier 1 focuses on long-term retirement savings with withdrawal restrictions, while Tier 2 works like a flexible investment account with easy deposits and withdrawals.

What is NPS Tier 1 and Tier 2?

The national pension scheme Tier 1 and Tier 2 accounts are designed to serve different financial goals under NPS. Tier 1 is the primary retirement account, where contributions are locked in for long-term savings, ensuring a steady retirement corpus with tax benefits.

Tier 2, on the other hand, is a voluntary and flexible account linked to Tier 1. It allows investors to withdraw funds anytime, making it suitable for short- to medium-term savings while still benefiting from market-linked returns.

NPS Tier 1 and Tier 2: the similarities

Both NPS Tier 1 and Tier 2 share a few similarities.

  • They both share similar charges and choices of fund managers and schemes.
  • Both incur the same Pension Fund Manager (PFM) charges (0.01%), custodian charges (0.0032%), and POP charges on every transaction.
  • You have the flexibility of porting across PFMs and funding options.

Difference between Tier 1 and Tier 2 NPS

Features Tier 1 Tier 2
Purpose Retirement Saving Plan Regular Saving Plan
Eligibility Must be an Indian citizen between the ages of 18 and 70 years. Must be enrolled in NPS Tier 1
Lock-in Period Till 60 years of age No lock-in period
Withdrawal Only after 60 years of age At any time
Minimum Contribution Rs. 1,000 per financial year Rs. 250 per financial year
Tax Benefits You are eligible for a deduction of up to Rs 1.5 lakh under Section 80CCD(1) and an additional Rs 50,000 under Section 80CCD(1B) No tax benefits
Maturity of the Scheme When subscribers turn 60 years of age (60% of the corpus is paid as lumpsum payment, and 40% must be utilised to buy an annuity plan) Not applicable
Investment Choice Active or auto-choice Active choice
Annuity 40% of the corpse No limit
Account Maintenance Charges Applicable Not Applicable
Partial Withdrawal Only 25% is allowed, for which you need to complete 3 years of investing in NPS There is no such condition

What are the benefits of investing in NPS Tier 1 & Tier 2?

The NPS is a government-backed investment scheme with guaranteed returns and long-term security. Here are some of its crucial benefits for National Pension Scheme Tier 1 and Tier 2:

  • The investor can enjoy tax benefits and reductions under Section 80CCD of the Income Tax Act.
  • Investors can choose their own asset allocation and switch between the two fund options.
  • Due to its lower minimum contribution requirements, it is accessible to a wide range of investors.
  • They are managed by the Provident Fund Manager (PFM), which helps maximize your returns with lower risks.

What are NPS Tier 1 and Tier 2 tax benefits?

NPS‌ Tier 1 is eligible for tax benefits, unlike NPS Tier 2. Here are some crucial tax benefits that investors should consider before planning to invest in the national pension scheme.

  • You can invest up to Rs 1.5 lakh to claim a tax deduction under Section 80C of the Income Tax Act.
  • Besides the Rs. 1.5 lakhs, you can also claim the additional tax benefit for your investment up to Rs. 50,000 under Section 80CCD (1B).
  • There is also a provision for tax reduction by the employer of the investor under Section 80CCD (1B) of the Income Tax Act, which means that only salaried individuals can avail this facility.

National Pension Scheme Tier 1 vs Tier 2: Which is the better option?

Now comes the question: Which one should you choose between NPS Tier 1 vs Tier 2?

If you are looking for long-term stability and a secure retirement, NPS‌ Tier 1 could be your choice.

Moreover, if you are looking for flexibility in investment to withdraw your money and do not want to get constrained by the lock-in periods (in the case of 60 years in Tier 1), you can invest some portion of your amount in Tier 2, which can be a great way to cope with financial emergencies like accidents or marriage.

Ultimately, the choice between two accounts depends on your financial goals, investment preferences, and level of flexibility.

Apart from this, another attractive option is the Fixed Deposit Scheme by reputed financial institutions like Bajaj Finance, which offers interest rates of up to 7.30% p.a. while enjoying significant returns.

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Conclusion

The National Pension Scheme (NPS) offers two distinct account types: Tier 1 and Tier 2. Tier 1 caters to long-term retirement savings with tax benefits and a lock-in period until 60. Tier 2 offers flexibility with no lock-in but lacks tax benefits. Choosing the right option depends on your goals. Opt for Tier 1 for retirement security and tax savings. Choose Tier 2 for short-term goals and easy access to funds. Consider your financial needs and risk tolerance before choosing Tier 1 and Tier 2 NPS.

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Frequently asked questions

Which is better, NPS Tier 1 or Tier 2?

Both Tier 1 and Tier 2 accounts have their strengths. Tier 1 offers significant tax benefits and builds a retirement corpus with limited withdrawal options. Tier 2 provides flexibility for deposits and withdrawals, similar to a savings account. Consider your goals: If long-term tax-saving retirement planning is your priority, Tier 1 is ideal. If you need more accessible savings, Tier 2 might be better. You can even have both. Choose the option that aligns with your financial needs and liquidity requirements.

Can you change an NPS Tier 1 account into a Tier 2 account?

No, an NPS Tier 1 account cannot be converted into a Tier 2 account. Tier 1 is mandatory for retirement savings, while Tier 2 is optional and can only be opened if you already have an active Tier 1 account.

Is there a way to use both Tier 1 and Tier 2 NPS accounts together?

Yes, investors can maintain both accounts simultaneously. Tier 1 builds a retirement corpus with tax benefits, while Tier 2 offers flexible withdrawals, helping balance long-term retirement planning with short-term liquidity needs.

What tax advantages do investments in NPS Tier 1 offer?

Contributions to NPS Tier 1 qualify for tax deductions under Sections 80C and 80CCD(1B), subject to prescribed limits. Employer contributions may also qualify for additional tax benefits under Section 80CCD(2).

Is it possible to invest in both Tier 1 and Tier 2 accounts at the same time?

Yes, investors can contribute to both accounts simultaneously. However, Tier 1 contributions are mandatory for retirement planning, while Tier 2 contributions remain voluntary and offer greater flexibility in withdrawals.

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