NPS Tier 1 vs Tier 2: Differences, Tax Benefits, and How to Choose

• NPS Tier 1 is the retirement-focused account; NPS Tier 2 is an optional investment account available only with an active Tier 1 account.
• Under the new tax regime, personal deductions under Sections 80CCD(1) and 80CCD(1B) (now called Section 124) are unavailable, but eligible employer contributions under Section 80CCD(2) (now called Section 124) remain deductible.
• For non-government all-citizen subscribers, the December 2025 rules permit up to an 80% lump-sum withdrawal at normal exit, but the current tax exemption covers only up to 60% of the corpus.
• NPS Vatsalya now starts at ₹250 and offers an old-regime deduction of up to ₹50,000 under Section 80CCD(1B) (now Section 124(3)), subject to the applicable conditions.

The National Pension Scheme (NPS) is a government-backed pension scheme that was launched in 2004. Though initially it was launched only for government employees, it was opened to all in 2009.

There are two types of NPS accounts: Tier 1 and Tier 2. While a Tier 1 account is the primary NPS account aimed at creating a retirement corpus, a Tier 2 account is more like a voluntarily savings account, which offers more flexibility in terms of deposits and withdrawals. Officially, NPS means the National Pension System. It is regulated by PFRDA, and voluntary enrolment is now open to eligible Indian citizens, NRIs and OCIs from age 18 to 85.

The practical difference is simple: Tier 1 is designed to preserve retirement money and therefore restricts access; Tier 2 lets you invest and withdraw more freely but normally provides no NPS-specific tax deduction.

NPS is a defined-contribution, market-linked pension system supervised by PFRDA. It does not promise a fixed return or a fixed pension; the eventual corpus depends on contributions, investment performance, fees and the payout option selected.

Tier I and Tier II NPS accounts are quite similar to each other in terms of choices of schemes as well as managers and charges. The asset classes that the managers choose are also the same in both cases.

The broad investment building blocks are similar, but limits can differ by account or scheme. PFRDA currently lists ten registered pension funds, and subscribers can select different pension funds and investment choices for Tier 1 and Tier 2.

A Tier 1 NPS account is the basic retirement account, which is mandatory if you want to avail yourself of NPS benefits. Once you open an NPS Tier 1 account, you are allotted a Permanent Retirement Account Number (PRAN), which acts like a unique identification number for your NPS account.

A Tier 1 NPS account can be opened with a minimum investment of Rs. 500. Thereafter, you can invest Rs. 1000 or more every year to create a retirement corpus.

The account is portable across jobs and locations. Because access is restricted, it is better suited to money that you genuinely intend to preserve for retirement.

A Tier 2 NPS account is a voluntary account that you can open only if you have an existing Tier 1 account. As compared to a Tier 1 account, these accounts offer more flexibility in terms of deposits and withdrawals.

You can open a Tier 2 account with a minimum investment of Rs. 1,000. However, unlike a Tier 1 account, it’s not compulsory to invest at least once every year in a Tier 2 account. Also, you can withdraw from this account anytime, just like a normal savings account. The subsequent minimum contribution is ₹250. Tier 2 remains market-linked, so “withdraw anytime” does not mean the value is protected like a bank savings balance.

Also Read: How To Withdraw Money from NPS Tier 2?

Under the old tax regime, an employee’s own Tier 1 contribution may qualify under Section 80CCD(1) (new Section 124), subject to the prescribed percentage of salary and the combined ₹1.5 lakh ceiling. Section 80CCD(1B) (now Section 124(3)) provides an additional NPS deduction of up to ₹50,000. A self-employed individual’s Section 80CCD(1) limit is linked to gross total income.

Under the new tax regime, deductions under Sections 80CCD(1) and 80CCD(1B) are not available. Section 80CCD(2) (now 124), however, remains available for eligible employer contributions. For non-government employees, the permitted percentage is 14% of salary under the new regime and 10% under the old regime; central and state government employees have a 14% ceiling.

This change was announced in the July 2024 Budget and should not be described as a Budget 2025 amendment.

Example: If the eligible salary for this purpose is ₹10 lakh and the employer contributes 14%, ₹1.4 lakh may be deductible. At a 20% marginal rate, the basic tax reduction is ₹28,000 before cess, assuming the full contribution qualifies.

Watch the separate perquisite rule: employer contributions to NPS, a recognised provident fund and an approved superannuation fund are subject to a combined annual threshold of ₹7.5 lakh; excess contributions and prescribed accretion can become taxable.

While Tier 1 and Tier 2 are structurally the same, you can’t avail yourself of any tax benefits in Tier 2 NPS.

• The precise exception is the Tier II Tax Saver Scheme for Central Government NPS subscribers, which carries a 3-year lock-in and old-regime Section 80C (now Section 123) eligibility. Regular Tier 2 contributions do not receive an NPS tax deduction.
• Tier 2 can be useful if you want the NPS fund-management structure without the retirement lock-in. It offers the same broad asset classes and access to PFRDA-registered pension funds, while allowing full or partial withdrawals.
• Costs are low, but “0.01%–0.09% expense ratio” is not an accurate description of the entire cost. PFRDA’s investment management fees for pension funds currently range from 0.03% to 0.09% of assets, and CRA, PoP, or withdrawal charges may also apply.
• Exit requests are processed on a T+2 settlement timeline under the PFRDA circular, subject to authorisation and operational conditions. “T” is the day on which the valid withdrawal request is authorised.
• Do not use Tier 2 as a direct substitute for an emergency savings account or a guaranteed fixed deposit. Its value is market-linked, and a withdrawal can crystallise a loss when markets are down.
• As at 31 March 2025, the available 10-year annualised returns for established Tier I Scheme E pension funds ranged from 11.20% to 14.39%; past returns do not guarantee future performance.

