NPS Tier 1 vs Tier 2: Difference And Tax Benefits

The National Pension Scheme (NPS) is a government-backed pension scheme which was launched in 2004. Though, initially it was launched only for government employees, it was opened to all in 2009. An investor can contribute into his/her NPS account during his/her employment years and start withdrawing the money once he/she attains the age of 60.There are two types of NPS accounts – Tier 1 and Tier 2. While Tier 1 account is the primary NPS account aimed at creating a retirement corpus, Tier 2 account is more like a voluntarily savings account which offers more flexibility in terms of deposits and withdrawals.

A Tier 1 NPS account is the basic retirement account which is mandatory if you want to avail 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. Upon attaining the age of 60, you’re allowed to withdraw up to 60% of your total accumulated corpus. The remaining 40% of the investment will be used to buy annuities to provide regular pension to you.The contributions of up to Rs. 2 lakhs made towards the NPS account are eligible for tax exemptions under section 80C of The Income Tax Act, 1961.Read also : How To Withdraw Money from NPS Tier 2

A Tier 2 NPS account is a voluntary account which 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.

While Tier 1 and Tier 2 are structurally the same, you can’t avail any tax benefits in Tier 2 NPS. In case you are a new investor, you should consider Tier 2 NPS as an open-ended mutual fund for investing your money. This is because the exposure to equity is limited. It is up to 75%. Thus, Tier 2 NPS can be a good option for you if you are a new investor with a low-risk appetite.

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.

Eligibility Requirement-

Indian citizens between 18 and 65 years of age are allowed to invest in Tier 1 NPS. In case of Tier 2 NPS, only Tier 1 members are allowed to invest in Tier 2 NPS.

Minimum Number of Contributions in a Year-

For Tier 1 investors, the minimum number of contributions in a year is 1. However, Tier 2 investors can opt not to make any investment in a year.

Lock-in Period-

The lock-in period for Tier 1 NPS investors is until the age of 60 years. The lock-in period for Tier 2 NPS investors is nil.

Minimum Number of Annual Contributions-

Tier 1 investors are required to make at least 1 contribution in a year. However, Tier 2 investors aren’t required to make any contribution in a year.

Tax Benefits-

A contribution made towards Tier 1 NPS is eligible for a tax deduction up to Rs. 1.5 Lakh under Section 80C. Furthermore, under Section 80CCD (1B), Tier 1 investors can avail a tax deduction of up to Rs. 50,000.Tier 2 NPS investors can’t avail any tax benefit.

Investment in Tier 1 can help investors lower their tax liability. It also allows them to accumulate funds for life after retirement. In case of Tier 2 NPS, it enables investors to get great returns in the long term.

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

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

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.