Difference between Tier 1 and Tier 2 in NPS

The National Pension Scheme (NPS) is one of the ideal retirement plans, backed by the Central Government.

From tax exemptions to flexibility regarding deposits and withdrawals, this monetary scheme comes with some salient features. Additionally, it offers two kinds of account preferences, NPS Tier 1 and Tier 2, where both have certain benefits associated with it.

So, if you are wondering which one will be more suitable for you, the following information might help. Give it a read!

As mentioned earlier, Tier 1 and Tier 2 are two types of NPS accounts, having a similar kind of structure. Both the charges and choice of fund schemes are pretty similar; however, having a Tier 1 is mandatory to open an NPS Tier 2 account.

Tier 1 NPS account is primarily meant for retirement savings where you have to make a minimum contribution of ₹500 while opening the account. Under this scheme, you can withdraw up to 60% of the total amount you have accumulated after your retirement.

The remaining 40% of the corpus is utilised to buy annuities to secure a regular monthly income source in the form of a pension.

If you are wondering what Tier 1 and Tier 2 NPS accounts are, here is what the latter one represents.

On the other hand, NPS Tier 2 is an open-access account you can opt for with a minimum investment of ₹1000. The withdrawal process generally takes three days to get funds transferred from the trustee’s bank account to yours. You can either withdraw the entire corpus as a lump sum or go for multiple withdrawals without any limit.

While certain similarities are there in terms of functionality, Tier 1 and Tier NPS differences are apparent.

Now that you know the meaning of Tier 1 and Tier 2 in NPS let’s learn about these differences.

The major difference between Tier 1 and Tier 2 NPS is that for the first one, it is mandatory to pay at least once every year. Such rules do not apply to NPS Tier 2 due to its no lock-in period feature. Hence, account holders have the freedom to skip a year in case they are a little short on cash. Also, you can treat it like a savings account and withdraw funds anytime you want. 

Apart from that, here are some other differences you should be aware of to choose a suitable investment account.

• Eligibility: Any Indian citizen between 18 and 65 years of age can open the Tier 1 account, where the applicant will be given a Permanent Retirement Account Number (PRAN). On the other hand, to be eligible for an NPS Tier 2 account, you must be a member of NPS Tier 1.
• Lock-in Period: In the case of NPS Tier 1, this period lasts till the subscriber is 60 years old. The Tier 2 account does not have any lock-in period, which is why you can withdraw the funds anytime you want.
• Contributions: As mentioned before, the minimum contribution to open a Tier 1 account is ₹500, and ₹1000 for a Tier 2 account. This is one of the major NPS Tier 1 and Tier 2 account differences.
• Tax Benefits on Contribution: This particular parameter plays a key role in understanding NPS Tier 1 and Tier 2 and determining which is better. For NPS Tier 1, a tax deduction of up to ₹1.5 lakhs is available under Sec 80CCD (1) and ₹50,000 under 80CCD (1B). However, such facilities are not available in the case of Tier 2 accounts.
• Taxation on Withdrawal: At maturity, the total amount is tax-exempt for NPS Tier 1 account. On the other hand, if you opt for a Tier 2 account, the entire corpus gets added to the investor’s taxable income and is taxed at the IT slab rate. Thus, an investor can acquire substantial NPS Tier 1 and Tier 2 tax benefits.

Keeping these differences aside, both NPS Tier 1 and Tier 2 possess certain similarities in terms of functionality. For instance, the fund management charges are the same for both these accounts, including the available asset classes (equity, corporate debt, government securities, and alternative investment funds).

Apart from assessing what Tier 1 and Tier 2 accounts are, keeping such differences in mind can help too.

As you can see, both these account types of the National Pension Scheme serve specific purposes. Thus, it is expected that it will benefit you in the long run. While Tier 1 account helps you to accumulate your retirement corpus and lower your tax outgo, Tier 2 works like a savings account, enabling you to meet the investment needs.

So, how will you make a choice? For new investors, it is always better to invest in a Tier 1 NPS account because of its tax benefits, lower risk of volatility with equity, etc.

A substantial retirement corpus and tax-saving come as a huge help when your professional income starts to recede. Here are some benefits you need to know about when investing in this scheme – 

• All NPS Tier 1 subscribers can claim tax deductions of up to ₹1.5 lakhs under Section 80CCE.
• Tier 1 investors are also eligible for an additional deduction of up to ₹50000 under Section 80CCD (1B). Keep in mind that this rebate is over and above the ₹1.5 lakh deduction under Sec 80CCD (1) of the Income Tax Act, 1961.
• In case of partial withdrawals, 25% of the withdrawn amount is exempt from taxes.
• If you choose to invest in an annuity, the entire invested amount is free from taxation. Nevertheless, income from the annuity will draw taxes at applicable rates.
• In case of lump sum withdrawal after attaining 60 years of age, up to 40% of the amount is exempt from taxes. The remaining is used to purchase an annuity whose returns are taxable.

Keep such factors in mind and claim substantial tax discounts while filing your ITR. However, keep in mind that all such benefits are limited to Tier 1 NPS account holders alone.

Both Tier 1 and Tier 2 have their benefits and drawbacks. Thus, an individual must select one after careful consideration.

For instance, Tier 1 accounts are much more rigid, offering fewer opportunities for withdrawal before maturity. Therefore, investors cannot rely on the Tier 1 quantum apart from major emergencies.

Tier 2 accounts do not have similar limitations. Here, a subscriber is free to withdraw the amount prematurely to fund various needs. Thus, Tier 2 account holders can better curtail all financial requirements with this accumulated amount.

On the other hand, Tier 1 account investments lead to significant income tax deductions for the subscriber. Under Section 80CCD (1), you can claim ₹1.5 lakhs as a deduction, along with tax exemption for an additional investment of up to ₹50000. Similar deductions are available on premature withdrawals and annuity purchases.

Tier 2 accounts do not have any tax benefits. This greatly reduces your ability to save on your yearly taxes.

These are some factors that you must consider before choosing between an NPS Tier 1 and a Tier 2 account.

NPS Tier 1 investment is open to all Indian citizens aged between 18 and 65 years. However, to invest in Tier 2 accounts, you would first need to become a Tier 1 subscriber. Besides this, Tier 1 account holders need to invest at least once every year. Tier 2 account holders do not need to invest annually to maintain their investments.

While people generally invest in either a Tier 1 or a Tier 2 account, it is possible to maintain both Tier 1 and Tier 2 investments at the same time. Therefore, a new investor can choose to open a Tier 1 and a Tier 2 account in one go.