Also Read: NPS vs EPF: Which Option is Better for Retirement Planning?

PFRDA currently recognises four broad asset classes: E for equity and related instruments, C for corporate debt, G for government securities, and A for alternative investments such as REITs and InvITs. Under Active Choice, the current caps are up to 75% in E, 100% in C, 100% in G and 5% in A, with the total allocation capped at 100%.

Under Auto Choice, the allocation changes with age. PFRDA lists LC25 Low, LC50 Moderate, LC75 High and Life Cycle–Aggressive. Up to age 35, LC75 holds 75% equity, LC50 holds 50%, and LC25 holds 25%; the equity share then reduces along the prescribed glide path. The newer life cycle–aggressive option holds 50% equity up to age 50 and reduces thereafter.

A younger investor with a long horizon and high tolerance for market falls may consider a higher equity allocation. Someone close to retirement, dependent on the corpus, or uncomfortable with sharp fluctuations, may prefer a larger C and G allocation.

• Under the updated All Citizen model, the first partial withdrawal becomes available after 3 years. Before age 60, up to 4 withdrawals are allowed with a 4-year interval; after age 60, withdrawals may continue until age 85 with a 3-year interval. Government-sector rules can differ.
• The first withdrawal can be up to 25% of the subscriber’s own contributions, excluding returns. Later withdrawals are calculated on incremental own contributions made after the previous withdrawal, together with any eligible unused portion.
• Current permitted purposes for the All Citizen model are children’s higher education, children’s marriage, one-time purchase or construction of a residential house subject to the ownership condition, medical treatment or hospitalisation of the subscriber or specified family members, disability or incapacitation expenses, and settlement of a qualifying financial obligation to a regulated financial institution against a permitted lien or charge.
• An eligible partial withdrawal of up to 25% of the subscriber’s own contributions is tax-exempt under Section 10(12B).

• There is no single 60% lump-sum plus 40% annuity rule for every subscriber now. For the All Citizen model, normal exit is available after reaching age 60 or completing the scheme’s 15-year vesting period, whichever makes the subscriber eligible under the applicable scheme. The account can continue automatically up to age 85 if the subscriber does not exit.
• At normal exit under the All Citizen model, up to 80% may be taken as a lump sum, and at least 20% must generally purchase an annuity. If the corpus is up to ₹8 lakh, 100% can be taken as a lump sum or through approved periodic options. For a corpus above ₹8 lakh and up to ₹12 lakh, specific lump-sum, systematic unit redemption and annuity choices apply.
• Government-sector normal exit generally retains up to 60% lump sum and at least 40% annuity, with separate small-corpus options.
• Tax point: PFRDA withdrawal permission and income-tax exemption are not the same. Current law exempts lump-sum withdrawal up to 60% of the corpus. For a non-government subscriber taking the full 80% now permitted, the additional 20% is taxable at the applicable slab rate; annuity income is taxable when received.
• Annuity choices commonly include a life-only pension, a joint-life pension with spouse, and options with return of purchase price. Compare the current quotations, payout frequency, nominee treatment and liquidity restrictions across PFRDA-empanelled annuity service providers before making an irreversible selection.

NPS Vatsalya, launched in September 2024, allows a parent or legal guardian to open an account in the name of an Indian minor, including an eligible NRI or OCI minor. The guardian operates the account for the child’s exclusive benefit.

• The updated minimum is ₹250 to open and ₹250 a year, with no stated maximum contribution. This replaces the earlier ₹1,000 annual figure in the supplied recommendation.
• At age 18, the child does not simply have one automatic outcome. After KYC, the subscriber may continue in NPS Vatsalya up to age 21, shift the corpus to an applicable regular NPS model, or exit under the prescribed corpus-based rules.
• The tax position also changed after launch. Under the old regime, a parent or guardian may claim up to ₹50,000 for qualifying NPS Vatsalya contributions; no contribution deduction is available under the new regime.

Tier 1 NPS can help you build your retirement corpus, and Tier 2 NPS can provide you with decent returns. Hence, you need to choose based on your investment objective.

• Choose Tier 1 for money intended for retirement, especially when you can use a valid old-regime personal deduction or an employer contribution. Choose Tier 2 only after Tier 1 is active and when you want a low-cost, market-linked investment account with flexible withdrawals and no general tax deduction.
• For many salaried people in the new regime, the first action is to ask payroll whether employer NPS contributions are offered. That benefit can reduce taxable salary without requiring the employee to claim deductions.

You can open Tier 1 through a PFRDA-registered Point of Presence in physical or online mode, or through the eNPS platform linked by PFRDA. Resident applicants generally need a photograph, PAN and proof of address; the portal or PoP will also complete KYC and request bank and contact details needed for the account.

• Visit the eNPS link provided on the official PFRDA/NPS Trust page or use a registered PoP.
• Complete registration and KYC using the accepted identity and address documents.
• Choose the pension fund, investment option and asset allocation that suit your risk level.
• Make the required opening contribution. Your Permanent Retirement Account Number, or PRAN, is then generated through the CRA process.
• After Tier 1 becomes active, log in and activate Tier 2 if you need it. Tier 2 cannot be opened as a stand-alone account.

Also Read: How to Open NPS Account: A Step By Step Guide?

Though the functionality of both Tier 1 and Tier 2 NPS accounts is similar, they differ from each other in terms of flexibility and the tax benefits they offer to the investors. However, to open a Tier 2 account, you need to mandatorily have a Tier 1 account.

The choice is therefore not “Tier 1 versus Tier 2” in isolation. Tier 1 is the foundation and retirement account; Tier 2 is an optional add-on for flexible investing. Before acting, check your tax regime, employer policy, subscriber sector and the current PFRDA exit rules because each can change the result.